Euro. Comm. Recommends Limiting Auditor Liability; U.S. Treasury ACAP Debates Liability; Publishing Addendum For Comment

On June 6, 2008, the European Commission published a recommendation calling for EU Member States to develop liability caps for auditors, or permit listed companies to develop such caps in consultation with their shareholders and governing boards, subject to judicial review and disclosure. These caps would pertain to statutory audits of listed companies.

As noted in an article by Jennifer Hughes in the June 7 Financial Times, "EU Calls For Limits to Auditors' Liability," EU Internal Markets Commissioner Charlie McCreevy said of auditor liability: “It is a potentially huge problem for our capital markets. The current conditions are not only preventing the entry of new players in the international audit market but are also threatening existing firms.”

Key points in the European Commission's (EC's) recommendation include:

The civil liability of statutory auditors and of audit firms arising from a breach of their professional duties should be limited except in cases of intentional breach of duties by the statutory auditor or the audit firm.

The limitation of liability should apply against the company audited and any third party entitled under national law to bring a claim for compensation.

Any limitation of civil liability should not prevent injured parties from being fairly compensated.

The EC explains in this Frequently Asked Questions (FAQ) document: “It is in the public interest to ensure sustainable audit capacities and a competitive market for audit firms at international level… liability risks arising from the increasing litigation trend combined with insufficient insurance cover may deter auditors from providing audit services for listed companies. If these structural obstacles (liability risks/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… 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.”

After noting that the EC adopted a recommendation on May 8 ‘strengthening the robustness and independence of inspections of firms auditing listed companies,’ the FAQ states: “Audit quality should be driven more by sound regular inspections whilst liability should complement such efforts but not make the audit business unattractive.” Furthermore, “audit regulators - not judges or courts - will in future play a pivotal role in maintaining the high audit quality which companies and investors deserve.”

The FT’s Hughes also quoted PwC partner Peter Wyman, saying, “This is a very significant step for auditors not just in Europe, but across the world because Europe will provide a lead.” Additional details on the EC recommendation are in this FEI summary (summary downloadable by FEI members only, see info on FEI membership).

U.S. Treasury ACAP Debates Liability; To Publish Addendum in FR for Comment
In related news, the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) voted on June 3 to formally publish in the Federal Register - and seek public comment on - an Addendum to its May 5 Draft Report. There will be a 30 day comment period on the Addendum (presumably, 30 days after it is published in the Federal Register (FR), as of June 9, the Addendum had not yet been published in the FR.) As previously reported, the comment deadline on the May 5 Draft Report is June 13.

The Addendum includes one recommendation and three matters for further consideration: (1) a recommendation that the PCAOB reconsider the form and content of the auditor’s report, (2) whether engagement partners (not just the ‘firm’) should sign audit reports, (3) whether audit firms should be required to make public a set of audited financial statements for their own firm, and (4) whether it would be appropriate to transfer to federal court jurisdiction certain claims against auditors and related issues regarding a uniform standard of care.

ACAP discussed auditor liability more broadly at its June 3 and prior meetings, but has yet to reach a consensus on any recommendation pertaining to auditor liability, including the federal vs. state court jurisdiction matter noted in its Addendum.

Here are a few highlights from ACAP’s June 3 meeting, particularly on the liability issue:

Ernst & Young General Counsel Kathryn A. Oberly, testified that changes in the law - including the ‘water[ing] down’ and eventual abandon[ment] of the privity requirement’ - combined with the explosion in market cap of public companies, has largely resulted in the threat of catastrophic loss to audit firms sued in connection with their role in auditing public companies.

PwC General Counsel Charles W. Gerdts III (testimony) and attorney Michael R. Young of Willkie, Farr & Gallagher (testimony), explained that the threat of catastrophic loss limited audit firms’ abilities to exercise their right to take the matter to trial, instead having no real choice but to settle, rather than – as Oberly soberly put it – ‘bet the firm.’

AON Deputy Chairman Barry Matthews warned ACAP in his testimony: “I want you to know that at no time have we encountered a situation in which there existed as substantial a threat to the continued viability and sustainability of the audit firms as that created today by the potential for mega professional liability claims brought in US courts.”

ACAP member Professor Gary John Previts, President of the American Accounting Association, said: “Right now we have a federally sanctioned cartel, that’s a personal observation, but how else in the world can you get 12,000 public companies audited within 90 days of year-end?” He asked, “What high standard, what impossible standard, do you hold them to, to accomplish that feat,” and likened the current model to “the difficulty of trying to make the Western Union model work in the 21st century.”

Previts referenced earlier remarks of ACAP member and former SEC Division of Corporation Finance Director Alan Beller, who said: “One of the things this committee is charged with doing is to look over hills and corners; I’d like to look over a five-year corner, five-years from now I think it is a certainty the U.S. capital markets will be less than 30% of global market cap, [it’s in the] low 30s today; [the] second point [is], it is quite likely that one or more of the Big 4 [audit firms] will have established real global operating entities that function as single entities with single systems of corporate governance.” Beller continued: “It is 100% certain to me that if we do not find a better path, a different path, from the one we currently are on, the chances are precisely zero that the American firms will be part of those global networks.”

On the subject of audit firm transparency as it may relate to potential efforts for liability reform, ACAP co-chair Don Nicolaisen said: “Not withstanding commentary I’ve heard from firms, and others, I do think there is tremendous value to having audited financial information for the largest firms, I say that for a number of reasons, one is, if they are desirous of some sort of litigation reform, for us to go to Congress and make a recommendation and say we don’t have any financial information but we want you to consider [liability reform], doesn’t have any appeal. Simply giving you my expressed view on this, similar to Arthur’s view, [ACAP co-chair Arthur Levitt, Jr.] we feel strongly [audit] firms that occupy this space, importance to our capital markets, responsible for auditing 95% plus of market cap, to operate without a baseline of financial information is not acceptable, that doesn’t mean it may not be acceptable to the committee, I want to make sure you understand where I am coming from, Arthur is in the same place.”

More generally, Nicolaisen said, “those who have recommendations how to move forward with a solution that provides either transparency [e.g., providing audited or certain other information about the firms to the public] combined with liability matters or ends up with a position saying both [transparency and liability were] discussed and no resolution, at some point we’re not going to fruitfully continue dialogue, either there is a solution reasonably obvious or not.”

Additional details from ACAP’s June 3 meeting (human capital, including education, training, and general recruitment and retention was also discussed) can be found in this FEI summary (summary downloadable by FEI members only, see info on FEI membership).

Noting that ACAP’s next public meeting is July 22, Nicolaisen said, “we encourage comments from the public on anything we’ve done between now and the end of June, even if it trickles in the first few days in July [it’s] OK too.”

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SEC IFRS Roadmap:New Commissioners Will Be on the Journey, Says White; Corp Fin Review Guidance Coming; FEI Forms CRIFR

SEC Corp Fin Director John White told FEI’s IFRS conference earlier today (June 5) that the SEC is working on the IFRS roadmap –‘it is not one of those back burner projects – it’s happening” Noting that confirmation hearings for three new Commissioners took place earlier this week, he emphasized “there will be five people voting – we have to get everybody in place” before proceeding on this major initiative. [UPDATE June 6: White's speech has been posted here: http://www.sec.gov/news/speech/2008/spch060508jww.htm ]
“We are taking this journey with the new roadmap with three new commissioners,” White said, adding, “we on staff will have to begin to understand their views.”
In a meeting with the press following his formal remarks, White explained the roadmap will not be proposed rulemaking per se, although proposed rulemaking may be one of the signposts along the roadmap. Asked during the press session if the SEC will have a 'quiet period' in rulemaking, given in part the White House memo directing federal agencies planning to issue proposed (final) rules by June 1 (with a later date for final rules), White said "We anticipate continuing going on with business as usual," noting there are a number of proposed rules currently out for public comment relating to foreign issuers, as well as a concept release on oil and gas, and the recent XBRL rule proposal, on which he said, "I have every expectation XBRL rule will be adopted before the end of the year."
White outlined a number of key questions being considered within the halls of the SEC – including whether IFRS should be permitted or required, whether all public companies should be under the scope of the IFRS option or mandate, or a subset of companies, and timing and transition issues.

Some time ago, noted White, some may have entertained the ‘dream’ that U.S. GAAP would become the global standard. However, with more than 100 countries requiring or permitting IFRS, he said some may see it as ‘an inconvenient truth,’ but those people ‘need to wake up from that dream’ of the single global standard being U.S. GAAP, and recognize the global movement is to IFRS. He reiterated the aim has been to achieve a single set of high quality standards that are globally accepted.

He noted the SEC has been actively involved, including with international counterparts at IOSCO, and through agreements like the SEC-CESR workplan, in sharing the results of reviews of IFRS filings, and in discussing issues like enhancing the governance of the IASB.

Separately, White noted that the SEC will be posting, possibly as early as today, a paper describing how to deal with the Corp Fin review process, including issues such as how to proceed from Corp Fin review to take up matters with the Office of the Chief Accountant, if applicable. He emphasized that the objectives of the review process as applied to IFRS filings are consistent with that of the review of U.S. GAAP filings. UPDATE: Here is a link to the doc referenced by White, posted today (June 5): "Division of Corporation Finance - June 2008: Filing Review Process."

FEI President and CEO Michael P. Cangemi, introducing White, noted that FEI has focused on keeping its members educated on IFRS and other financial reporting matters, as well as the other needs of companies, including operational issues.

Some of these initiatives at FEI include the creation of an IFRS focused subcommittee within FEI’s Committee on Corporate Reporting (CCR), and the announcement today that FEI has led the formation of a new national coalition, the Corporate Roundtable on International Financial Reporting (CRIFR), to provide a forum for companies of all sizes and funding models to discuss all business issues related to the promulgation, implementation and convergence of IFRS by U.S. companies. CRIFR’s charter members include FEI, Eli Lilly, Honeywell, McGraw Hill, Source Technologies, SMSC and Tyco. See the FEI press release.

Today's conference, "The World Is Moving to IFRS - Are You?" was hosted by Financial Executives International (FEI), and exclusively sponsored by BNA Tax & Accounting.We’ll have more highlights from panels that followed John White's keynote in subsequent posts.

COSO Releases ED on Monitoring Internal Control; Can Impact Sarbanes-Oxley Section 404, SAS 112 Assessments of Internal Control

On June 4, 2008, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) released for public comment its Exposure Draft (ED) entitled, "Guidance on Monitoring Internal Control Systems." The comment period ends August 15, and final guidance is anticipated by Fall, 2008.

COSO's 1992 Internal Control -Integrated Framework (as supplemented by COSO's 2006 Guidance for Smaller Public Companies - which can be applied by companies of all sizes) is recognized by the SEC’s rule on management reporting, and in PCAOB’s internal control audit standard (AS5) as a suitable and generally accepted framework on which to base assertions as to the effectiveness of internal control under Sarbanes-0xley Section 404. For all intents and purposes in the U.S., the COSO framework is ‘the’ internal control framework. (The SEC and PCAOB permit reference to certain other frameworks used outside the US, such as Turnbull in the U.K.)

Similarly, private companies are subject to AICPA standards like SAS 112 on ‘Communicating Internal Control Related Matters Identified in an Audit’ which reference the COSO framework.

The proposed guidance contained in COSO’s Exposure Draft released June 4 more fully develops the Monitoring component of COSO's internal control framework. (The five components of COSO's internal control framework are: control environment, risk assessment, control activities, information & communication, and monitoring.)

The objective of the Monitoring ED is to assist companies in improving Monitoring to make it more efficient and effective, including to better leverage management's work in terms of reliance by auditors on that work, as part of the overall efficiency and effectiveness of internal control assessments.

Links to the 3 volume Exposure Draft (Exec Summary, Guidance, and Application Guidance or Examples) as well as an introductory letter from the COSO Chairman, Dr. Larry E. Rittenberg, and a related press release issued June 4, can be found on COSO's newly redesigned website here. Be sure to check out other aspects of COSO's redesigned website at www.coso.org.
COSO selects a firm to lead a project team in developing its guidance. The project team includes representatives from COSO’s five sponsoring organizations (the AAA, AICPA, FEI, IIA, and IMA) and other experts. Grant Thornton, LLP was selected last year to lead the development of the Monitoring guidance under the auspices of the COSO project team. The project leader is R. Trent Gazzaway, Managing Partner of Corporate Governance, Grant Thornton LLP.

FEI President and CEO Michael P. Cangemi is FEI’s COSO board representative. Rick Brounstein, CFO of NewCardio, Inc. is FEI's member representative on the COSO Monitoring project task force, with input from members of FEI’s Task Force on Monitoring (TFM).
In fall 2007, COSO released a Discussion Document on Monitoring, a precursor to the current ED. Comments sent on the Discussion Document by FEI and others are posted here.

Check back to FEI’s website www.financialexecutives.org later this week for a summary of the COSO ED.