With massive auditor liability claims on the horizon - including several well over the billion-dollar threshold - a number of efforts are now underway in Europe to strengthen auditor oversight.One was the adoption of Europe's 8th Directive on Statutory Audit, a broader adoption of a 1984 directive, which now pertains to the approval of statutory auditors in EU member states. The expanded directive, which will likely be implemented by sometime in mid-2008, will impact some 25 EU member countries.
Another was last year's creation of the European Group of Auditors' Oversight Bodies, a somewhat truncated version of the U.S. Public Company Accounting Oversight Board.
The body, which was first proposed in 2003 by the European Federation of Accountants (FEE), is charged with facilitating cooperation between the public oversight systems of EU national governments and to bring about an exchange of "best practices."
However, the EGAOB is an advisory body with no legal status. It also has no enforcement powers. As a result, the FEE continued to stress the need for an EU equivalent to the U.S.'s PCAOB. It would propose common principles, support convergence of good practice and provide a cross-border coordination function.
Currently, about half of EU member nations have their own audit oversight bodies, while several others are in the process of establishing their own.
Meanwhile, at a recent conference on auditing held in Brussels, FEE delegates expressed anxiety as a result of pending auditor liability claims and their impact on the future of the Big Four firms in the EU.
In fact, against the dangerous backdrop of a potential collapse of one or more of the international firms, some EU governments (including Germany, Austria, Greece and Belgium) have now capped auditor's liability. Others (including Denmark and the Netherlands) have introduced or are introducing proportional liability, combined with some limitations on who can sue auditors.
At the auditor conference, Patrice Muller, of London Economics, unveiled a European Commission study that concluded that a limitation on auditor liability would "reduce risk caused by potential catastrophic claims" against one of the Big Four firms.
It paints a bleak scenario, indeed, for auditors in Europe. The paper noted that currently, audit firms in the EU face 11 claims in the range of $200 million to $1 billion, and five claims in excess of $1 billion. The risk of a major award against one of the Big Four firms has increased substantially in recent years. The largest single claim that the largest firm in Europe could sustain and still survive is estimated at roughly $700 million.
But the spate of auditor liability claims, and even the collapse of a global audit firm, may not result in an emergence of second-tier firms to pick up the pieces, as it has in the U.S.
The consultancy said that middle-tier firms face a number of barriers to entry into the market, including reputation, capacity and the breadth of their networks. Middle-tier networks are unlikely, at least in Europe, to become a major alternative to their larger counterparts.
Charlie McCreevy, European commissioner for the internal market section, said that "a limitation on auditor's liability" could cut back the risk of a collapse of one or even two of the Big Four, "without reducing incentives for audit quality."
A liability limitation might also contribute to lowering the barriers to entry into the international audit market, he added. Later this year the commission will produce a report on auditors' liability that will outline policy options.
At the Brussels conference, PCAOB Chairman Mark Olson said that any pan-Europe auditor oversight body should be structured to serve the public interest and involve all stakeholders appropriately.
Olson pointed out that the U.S. oversight watchdog does not set accounting standards or regulate disclosures by public companies; rather, its role is to improve the quality and reliability of audits of financial statements of public companies. By doing so, investors could have more confidence in those financial statements and, ultimately, in the integrity of the capital markets. Olson also stressed the need for an inspection program.
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