EU Seeks to Limit Auditor Liability to Boost Sector, Attract Insurance

June 6, 2008

European Union countries should limit the civil liability of auditors in order to encourage new firms to enter a sector now dominated by four firms and in this way protect European capital markets, the EU executive arm said.

The European Commission said it had issued a recommendation to the bloc’s 27 members asking them to decide on the method for limiting auditors’ liability in response to an increasing trend to litigation and lack of sufficient insurance in the sector.

“We have concluded that unlimited liability combined with insufficient insurance cover is no longer tenable,” EU Internal Market Commissioner Charlie McCreevy said in a statement on Friday.

“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,” he said.

“In a context of high concentration and limited choice of audit firms, this situation could lead to damaging consequences for European capital markets,” he added.

The Commission recommendation presented a set of key principles to ensure that any limitation is fair for auditors, the audited companies and investors.

It said the limitation of liability should not apply in the case of intentional misconduct on the part of the auditor, would be inefficient if it did not also cover third parties and that damaged parties had the right to be compensated.

Until 1989 there were eight large international auditing firms — Arthur Andersen, Arthur Young & Company, Coopers & Lybrand, Ernst & Whinney, Deloitte Haskins & Sells, Peat Marwick Mitchell, Price Waterhouse and Touche Ross.

But after a series of mergers and an accounting scandal involving Arthur Andersen in the wake of the collapse of the U.S. energy trader Enron there are now only four — PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG.

“If these structural obstacles — liability risks and the lack of insurance — persist, mid-tier audit firms are unlikely to become a major alternative to the “Big 4″ audit networks on European capital markets,” the Commission said.

“But there is also a risk of losing some of the existing players. One of the reasons might be that catastrophic claims cause the collapse of one of the major audit networks,” it said.

(Reporting by Jan Strupczewski; Editing by Quentin Bryar)

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