Auditors face confusion as liability dust refuses to settle

When will the dust settle on the auditor liability issue? On the one hand, we
have ongoing negotiations in the UK around how exactly the proportionate
liability clause should be implemented. On the other, the EU is discussing
further legislation that could render UK liability debates redundant.

UK: further rows

The UK introduced proportionate liability in the 2006 Companies Act. The next
step for auditors and for companies is to negotiate among themselves what
proportion of liability the auditors are prepared, or indeed, ought to take.

That will hardly be an easy process. Some firms have apparently begun early
consultations with lawyers as to the re-negotiations of their contracts. But
what will be an acceptable level of liability?

Is it as simple as saying that a firm can only be held liable for a certain
percentage of liability? What kind of liability, many will wonder, and what kind
of mistake by an auditor would lead to the clause being invoked?

This has led to senior figures highlighting how insufficient the protective
clause is since it is unclear as to how exactly the ‘proportional liability’
should be interpreted.

The confusing scenario that may eventuate is one in which each party –
ranging from engagement partners, to clients, audit committees and investors –
would take legal counsel on the Act, and solicitors would no doubt find the
‘best’ interpretation for each respective party.

In absolute absence of any further central guidance, it could all end up as a
lawyer’s paradise, rather than as a protective mechanism.

Some have foreseen the potential chaos and have already approached the
Financial Reporting Council to ask it to revisit this issue ahead of AGM season
next year when things could become a bit messy.

The regulator is understood to have agreed, in principle, to look into the
issue, to come up with wording that would set a common benchmark which everyone
can use to re-negotiate their contracts. This cannot happen too soon, as the act
is set to be effected next year.

EC: new debate

At the same time as those negotiations, the European Commission is consulting
on the issue of liability as well, with its consultation document issued last
month calling for further acceptance or rejection of proposals by 15 March to
look at how best to deal with the liability issue.

Such a move could render UK law redundant. The report proposed the
introduction of a fixed monetary cap at European level, but this might be
difficult to achieve; the introduction of a cap based on the size of the audited
company, as measured by its market capitalisation; the introduction of a cap
based on a multiple of the audit fees charged by the auditor to its client; and
the introduction by member states of the principle of proportionate liability,
which means that each party (auditor and audited company) is liable only for the
portion of loss that corresponds to the party’s degree of responsibility.

The problem with this – and there can be little doubt that the EC’s Internal
Markets Commissioner, Charlie McCreevy, is unaware of it – is that, in some
respects, this is all following on the heels of a debate that the UK has already
had, with even the law already inclusive of the solution. The solution however,
being particular to the UK, in the form of proportionate liability.

What this could actually mean is that the EC could separately throw all this
out of the window and opt for caps for everyone across the continent, despite
McCreevy’s best intentions to not apply a ‘one-size-fits-all’ approach.


Auditors could be forgiven for being a bit exhausted by the argument.
Investors sometimes get hot under the collar about it all.

One senior investor said it was a shame that the London Economics study
(auditor liability study) deliberately ignored the arguments and offers of
evidence about the risks of rushing to dish out further liability reforms in

‘The only thing that seems to matter in this debate is that no matter how bad
their practices have become, no Big Four firm can be allowed to fail,’ the
source said.

The audit industry is facing a large number of uncertainties at the moment,
not least of which is the issue of whether or not there will be any regulatory
intervention owing to the perceived lack of choice in the market for companies.

Couple that with standards changes and convergence, auditors could be
forgiven for wanting a bit of certainty in what they do.

On liability, an issue about which they’ve personally been at pains to lobby
for over the years, the final conclusion does not appear to be imminent.

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