Blogs are supposed to be engaging, whimsical, opinionated and should at least try to provide an entertaining angle on the great matters of the day. I am not sure, therefore, that it is a great idea to devote an entire posting to the bleak, bone-dry world of accounting and auditing, but I’ll give it a try all the same.

The bean-counters have, after all, attracted quite a lot of attention inside the European Commission recently. This has a lot to do with the somewhat surprising notion that accountants and auditors are a bit like those mountain gorillas in central Africa that have been dropping dead at an alarming rate in recent years. In other words, there are plenty of people who believe the profession is an endangered species that requires urgent protection.

Enter Charlie McCreevy, the EU internal market commissioner and himself a former accountant. He has for some time been arguing that the big audit firms should be shielded from potentially ruinous litigation, pointing out that neither the audit world nor businesses in general could function with only three global practices.

At present, the books of virtually every big company around the globe are checked and signed off by one of four firms: KPMG, Ernst & Young, PwC and Deloitte. Already some companies - which have been forced to rotate their auditors in several jurisdictions - are finding it difficult to get the expertise they need while remaining on the right side of corporate governance rules. Going down to three global audit firms is generally seen as a very, very bad thing.

Until 2002, there was actually another member of the pantheon - Arthur Andersen. The firm famously collapsed in the wake of the financial scandal that sunk Enron, one of its clients, and the spectre of that downfall has haunted the industry ever since.

Though Arthur Andersen disintegrated long before any litigation took place, the remaining firms fear that one of the many multi-billion dollar lawsuits currently pending against them in Europe and the UK could trigger another collapse. That is why they have been busy lobbying governments and regulators around the world to give them protection against damages claims, saying that they are often unfairly targeted by investors, for example after the bankruptcy of one of their clients.

On Thursday, Mr McCreevy made clear he intends to follow their pleas. In a Commission policy paper, he says the industry should either be protected through a liability cap or through a principle known as "proportionate liability", which means the audit firms would only be responsible for their own mistakes not their clients’.

There are several reasons why a liability cap strikes me as a risky idea. For a start, it does not seem clear why auditors should be granted such generous relief but not other professions that also regularly face huge losses through litigation. Should we not also introduce a Europe-wide liability cap for hospitals and law firms or for food and drink producers? How about the poor old tobacco industry?

Granted, the latter certainly do not perform a function that is as much in the public interest as auditing. But it seems particularly unfair to offer what is essentially state protection to an industry whose very market is created by the statutory obligation on companies to get their books audited. What next? A legally guaranteed profit margin?

But the more weighty objection to a liability cap is the one made persistently by investors. They have been warning Brussels about "moral hazard", and pointing out that a legally enshrined cap would take away a crucial incentive for the firms to do their job properly and supply investors with accurate numbers.

The Commission is, of course, well aware of these concerns. It would not surprise me, therefore, if Mr McCreevy had already trained his sights firmly on the weakest of the options laid out in Thursday’s paper - the principle of "proportionate liability".

This is not something the Commission can introduce through EU legislation, but it would rather have to persuade member states to adjust their national law books. That roundabout strategy may not be a bad thing. Charlie McCreevy is a committed fan of "soft-touch" regulation that leaves member states the flexibility to adjust a broad EU agreement to national specificities.

True, it would not offer the kind of protection to audit firms that a fixed cap would give. But a little risk may be just what the industry needs to stay on its toes. 

January 18th, 2007 in Commission | Permalink