Auditors’ Multi-Layered Liability Regime

Abstract

The proposals to limit auditor liability, principally aimed at protecting the Big-4 from the risk of a catastrophic exposure to damages, are grounded on the assumption that auditors are generally over-deterred. The 2008 EC Commission Recommendation on auditor liability relies heavily on this assumption and the economic rationale that underpins it, which is entirely focused on liability towards investors and the US narrative concerning securities class actions. However, the case is much more complex. Any discussion about auditor liability must investigate the following questions: who the auditor’s principals are; whether they are in a position to negotiate in order to design the optimal liability regime; whether and at what stage market failures prevent contractual negotiation; what kind of positive (or negative) interferences stem from multiple negotiations and a multi-layered liability regime; how such a multi-layered regime might be designed. This article covers these issues. It conducts a step-by-step analysis of each layer and considers the potential interactions amongst them. Its conclusion is that it is impossible to assess the optimal level of deterrence in multi-layered liability regimes of such complexity. From a wealth perspective, the case for a mandatory limitation of liability can be argued exclusively with regards to liability towards secondary market investors, albeit subject to numerous qualifications that the conventional wisdom too easily overlooks.