An insurance leader has warned a Europe-wide auditor liability
cap will not lead to cheaper insurance for firms and could weaken
the credibility of audit reports in the case of litigation. The EC
last month fanned the auditor liability debate by recommending
member states consider adopting up to three proposed models to cap

Introducing the recommendation, Internal Market and Services
commissioner Charlie McCreevy said the EC concluded unlimited
liability combined with “insufficient” insurance cover is no longer

“It is a potentially huge problem for our capital markets and
for auditors working on an international scale. The current
conditions are not only preventing the entry of new players in the
international audit market, but are also threatening existing
firms. In a context of high concentration and limited choice of
audit firms, this situation could lead to damaging consequences for
European capital markets,” he said.

Artificial imbalance

But the recommendation, which was largely welcomed by the
accounting profession, has come under attack by the European
insurance and reinsurance federation (Comité Européen des
Assurances – CEA). Federation vice-president Gérard de la
Martinière told The Accountant liability caps would create
an artificial imbalance between the liability of auditors and
unlimited liability of management.

de la Martinière said he has seen no evidence of a lack of
insurance coverage for audit firms, and believes auditors: “do not
like to pay too much to get this coverage [but] claim that they
need a cap to limit their spending”.

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However, David Radley-Searle, a partner and director of the
International Business Centre at Spanish firm Grant Thornton
Audihispana, said there is ample evidence insurance premiums have
risen in recent years and limiting liability should provide some
relief on the cost of coverage.

“We have seen now clear signals in Spain that a limitation of
liability would give rise in the short-time to lower premiums or
better thought out insurance cover,” he said. “The market force is
at play here and at the end of the day if insurance people realise
that their risk is lowered due to [less] collateral risk [for] class actions or third parties, because the auditor is going to be
liable for his or her actions, then it should lead to cheaper

He suggested liability caps could even benefit the insurance
industry by allowing more players to enter the audit firm market.
Radley-Searle said limiting liability would benefit the mid-tier to
a degree, as unlimited liability is a market entry barrier when
pitching to larger quoted companies, but it would not influence the
type of work or strategy firms pursue.

Out of the three models presented by the EC – applying a
liability cap, introducing proportionate liability or allowing
liability to be limited by contract – the Grant Thornton member
firm prefers a model of proportionate liability where any damages
should be proportional to the damage that has been caused.

de la Martinière admits steps should be taken to restrict the
liability placed on auditors, which has spiralled out of control in
recent years as regulators have imposed more rules and
responsibilities on auditors in the wake of corporate failures such
as Enron.

He is calling for an international approach to liability reform
and believes legislators need to revise the scope of the auditor’s
role and strip back certain functions and responsibilities.

However, he says there could be professional resistance to
reducing the responsibility of the auditor’s role because expanding
it “meant more fees, but on the other hand they do not like the
liability which is associated to this extension of their

Choosing the right model

The European Commission has proposed member states follow one or
more of the following methods:

(a) establishment of a maximum financial amount or of a formula
allowing for the calculation of such an amount;

(b) establishment of a set of principles by virtue of which a
statutory auditor or an audit firm is not liable beyond its actual
contribution to the loss suffered by a claimant and is accordingly
not jointly and severally liable with other wrongdoers;

(c) provision allowing any company to be audited and the
statutory auditor or audit firm to determine a limitation of
liability in an agreement. <

Source: European Commission