EU Commission consults on possible reform of auditor liability rules in the EU

Thursday, 18th January, 2007: The European Commission has today launched a public consultation on whether there is a need to reform rules on auditors’ liability in the EU and on possible ways forward. This follows the commissioning of an independent study on the economic impact of current auditors’ liability regimes and on insurance conditions in Member States which identified, inter alia, four key issues, viz:

1. the international market for statutory audits of large and very large companies is highly concentrated and dominated by the Big-4 networks (Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers). The likelihood of new entrants into this market is very limited in the coming years. Additionally, under the current circumstances, middle-tier firms are unlikely to become a major alternative if a Big-4 network fails;
2. the level of auditor liability insurance available for higher limits has fallen sharply in recent years. The remaining source of funds to face claims may essentially be the income of partners belonging to the same international network. Constantly large claims might, therefore, put at risk an entire network;
3. the failure of a network could lead to difficult consequences for the wider economy – like a significant reduction in large company statutory audit capacity possibly creating serious problems for companies whose financial statements need to be audited; and
4. a limitation on auditor liability would reduce this risk. While there exist a number of variants of statutory audit liability limitation, the diversity of circumstances in terms of both audits and company size is such that it is unlikely that a ‘one-size-fits-all’ EU-wide approach is the most useful.

Arising from the foregoing, the Commission has presented four possible options for reforming auditors’ liability regimes in the EU, viz:

• the introduction of a fixed monetary cap at European level;
• the introduction of a cap based on the size of the audited company, as measured by its market capitalisation;
• the introduction of a cap based on a multiple of audit fees charged by auditors to their clients; and
• the introduction by Member States of the principle of proportionate liability, whereby each party (i.e. auditor and client entity) would be liable only for the portion of any loss that corresponded to the relevant party’s degree of responsibility,