An audit cap: it's a resigning matter.

The threat was bold and scary, but was it a little bit hollow? When the Big Four made it clear two weeks ago they might resign the audits of big banks or insurance companies if they didn’t get protection in the form of some sort of audit cap, there were some who laughed it off as posturing.

Since the threat was issued there has been serious discussion about whether it could happen. Managers and partners in the larger firms have concluded that though it may have been unthinkable a year ago, the odds have increased in favour of such a cataclysmic event.

If it did happen, it would shock the City and attract a storm of criticism, but it would also send an emphatic point to government that auditors bear a huge risk when undertaking the audits of large financial companies.

But could they really go on the offensive? It’s worth speculating on what the conditions would need to be for such an event to take place.

First, could one firm do it in isolation? The answer is probably not. A single firm could give up a big audit but it would be worthless if another of the Big Four stepped into the breach. The other three would need to stand off. If they did, however, they would clearly raise suspicions of coordination and possibly prompt accusations that they were attempting to run a cartel.

And what about the client? Surely the client would have to be in on the plot. To persuade a client of the need to lose their auditor, for the auditor’s sake, and then take on a non Big Four firm in their place, for the plot to work, would be no small achievement.

To really have an impact it would have to be a FTSE100 client with the kind of risky magnitude the Big Four are clearly worried about. Remember, Equitable’s claim against Ernst & Young, still to reach court, is £2.6bn, while the largest of the Big Four turns over £1.5bn. So, we’re talking Lloyds TSB, Royal & Sun Alliance or HBOS territory. Could a Big Four firm here turn their back on a client like that?

If they did, one possible outcome is a collision of interests between the UK office and the partners in offices abroad. The London office may feel they need more protection, but to offload a client that would deprive partners of work in Paris or Hong Kong could lead to internal strife.

And the problems for the client only start there. Finding another auditor in the UK could prove nigh on impossible. There’s not only the risk to think about but whether a large firm, a Grant Thornton, or BDO Stoy Hayward could do the work.

Firms up at this level have spent many years structuring their businesses to deal with clients of an entirely different and much smaller nature.

A week ago Peter Wyman, head of professional affairs at PricewaterhouseCoopers, said: ‘If we can’t limit liability or get insurance then we have to manage risk in any other way we can by removing ourselves from high-risk audits.’

Wyman is likely to have been sincere about his comments. But he will also be fully aware of the implications of such a decision. Saying you could do something is an awful lot easier than doing the deed itself.

MAKING A CAP THAT FITS
While the DTI may have killed off the prospect of a liability cap, all is not lost for auditors. Even before the government mentioned the potential of a cap being introduced into legislation, the profession had long been advocating the need for a system of proportionate liability to replace the joint and several system that currently exists.

Following the collapse of Andersen and the drawing up of the companies bill, it was felt that something needed to be urgently done to protect another Big Four firm from collapsing. Since the government had not been prepared to look at proportionate liability, the accounting world was happy to accept a compromise of a cap.

While Patricia Hewitt’s announcement of a consultation was widely welcomed in accounting circles, others had more severe doubts, especially among the investor community. Already upset at what they saw as a gradual erosion of audit quality due to the use of audit tendering as a loss leader, it was believed that the potential introduction of a cap would give even less incentive to provide high-quality audit work.

When the DTI referred the issue to the Office of Fair Trading, it’s quickly turned-around report seemed to agree with everything the investors had complained about.

It seems the DTI, under pressure from the Treasury, had to accept the word of the report, despite claims from accountants that it was factually incorrect. But the death of cap brought hopes fresh life to the push for proportionate liability.

This may take more time to emerge but will be more widely accepted. It just remains for the Big Four to avoid any more dangerous situations in the mean time.