I wish to complain about this parrot what I purchased not half an hour ago…
The Companies Act 2006 (“CA06”) was intended to provide an elegant solution to an old problem: auditors’ unlimited joint and several liability risked them bearing 100% of losses resulting from a corporate failure, even if only partly responsible. Auditors were keen to remedy this unfairness; investors wanted conditions. So CA06 permitted LLAs only if ratified by shareholders at AGM. While auditors believed that investors supported the reform, in practice, investors’ right of veto enabled them to block change.
‘E’s dead, that’s what's wrong with it!
Attempts to implement LLAs illustrated the reasons why the voluntary regime had no legs. Although some listed clients voiced support, none wanted to be first. The burgeoning financial crisis meant that boards of listed companies had other issues higher up their agendas than auditors’ terms of engagement.
‘E’s passed on! This parrot is no more! He has ceased to be!
The SEC administered a lethal injection by concluding that agreeing an LLA could compromise auditor’s independence. To put this in context, consider that the SEC tolerates Germany’s fixed €4 million statutory cap, but objects to the element of negotiation and agreement required under UK law.
Well, I’d better replace it, then…I got a slug…
I doubt that directors and investors of small quoted companies grieved over the fact that voluntary LLAs turned out to be nailed to the perch. Tim Goodman’s article in the Winter 2008/9 edition of the QCA Voice stated: “The QCA has argued that…any liability claims against its members’ auditors would not be big enough to create such a catastrophic claim…”. But the need for LLAs is about more than individual audit firms and companies. The collapse or takeover of a firm would reduce every company’s choice of auditor, with inevitable negative consequences. But any company taking action needs to know it's not alone. It’s like the approach to other community-wide risks; we all bear some of the cost of policing so that all can benefit from a police force.
Pray, does it talk?
Tim Goodman’s article also raised the spectre of falling quality, stating: “…limiting liability…may lead to a reduction of audit quality and scope”, as if self-preservation is, for the auditor, the sole driver of quality! Auditors’ work is under greater scrutiny than ever, with independent inspection and public reporting, which most recently found that the quality of UK auditing is “fundamentally sound”. Maintaining and increasing the number of competing firms of a size to audit quoted companies will maintain and increase quality without increasing fees.
And now for something completely different?
There’s global recognition that the capital markets are best served by an auditing profession which can protect itself on reasonable commercial terms, hence the EU’s recommendation that member states take steps to allow auditors to limit liability. Although we would have liked CA06 to introduce statutory fixed caps, the investment community clearly opposed them. But an amendment to the Act bringing in statutory proportional liability is one possibility. The UK’s attempt to introduce voluntary LLAs may read like comedy. However, while the failure of a large audit firm, with the resulting adverse consequences, continues to be the biggest risk to audit quality in the UK, it's clear that doing nothing is not a serious option.
Oliver Tant is KPMG’s UK Head of Audit. He joined the audit practice of the then Thomson McLintock in 1982. For the past three years, he has been Global Head of Private Equity, as well as being a Lead Partner within the UK practice. Over time, his clients have included Alchemy, Charterhouse, Compass, Otto Vers and, Granada and TUI Travel. Co-writer Helen Brennan is a senior manager in KPMG's audit practice. She qualified as an accountant with Shipleys in 1998 and has worked for KPMG for the past ten years.