By James Hamilton, J.D., LL.M.
The European Commission is the latest body or group to call for a cap on auditor liability. The Commission has proposed four possible options for reforming auditor liability regimes in the EU. This action follows an independent study on the economic impact of current auditors' liability regimes issued last year. A conundrum has arisen under which the increasing risks of auditing large public companies has been accompanied by a sharp decrease in access to insurance for auditors of international and listed companies, thus leaving partners in audit firms with the unattractive prospect of entirely supporting the liability risks themselves.
Here are the four options. First, a fixed monetary cap could be implemented at the EU level, but this might be difficult to achieve. Second, there could be a cap based on the size of the audited company, as measured by its market capitalization. Third, liability could be capped based on a multiple of the audit fees charged by the auditor to its client company. The fourth option is 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.
Currently, a small number of EU members, including Germany, have a statutory limitation on auditor liability; and in the U.K. a bill currently reviewed by Parliament foresees proportional liability by contract.
A debate about possible reform of auditor liability is also underway in the United States. In late 2006, the Committee on Capital Markets Regulation set up by the US Treasury considered whether Congress should be invited to explore further protecting audit firms from catastrophic loss. Two approaches have been suggested: either creating a safe harbor for certain defined auditing practices or setting a cap on auditor liability in specified circumstances.