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Auditor liability – international developments

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First principles - the exposure of the auditor The audit gives en entity’s owners an expert, independent opinion on whether the financial statements comply with accounts preparation rules (the true and fair standard in EU terms)

An auditor can be sued by (among others)

- The entity’s management- Persons who buy shares in the entity - Third parties- The entity’s new owners- The entity’s liquidator

Under joint and several liability rules, the auditor can be made to assume full responsibility for loss, even where others are also negligent

Approaches to limiting auditor’s exposure (1) – limited liability structures

Audit firms may be allowed to organise themselves in limited liability structures- these may either be commercial limited companies or specially-devised vehicles such as the ‘limited liability parttnership’

Where auditors practise in such formats, the debts and liabilities of the firm belong to the firm and individual partners bear no personal responsibility for them

This approach protects the personal assets of partners but does not protect the firm from a huge claim

Approaches to limiting auditor’s exposure (2) – liability caps

The law in some countries specifies a maximum amount for which auditors may be sued in the case of their negligence

In the EU, such caps exist in Germany, Austria, Greece, Belgium and Slovenia

Such caps may not protect the auditor in the case of fraud or intentional damage

The law will also address whether the cap applies to actions by third parties as well as the audited entity

Approaches to limiting auditor’s exposure (3) – proportionate liability

Legal reforms have taken place in the USA and Australia, with effect that damages for economic loss should be allocated in accordance with courts’ determination of wrongdoers’ relative responsibility for the cause of the loss

Approaches to limiting auditor’s exposure (4) – the UK reform

The UK now allows individual companies and their auditors to enter into ‘liability limitation agreements’ whereby the liability of the auditor to the company is limited on some agreed basis

No restriction on how liability is to be limited BUTthe basis must be ‘fair and reasonable’ bearing in mind

- the auditor’s statutory responsibilities - the auditor’s contractual obligations - the auditor’s professional obligations The company’s shareholders must approve any such agreement for it to be valid

The EU initiative on auditor liability The issue has become politicised following Enron et al

The revised statutory directive called on EC to carry out study of EU’s audit liability regimes

This study has been followed by consultation exercise, offering four possible bases for reform:

- One single monetary cap

- A variable monetary cap

- Limitation by reference to the audit fee

-- Proportionate liability

Arguments in favour of

reform

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The markets need an adequate suppply of qualified and experienced auditors - we cannot risk another big firm collapse

We must address the issue of competition – markets where liability is limited show that it is possible for mid-tier firms to compete for listed company business

Active threat of litigation drives up insurance costs

Audit profession now much more regulated

Joint and several liability is a disproportionate sanction

Concluding arguments

Exposure to liability for negligent work remains a driver of quality

Shareholders need to have rights against a negligent auditor

Any reform needs to safeguard audit quality

Auditors should not be guarantor of shareholder losses

Any reformed basis of auditor liability should strike better balance and reflect real nature of audit function and relationship between auditor and stakeholders

Thank you

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