Seeks Cap on Liability Of Accounting Firms
By David Reilly
The Wall Street Journal
Thursday, November 30, 2006
Congress should consider curtailing the liability accounting
firms face from auditing public companies either by capping
their potential courtroom damages or by creating special
protections for some auditing activities, according to a
report due today from a committee weighing the
competitiveness of U.S. capital markets.
The report, from the Committee on Capital Markets
Regulation, is also calling for U.S. authorities to curb
contentious audit requirements related to checks on
companies' internal controls as called for by the
A cap on auditor liability is a long-sought goal of the
accounting industry, which argues that an outsize court
award following a corporate blowup could lead to the
collapse of a big firm, imperiling global capital markets.
In its report, the committee noted that such protections
already exist in many European countries.
The committee didn't offer a detailed recommendation on how
a cap would work. "There are many possible approaches, and
we're not picking one or another," said Hal S. Scott, a
Harvard Law School professor and a founding member of the
committee. "What we're saying is that there's a problem here
that needs fixing."
That problem, the report says, leads to higher costs that
erode U.S. competitiveness even if a major accounting firm
doesn't fail because of a court award. "Auditors may have
incentives to engage in 'defensive auditing,' just as
doctors faced with potential financial ruin from medical
malpractice cases practice 'defensive medicine,' " the
But investors have long balked at the idea that auditors are
deserving of special protections, a view that hardened in
the wake of the accounting firms' failure to catch corporate
scandals earlier this decade. In addition, no major audit
firm has gone out of business because of a big court award
in recent times. Arthur Andersen LLP's demise was the result
of a criminal conviction, later overturned on appeal.
While many accountants are sympathetic to the idea of caps,
they question whether they are a practical solution. "You
don't want to drive any more of the firms out of business,"
said Donald Nicolaisen, a former chief accountant of the
Securities and Exchange Commission who is also a retired
partner of PricewaterhouseCoopers LLP. "But it's more in the
execution of how you'd make it happen, and I don't know how
workable that is. You certainly don't want to give the firms
a free pass."
When it comes to Sarbanes-Oxley, and in particular its
requirements related to checks on companies' internal
controls, the committee didn't call for "statutory changes"
to the law, which has been assailed by companies, in
particular small enterprises, as imposing overly burdensome
costs. Nor did the report say that small companies with
market values of less than $75 million should be exempt from
But the committee said the SEC should continue to exempt
these small companies from complying with the rules until
they can be made more cost-effective. If that doesn't occur,
the report said, the SEC should ask Congress to change the
law so auditors aren't required to sign off on the
effectiveness of these companies' controls.
The committee's report also calls for a relaxation of the
requirement that auditors test the effectiveness of all
controls annually. But it rejected the idea that auditors
could simply sign off on the design of internal controls,
rather than their effectiveness.
David Reilly at