As reported in the on-line Financial Times for March 10 – here – the Securities and Exchange Commission has declared that financial statements are unacceptable for US purposes, where UK companies have followed that country’s recent rules permitting negotiated agreements for the proportionate liability of their auditors.
The only surprise about the SEC’s position – which effectively slams the door on the world’s only remotely influential action affecting the large auditors’ deadly litigation exposure – is that it took so long to arrive.
The British initiative was uncertain enough from the outset, but was bound to be dead on arrival. It is not just that Washington’s attitude toward British rule has been revolting since 1776. London had every reason to see the SEC’s hostility right out in broad daylight.
For as I wrote last July – here – the new UK rules were “hostage to the unremitting hostility of the SEC to any attempts to reduce unlimited auditor liability exposure, as well as the uncertain application by US judges of limits contracted under foreign laws.”
Since the 1860’s, when Mr. Deloitte himself led the Victorian-era pioneers of independent audit in fighting off potential government take-over of their newly defined function, the principle has been established that auditor engagement and payment directly by clients were acceptable.
Despite endless futile debates since, no intellectually certain or solid basis has emerged upon which to measure the elusive and ever-shifting “appearance” of impaired independence (see here). So the SEC’s passionate history of opposition to auditor liability limits is matched only by its irrationality.
Which should be a signal to the stiff upper lips in London, whose fallback proposal is to seek the same package via British legislation: Forget it. Fold the hand.
Because the SEC is not about to accept limitation agreements, even in the doubtful case that the UK profession might succeed in shepherding an enabling law through Parliament, it is an immovable opponent. So move on to something productive.
Trans-Atlantic struggles over conflicting regulatory schemes are the common stuff of impasse. Look only at the state of extra-territorial examinations by the Public Company Accounting Oversight Board, still close to immobilized, nearly seven years after the passage of Sarbanes/Oxley, by cross-border conflicts over secrecy laws and client confidentiality. Or listen to the inflamed rhetoric with which UBS is opposing the identity disclosure of 25,000 of its clients – banking secrecy being one of the few topics to arouse observable dudgeon among the phlegmatic Swiss, even with the early signs of reluctant easing.
More importantly, even a UK “success” would be hollow. Proportionate auditor liability – along with its companion, monetary liability caps – are both politically unachievable in the US and, in any event, are ineffectual to solve the fundamental problem, namely the crying fragility of the auditors’ financial capacity to answer litigation claims of death-blow magnitude.
The capital structure of the Big Four partners can be calculated to have upper limits on a worst big case of under $2 billion – here. Yet the size of the recent failures that embroil the auditors extend from the Lehman Brothers bankruptcy, where with $635 billion of assets there is an estimated quarter-trillion dollar recovery shortfall, to the ever-shifting $50 or $67 billion involving the feeder funds to now-jailed Bernard Madoff – and lists of other claims, complex to maintain but readily accessible (here).
With those numbers over-hanging, no reasonable Big Four chief executive could with confidence send a team of trial lawyers into court, with the life of his firm in their hands, but depending for survival on achieving a jury’s fault allocation at a percentage in the low single digits.
So – taking note of the dictionary definition of a chimera as “an impossible or foolish fancy” – the SEC’s entrenched if churlish animosity should inspire the large audit firms to re-deploy the well intentioned but misdirected resources they have devoted to this futile exercise.
For the large firms, “liability caps” is a losing position – whether as skirmish, battle or campaign. Better to select a ground for change on which there is some non-zero possibility for success.
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