A key committee of the American Institute of Certified Public Accountants has concluded that liability waivers will not necessarily weaken an auditing firm’s independence, so long as the firm promises to conform to Generally Accepted Auditing Standards.
The AICPA’s Professional Ethics Executive Committee recently re-exposed a draft document outlining its views on factors that could compromise an auditor’s independence. It proposes one new and one revised interpretation under Rule 101, Independence, based on comments it received to a similar exposure draft issued a year earlier.
The first and perhaps most significant proposal says that certain types of indemnification and provisions limiting an auditing firm’s liability threaten the auditor’s independence because they may give an auditor a false sense of security and encourage less thorough auditing. The proposal says the threat can be mitigated, however, if the provisions are contingent on the auditor adhering to professional audit standards.
The proposal reads: “An indemnification or limitation of liability provision that requires the client to reimburse the member for litigation costs and expenses … would not impair independence as long as such provision is contingent upon the member having performed such services in accordance with professional standards, in all material respects.”
In last year’s exposure draft the committee said an auditor’s independence would be impaired if it sought to limit or eliminate liability from a client’s negligence or its own, but not when problems arise from a client’s fraudulent behavior. Lisa Snyder, director of the professional ethics division for the AICPA, says the committee changed its view based on comment letters and further task-force review.
“We’re contending that indemnification provisions do not themselves compromise auditor independence as long as the auditor is still held to comply with audit standards,” Snyder says. “It is an effective safeguard, when you look at what the threat is. The auditor knows they’re going to have perform a good audit or they’ll never get indemnified unless they can prove the audit was done in accordance with professional standards.”
“The auditor knows they’re going to have perform a good audit or they’ll never get indemnified unless can prove the audit was done in accordance with professional standards.”
— Lisa Snyder, AICPA
The AICPA view differs from that of the Securities and Exchange Commission, which says auditors lose their objectivity if they are protected in any way from liability stemming from a client’s knowing misrepresentation. It also differs from the view of a group of banking regulators, which determined last year that financial institutions could not give auditors any limitations on liability via engagement letters.
Snyder contends that the ethics committee is studying the issue and making its determination strictly from an ethics perspective. The AICPA says auditor-liability protections have more basis in private-company audits, where fraud may be exposed because private companies typically don’t have the same control environment, especially following the implementation of Sarbanes-Oxley provisions.
The U.S. Chamber of Commerce likes the direction AICPA is heading. “The chamber has had a long-standing position that provisions like these should be allowed between audit firms and their clients,” says David Chavern, vice president for the chamber. “We do not think these provisions should be barred by any one group.”
The new proposal also provides guidance on arrangements where a member and client agree to use arbitration, mediation, or other alternative dispute resolution methods, or an agreement to waive a jury trial.
The proposal also addresses forensic-accounting services and tax services, Snyder says. The committee originally held that an audit firm should not perform forensic-accounting services for a client because the forensic work might result in confidentiality restrictions that would affect the audit.
Comments disputed that premise, however, calling it a scope limitation, not a threat to independence. In the current proposal, the committee calls for a ban only on expert-witness testimony, where a forensic accountant is openly advocating for a client.
In tax services, the committee proposal says audit firms should not provide tax-compliance services unless safeguards are in place to assure that independence is not threatened.
The committee is accepting comments to its new proposals through Nov. 8.
Big 4 Grow More Slowly Than Smaller Accounting Firms
Despite indications that audit work should have declined in the past years as companies get better at meeting Sarbanes-Oxley requirements, the top 100 accounting firms showed an average jump in revenue of 16.5 percent in the past year, an increase from 9.1 percent growth the year before and the biggest jump since 2000, according to an accounting industry news source.
Firms outside the Big 4 showed the stronger overall results compared with their big brother firms. Among the Big 4, revenue grew an average 14.7 percent—but for firms that ranked fifth through 100th in the listing, revenue grew 21.9 percent, said Public Accounting Report, which researched and compiled the Public Accounting Report 2006 Top 100 listing.
Jonathan Hamilton, editor of the report, says companies are facing greater regulation and relying more on their accounting firms for a wide range of services contributed to the growth. SOX alone, however, can’t necessarily be assigned all the credit for the growth.
“It’s hard to say because most firms won’t break out it and say, ‘This is what we made on SOX this year,’” Hamilton says. “Everyone’s busy because of the different tentacles of SOX,” such as the wall regulators have erected between tax accountants and auditors, requiring companies to engage different firms for certain tax and audit work.
The results are somewhat skewed as well by the merger last year of RSM McGladrey with American Express Tax and Business Services, Hamilton notes.