Support Growing in EU for Limiting Auditor Liability

There is growing support in the EU for limiting auditor liability, according to a consultation conducted by the European Commission. The audit firms favor a cap on liability, while others urged the Commission to implement proportionate liability. Some respondents to the consultation suggested that the Commission adopt a more holistic approach where action on auditor liability might take place in the context of a broader package of reforms designed to increase competition and choice in the audit market.

But regardless of what form of limitation is adopted, there is agreement that member states should be given maximum flexibility to adopt the limitation that suits their national needs. Importantly, CESR does not favor reform of auditor liability at the EU level. Moreover, CESR sees no clear link between auditor liability and the concentration of audit firms.

Respondents to the consultation were divided between those who consider that a reform on auditors' liability could protect against catastrophic losses, and those who reject the idea that catastrophic losses represent a real risk that should be addressed. But the majority recognizes that the lack of choice in the audit market could jeopardize the efficiency of financial markets and that comprehensive action to reduce barriers of entry to this market should be taken. However, not all agreed that limiting auditors' liability would be an appropriate means to address the issue.

Investors do not think that the case for reform at the EU level has been made. They see no evidence of potential catastrophic claims that could bring down a network. Although generally opposed to reform, they consider that proportionate liability is the least problematic option.

The corporate community is divided on the question of auditor liability limitation. Those who are opposed consider that there is not sufficient evidence of a major threat to the public interest in the EU. Similar to the banks, they believe that the failure of a network appears to be linked essentially to a reputation risk, and not to financial liability.

For their part, banking and securities regulators believe that there is no convincing evidence that EU audit firms have left or are considering leaving the audit market as a result of liability problems. Further, there is no evidence that limiting auditor liability will help mid-tier audit firms become significant players in the international audit market. The main barriers to entry are perceived to be the reputation of the audit firm and the investment needed to enter such a market.

The Big Four audit firms favor a limitation of auditor liability using a combination of proportionality and absolute cap. Specifically, the Big Four seek a system of multiple caps that would vary depending on the characteristics of the audited company.

The mid-tier audit firms generally favor proportionate liability as an appropriate reform of auditor liability. In their view, the UK experience indicates that introducing proportionate liability by having it enshrined in statute would be preferable.