On October 6, the U.S. Treasury Department's Advisory Committee on the Auditing Profession issued its Final Report. The report was the product of 12 months of work by the Committee, which was headed up by former SEC chairman Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen, and consisted of no fewer than 21 members.

Among many other things, the 200+ page report examined in great detail the "possible impact of the current U.S. liability system on audit effectiveness and the continued sustainability of the public company auditing profession." The Committee, however, was "unable to reach a consensus as to whether limits on auditor liability would be beneficial or harmful to the capital markets and to investors or, for that matter, whether such limits are necessary to sustain the auditing profession," and therefore presented no recommendation on this issue.

The Committee did present many interesting pieces of information that it gathered in considering this issue. These include:

The six largest auditing firms that each audit more than 300 U.S. public companies and together audit over 99% of the total U.S. public company market capitalization were asked by the Committee to supply a wide range of information regarding historical and pending litigation.

These six auditing firms disclosed that they are currently defendants in ninety private actions related to audits of both public and private companies (either shareholder class actions or actions brought by companies or bankruptcy trustees) with damage claims against the auditors in each case in excess of $100 million.

Forty-one of these ninety cases seek damages in excess of $500 million, twenty-seven cases seek damages in excess of $1 billion, and seven cases seek damages over $10 billion. Of the forty-one claims in excess of $500 million, nineteen were lodged by private companies or bankruptcy trustees and allege claims of over $30 billion in the aggregate.

Over a twelve-year period, since the enactment of the Private Securities Litigation Reform Act of 1995, the six largest auditing firms have paid out $5.66 billion to resolve 362 cases related to public company audits, private company audits, and all other non-audit services, with 65% of the total ($3.68 billion) related to public company audits.

Information provided by the six largest auditing firms indicates that the weighted average of "litigation and practice-protection costs" was 6.6 percent of these firms' revenues and 15.1% of these firms' audit-related revenues for the most recent fiscal year.

Over the 1996-2007 time period, median settlements by auditing firms in shareholder class actions (a subset of litigation against auditing firms) were 4.8% of the total estimated damages.

After reviewing the record summarized above, the Committee did not agree as to whether the litigation threats faced by the auditing profession are sufficient to justify substantial change to the current liability regime, or what change would even be most appropriate to limit liability risk. Some Committee members believed that the "catastrophic litigation risk faced by the auditors of public companies is an unacceptably severe hazard to auditing firms, to investors, and to the stability of the U.S. capital markets, requiring actions to reduce the hazard." Others, however, simply did not believe the case had been made that the risk of litigation is catastrophic and they opposed significant change to the liability regime for auditing firms.

Given the lack of consensus among its members, the Committee made no recommendation on this issue in its report, and concluded by stating:

This Committee's charge is primarily to identify matters impacting - positively and negatively - audit quality and the sustainability and competitiveness of the auditing profession. While the Committee's charge does not include venturing into the general area of litigation policy, some Committee members feel that if, and when, such change is considered, it should go forward in a context broader than just consideration of the impact on the auditing firms. Litigation is clearly of significant concern to the auditing firms but is also of concern to investors and other market participants. And, changes in the litigation environment impacting auditors may potentially affect other market participants. The Committee believes it is important that the litigation system be fair and rational in serving the needs of both auditing firms and the public interest. However, as noted above, Committee members could not agree whether or not the existing litigation system satisfies those objectives.

Read the Final Report of the U.S. Treasury Department's Advisory Committee on the Auditing Profession

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