An assessment of the implications for competition of a cap on auditors' liability
This report contains the OFT's advice to Government on the implications for competition in the audit market of proposals to permit auditors to limit their liability by way of negotiated caps.
The current liability position
1.2 At present auditors may not limit their liability for fault due to negligence or incompetence in audit work. Alongside regulation and reputation, liability acts as a discipline on audit quality in a context where shareholders and other third parties rely on information from an audit which is paid for by the company being audited. ...view middle of the document...
1.6 Second, unlimited liability does not appear to be causing Big Four firms to withdraw audit services. Audit, and the non-audit services sold to audit clients, are valuable business that the Big Four firms appear keen to retain. Third, as in the case of Andersen, reputation damage rather than financial damage is likely to be the primary cause of collapse for a Big Four firm implicated in a major audit scandal, should that ever occur in future. If the claims are generated abroad, a cap on liability in the UK would offer little protection for an audit firm's global network.
1.8 Lack of adequate safeguards and some forms of cap design – for example caps that afforded proportionately more protection to large auditors – could distort competition.
1.9 It is likely that allowing audit caps would be competitively neutral overall. Arguments that allowing caps would be pro-competitive are not compelling. Some forms of cap design could distort competition, so it will be important to ensure that there are no anti-competitive effects if scope for caps is allowed.
Office of Fair Trading
Following the Enron affair and subsequent collapse of Andersen, the OFT announced that it would keep the accountancy and audit market under review and would advise on any competition implications arising from any proposals for regulatory reform.1 The Department of Trade and Industry (DTI) recently consulted on the issue of permitting auditors to limit their liability (the Consultation),2 with a cap on auditor liability one of the suggestions put forward. Given the Government's objective of improving quality and competitive supply in the audit market, DTI asked the OFT to advise on whether a negotiated cap would significantly affect competition in the audit market, and, if so, how. The OFT was asked to consider the issue against the impact of the measures already taken and being considered to extend the coverage of the audit and improve audit quality. Given the limited time available, DTI recognised that the OFT's advice would be based on the responses to the Consultation and other readily available information. We reviewed the responses to the Consultation alongside fee data, market reports and the available annual reports of the Big Four, and compiled evidence to support or refute each potential impact on competition from the policy proposals. There is necessarily an element of judgment in our conclusions, given the time constraints, the lack of 'hard' evidence in the responses, the scarcity of historical data for the accounting firms and the requirement to consider the proposal alongside a package of forthcoming regulatory changes.3
OFT Press Release PN 79/02, 22 November 2002. Director and Auditor Liability: A Consultative Document (DTI, December 2003). 3 Factors such as individual regulations, reputation and competitive dynamics all interact and need to be considered as a whole.