Auditors' liability - the great debate begins

The financial scandals of Enron and WorldCom in the US, and now Parmalat in Europe, have further fuelled the debate on the role of auditors and their potential liabilities. Regulators and fund managers have lined up on one side to insist on a clear divide between auditors and their clients to ensure impartiality, while on the opposite side the accountancy profession says that auditors are facing unlimited potential liabilities caused by directors' negligence or fraud, which is ultimately contrary to public interest. Now, in the UK, both sides can voice their views following the launch of the Department of Trade and Industry consultation paper on directors' and auditors' liability.

The DTI consultation paper reveals clues on its line of thinking in relation to possible reform of auditors' liability. It leans fairly heavily on the recent Company Law Review and on the conclusions of the European Commissioner for the single market, Frits Bolkestein, that the EU will refrain from interfering in member states' jurisdictions on this issue. It also makes clear that the DTI will need considerable persuasion that any extension of the duty of care owed by auditors to third parties should be laid down by statute.

Accountancy's 'Big Four' - Ernst & Young, KPMG, PricewaterhouseCoopers and Deloitte & Touche - have lobbied for the introduction of proportionate liability for auditors, which is quite understandable, as they are often seen as the only deep-pocketed defendants. But the DTI has virtually dismissed this possibility.

The debate appears to rest mainly on the extent to which s 310 of the Companies Act 1985 will be amended to allow auditors to limit their liability.

If limited liability were permitted, the likely options would be either to let individual companies agree limitations of liability with their auditors, or grant auditors the ability to limit liability contractually, subject to guidelines set by the Secretary of State. Options might be that liability would be capped as a multiple of the audit fee or total fees paid to the auditor; as a multiple of the auditor's turnover; or at an arbitrary level - say £500m for the Big Four, £100m for second-tier firms, and so on.

The Big Four are lobbying for these changes, but it will not be an easy ride. The debate is under way; interested parties should submit their views to the DTI by 12 March 2004.