Auditor liability issue must be tackled

ADDRESSING A recent meeting of the House of Commons’ treasury committee convened to consider the roles of various stakeholders in the current credit crisis, the chief executive of the British Financial Reporting Council, Paul Boyle, said the value of an audit could only be measured against an environment where audits, or audit services, did not exist. The difference, in his view, is considerable.

The same committee drew attention to what is often referred to as the “audit expectation” gap – the nature and purpose of a statutory audit of financial statements and what it actually delivers compared to the expectations of different stakeholders.

Much of the recent commentary around audit is informed by this expectation gap, but it is not the only area of misunderstanding surround the audit services market. It is popular to conceive of an audit market populated by large multinational firms as being robust and permanent.

This ignores the rate of change in the market – we used to talk about the Big 8, not the Big 4. Could one of these firms fail, thereby reducing choice in the market further? If so, what would the impact be on the capital markets? The answers to these questions are yes and considerable.

Yet this is the very real scenario that currently confronts capital markets.

The recently published 2007 Report of the Company Law Review Group (CLRG) has once again raised reform of Ireland’s existing auditor liability regime as a vital issue of public policy in need of urgent attention. And while this may be a difficult time to address this issue, it is one that will not go away.

The issue addressed by the CLRG is essentially about preserving the continuity of supply of audit services in this State, particularly in the capital markets sector. It is a local manifestation of a global issue but one which is particularly acute in this State.

It is not about individual auditors or audit firms. Auditors should be accountable for their own actions.

As things stand in Ireland, the prohibition in company law on limitation of auditor liability, combined with the legal principle of joint and several liability, ensures that auditors are liable not only for losses caused by their own actions or failures but also for those who may have primary responsibility for such losses.

Audit firms are thus exposed to the threat of catastrophic loss, notwithstanding that most partners in those firms are likely to have had no involvement or culpability in the matter in question. The firms are often not in a position to insure themselves against their potential loss.

Perhaps now more than ever, in the absence of meaningful reform in this area, there exists a very real threat of the failure of another major audit firm.

The failure of a major audit firm would be extremely problematic for the world capital markets as the path to economic recovery is sought.

In the case of Ireland, it would leave the audit market in turmoil and would raise serious questions about its ability to support the significant economic investment from abroad which has been identified as a key component to regaining economic prosperity.

The CLRG has accepted that it is “in the interests of investment and enterprise in Ireland that competition and the continuity of supply of audit services is safeguarded”.

It has therefore rightly recommended that the current regime must be reformed. Perhaps most importantly, the CLRG cites the views on this issue of the Irish Auditing and Accounting Supervisory Authority (IAASA), the statutory body charged with oversight of the audit profession.

IAASA agrees that the current regime is inherently “unjust and inequitable” and concurs with the CLRG recommendation that reform is “merited”.

In all other EU jurisdictions, some form of liability limitation is possible, some more effective than others at preventing catastrophic loss. Ireland’s regime is the most severe in Europe.

Following an extensive and in-depth study into auditor liability, in June 2008, the European Commission published a formal recommendation to EU member states on “the limitation of civil liability of statutory auditors and audit firms”.

Highlighting the risks associated with a failure to address this matter urgently, the commission expects progress reports from member states on reforms implemented by mid-2010. Action on this issue is needed immediately.

Aidan Lambe is director of technical policy at the Institute of Chartered Accountants in Ireland