Center for Audit Quality Pushes Treasury's Levitt Committee on Audit Profession to Limit Auditor Liability

In a comment letter to the Levitt Committee on the Auditing Profession, the Center for Audit Quality said that the committee’s second draft report still did not address the catastrophic litigation threat that, in CAQ’s view, is the single greatest threat to the auditing profession’s sustainability. While agreeing with the committee’s recommendation that the PCAOB should monitor potential sources of catastrophic risk that would threaten audit quality, CAQ believes that the committee’s implication that auditing firm conduct is the sole cause of increased catastrophic risk is misleading. The threat of catastrophic loss primarily comes from factors other than audit firm conduct, posited CAQ, and it is those other factors, largely found in the litigation environment, that the PCAOB should monitor.

Treasury established the advisory committee to examine the sustainability of a strong and vibrant auditing profession. It is co-chaired by former SEC Chair Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen. Other members of the committee include former SEC Corporation Finance Director Alan Beller and former Fed Chair Paul Volcker.

The center supports the committee’s recommendation that the PCAOB require that, beginning in 2011, the larger auditing firms file with the Board on a confidential basis audited financial statements. The center agreed with the conclusion that public dissemination of the firms’ financial statements should not be required. The PCAOB should determine the nature and form of audit firm financial and risk information that would be important for them to assess audit firm stability and sustainability, and that information should be treated as confidential under Section 105 of the Sarbanes-Oxley Act.

While the report characterized the serious litigation risk facing audit firms as real and discussed past catastrophic litigation, noted the center, it did not contain even limited litigation reforms such as exclusive federal jurisdiction and a uniform standard of care. Even more, the committee did not consider any of the measures proposed by the CAQ in a June letter, including a revised Rule 10b-5 and caps on liability for audit firms.

The center urged the committee not to be lulled into inaction by arguments that link high audit quality to auditor liability. To suggest that auditors will not perform well unless faced with unlimited liability is a totally unsupported assertion, emphasized CAQ, which does a disservice to the audit profession and investors. In CAQ’s view, appropriately measured liability and robust regulation, combined with clear professional standards, are strong motivators of audit quality. Indeed, continued CAQ, extreme disproportionate liability threats can lead to over-auditing and inefficiently cautious behavior, as well as hurting the profession’s ability to attract new talent.

While acknowledging that independent auditors should be exposed to both the legal and economic consequences of failure and that potential liability can provide incentives for more careful audits, the center said that the extraordinary growth in auditor liability reflects audit client capitalization, not auditor misconduct. In this regard, the center cited a written submission of Kathryn A. Oberly, Americas Vice Chair and General Counsel, Ernst & Young LLP, on June 3, 2008, which noted that the size of the damages being claimed has grown substantially, in tandem with the growth in market capitalization of the firms’ audit clients.