April 22, 2008

Auditor Liability Caps: Now Available in the UK

A persistent issue for auditors, public companies and their regulators in the wake of the 2002 collapse of Arthur Andersen is how do we prevent the Big 4 from becoming the Big 3 due to a catastrophic liability event? For some time now, auditors have called for the imposition of liability caps, and that approach has been debated by policymakers examining the issue. For instance, in 2006, the Treasury Department’s Committee on Capital Markets Regulation considered whether Congress should look into the possibility of protecting audit firms from catastrophic loss, either by creating a safe harbor for specified auditing practices or by setting a cap on auditor liability in some circumstances. Currently, the Treasury Department’s Advisory Committee on the Auditing Profession is considering the impact of auditor liability on the profession and whether any potential changes should be made to auditor liability regimes, with recommendations expected this summer. The European Union has also been studying the issue of auditor liability, and practices vary considerably among EU member states.

While the question of auditory liability protection is debated in the US and the EU, the UK has recently moved forward with changes to the Companies Act that permit auditor liability limitation agreements. As noted in this memo from Edwards Angell Palmer & Dodge, provisions effective earlier this month now permit auditors to enter into agreements with their clients that cap the auditor’s liability exposure to the company, so long as (1) the agreement does not limit the auditor’s liability to less than a “fair and reasonable” amount, and (2) the agreement is approved by the company’s shareholders. Under proposed guidance from the UK’s audit oversight body – the Financial Reporting Council – these types of agreements could be for a fixed limit based on a specified amount or formula, a proportionate share based on the auditor’s responsibility for a loss, or a mix of fixed and proportionate caps. The agreements may only cover one fiscal year, so they would be subject to shareholder approval on an annual basis.

While the UK approach is certainly interesting, I don’t think that it is likely to change the direction of the debate in the US. The first quarter of 2008 has come and gone without the roundtable on securities litigation reform that the SEC promised last summer, and it seems unlikely in the near term – particularly considering the ongoing sub-prime crisis and election year politics – that the issue will be taken up by Congress or the SEC.

Halloran to Leave the SEC

Yesterday, the SEC announced that Chairman Cox’s Deputy Chief of Staff and Counselor Mike Halloran will be leaving the SEC in May to return to private practice. Mike has had quite a bit of influence on the regulatory agenda at the SEC over the last one and a half years, perhaps most notably on the Commission’s and the PCAOB’s efforts to revisit the implementation of Section 404 of the Sarbanes-Oxley Act.

New 3rd Edition: Romeo & Dye Treatise

Peter Romeo and Alan Dye just wrapped up the 3rd Edition of their “Section 16 Treatise” and we have been mailing this two-volume set with thousands of pages to the many of you that ordered it. For me, it felt kind of like Christmas in April when a copy of the Treatise arrived at my door yesterday!

If you didn’t order this essential body of work, you can still have it rushed to you – try a no-risk trial to the Treatise today.

– Dave Lynn