February 1, 2006

More on Auditor Engagement Letters and Limits on Liability

It could be just a rumor, but I am hearing that PricewaterhouseCoopers has broken from the Big 4 pack and is not demanding liability limits like their brethren. In our “Auditor Engagement Letters” Practice Area, we have posted a recent letter from the Investment Company Institute urging the AICPA to take a position on auditor indemnification that conforms to the SEC’s position and recommending that the SEC require that companies disclose any contractual provisions with their auditors that limit liability. The SEC’s position is embedded in Section 602.02.f.i of the SEC’s Financial Reporting Policies (which is the SEC’s guideline that prohibits companies from indemnifying their auditors – and which was reaffirmed in late ’04 as the SEC’s position in FAQ #4 of “Other Matters” as part of the SEC’s Auditor Independence FAQs).

Following up on my blog about the PCAOB’s Standing Advisory Group’s upcoming consideration of this issue, consider this useful background from Jack Ciesielski’s AAO Weblog:

“Last June, the Federal Financial Institutions Examination Council came out strongly against practically any kind of limitation on auditor responsibility through engagement letters. Their hard-line comment document is still a work in progress; no formal policy has been issued yet. When they do, it’ll affect firms that report under the auspices of the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS).

While it’s not a regulator, the Professional Ethics Executive Committee of the American Institute of CPAs also exposed a comment document regarding liability caps; in fact, they’re debating the comments received on it this afternoon and deciding to issue a decision. As you can see from the PCAOB’s backgrounder, they examined the same kinds of liability limitations as the FFIEC. With regard to many of the kinds of limitations, the two bodies were in surprising agreement. (For instance, both agreed that auditor indemnification against claims based on the audit client’s negligence would not be a good thing for auditor independence.) In other areas, the AICPA was more favorably disposed to allowing limitations while the FFIEC was not. (Example: clauses that limited punitive damages were okay with the AICPA, but not the FFIEC.)(more).”

Don’t forget to take our new survey on auditor inspection reports and engagement letters.

Ask Your Auditor about its PCAOB Inspection Report

Here is another topic that I have been blogging about for a while: how companies should endeavor to get as much information as they can from their independent auditors regarding the inspection reports issued by the PCAOB. As you might recall, companies have no right to receive the non-public sections of these reports from the PCAOB – but auditors are permitted to voluntarily share them with their clients (which has now been confirmed by the PCAOB numerous times).

At a minimum, I believe that companies should be asking auditors the following questions:

1. Do you believe that any of the issues raised in the non-public portions of the inspection report will affect our audit?

2. Can you describe generally the types of quality control criticisms contained in the non-public portions of the report?

Please let me know if there are other questions you think companies should ask – and whether your auditor was willing to respond to these questions. And don’t forget to take our new survey on auditor inspection reports and engagement letters.

Underwriting Agreements and Legal Opinions After the ’33 Act Reform

I have received some provocative questions for tomorrow’s webcast panel – “Underwriting Agreements and Legal Opinions After the ’33 Act Reform.” With ’33 Act reform still in its infancy, many are looking to Wall Street lawyers and bankers to see what procedures and practices are developing. Come find out from our expert panel!

February Issue of E-Minders is Posted!

We have posted our latest issue of E-Minders.

Disclosure of Shares Pledged as Collateral

Today’s WSJ carries this interesting article about the SEC’s proposal that would require companies to disclose any pledges of stock by named executive officers and directors. Ron Mueller notes that in his experience roughly 10% of companies now prohibit or limit the extent to which executive officers can pledge – but the remaining question is how many officers and directors actually pledge at all?

I don’t think there is any way to know how many officers pledge shares. The only situations that the lawyers hear about are those in which problems ensue (e.g., when the brokers call the shares to satisfy the pledge arrangement).