Commission staff working document - Accompanying document to the Commission recommendation concerning the limitation of the civil liability of statutory auditors and audit firms - Impact assessment {C(2008) 2274 final} {SEC(2008) 1974}
Date: 2008-06-05
Institutions: European Commission
Subjects: accountant, audit, auditing, impact study, professional ethics, professional qualifications

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 5.6.2008 
SEC(2008) 1975 

COMMISSION STAFF WORKING DOCUMENT 

Accompanying document to the 

COMMISSION RECOMMENDATION CONCERNING THE LIMITATION OF THE 
CIVIL LIABILITY OF STATUTORY AUDITORS AND AUDIT FIRMS  

IMPACT ASSESSMENT  

{C(2008) 2274 final} 
{SEC(2008) 1974} 

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TABLE OF CONTENTS 

1. 

2. 

Introduction................................................................................................................. 4 

Procedural issues and public consultation ............................................................ 4 

2.1. 

EU Directive on Statutory Audit and its follow-up................................................. 4 

2.2. 

Study on civil liability systems of statutory auditors in the EU ........................... 6 

2.3. 

Inter Services Steering Group ................................................................................. 6 

2.4. 

Impact Assessment Board ....................................................................................... 6 

3. 

Problem definition...................................................................................................... 7 

3.1. 

The public interest ..................................................................................................... 7 

3.2. 

Issues in the international audit market ................................................................. 8 

3.2.1.  The demand side: listed companies....................................................................... 8 

3.2.2.  The supply side: the type of players..................................................................... 11 

3.2.3.  The supply side: the Big 4 – too few players? .................................................... 12 

3.2.4.  Failures preventing the entry of new players ...................................................... 15 

3.3. 

Risk exposure for the audit profession................................................................. 16 

3.3.1.  The liability regimes ................................................................................................ 16 

3.3.2.  Deep pocket syndrome........................................................................................... 17 

3.3.3.  Predictability of litigation costs .............................................................................. 18 

3.4. 

Lack of insurance capacity..................................................................................... 19 

3.4.1.  Professional indemnity insurance for smaller audits ......................................... 19 

3.4.2.  Self-insurance .......................................................................................................... 20 

3.4.3.  Reducing audit risks by imposing higher audit fees? ........................................ 21 

3.4.4.  Financial capacity of the audit firm and the individual audit partner ............... 21 

3.5.  Which market participants are affected? ............................................................. 24 

3.6. 

Does the EU have the right to act?....................................................................... 27 

4. 

5. 

Objectives ................................................................................................................. 27 

Policy options ........................................................................................................... 27 

5.1. 

No EU action (Option 1) ......................................................................................... 27 

5.2. 

Possible options in substance ............................................................................... 28 

5.2.1.  Compulsory insurance for all auditor liability risks (Option 2) ......................... 28 

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5.2.2.  Establishing “safe harbours” (Option 3) .............................................................. 29 

5.2.3.  Limiting auditors' liability (Option 4)..................................................................... 30 

5.3. 

Screening of the options......................................................................................... 33 

5.4. 

Legal instruments .................................................................................................... 34 

6. 

Analysis of impacts ................................................................................................. 35 

6.1. 

No EU action at the EU level (Option 1) .............................................................. 35 

6.1.1. 

Impact of market forces in the future.................................................................... 35 

6.1.2.  The Big 3 scenario and its consequences for the capital markets .................. 36 

6.1.3.  Current situation in the Member States ............................................................... 37 

6.1.4.  Current situation in the United States .................................................................. 39 

6.2. 

Impact of option 4a on the objectives (Capping liability by a Directive) ......... 40 

6.3. 

Impact of option 4b on the objectives (Introducing proportionate liability by a 
Directive)................................................................................................................... 41 

6.4. 

Impact of option 4c on the objectives (convergence of liability limitations).... 42 

6.4.1.  Reaching convergence by a Recommendation.................................................. 43 

6.4.2.  Reaching convergence by a Directive (option 4 c implemented via a 

Directive)................................................................................................................... 45 

6.5. 

Impact on Audit Quality .......................................................................................... 46 

6.5.1.  General impact of a liability limitation on audit quality....................................... 46 

6.5.2. 

Impact of each of the options on audit quality .................................................... 47 

6.6. 

Positive impact mainly for the Big 4? ................................................................... 48 

6.7. 

Possible up- and down-sides for stakeholders outside audit firms ................. 49 

6.8. 

Other impacts (for options 4a, 4b and 4c) ........................................................... 50 

7. 

Comparing the options ........................................................................................... 51 

7.1. 

Criterion 1: Effectiveness regarding the objectives............................................ 51 

7.2. 

Criterion 2: Efficiency .............................................................................................. 53 

7.3. 

Criterion 3: Audit quality ......................................................................................... 53 

7.4. 

Criterion 4: Acceptability......................................................................................... 53 

7.5. 

Overall comparison ................................................................................................. 55 

7.6. 

Conclusion ................................................................................................................ 56 

8. 

Monitoring and evaluation ...................................................................................... 57 

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1. 

INTRODUCTION 

European  legislation1  requires  a  company’s  financial  statements  (i.e.  annual  or 
consolidated  accounts)  to  be  audited  ("statutory  audits").  Statutory  audits  must  be 
conducted by independent, registered auditors and audit firms ("statutory auditors"). 
Statutory  auditors  should  provide  an  independent  opinion  about  a  company's 
financial position, as reflected in the financial statements – this opinion is important 
as investors will rely on it when making decisions2. 

Corporate  failure  (particularly  bankruptcy),  and  the  exposure  of  previously 
undetected cases of management deception, often lead to accusations of audit failure, 
which in turn can lead to law suits. Individual shareholders, creditors and prospective 
purchasers of the audited company may suffer damages for which statutory auditors 
may  be  held  liable.  In  the  case  of  listed  and  large  unlisted  companies,  whether 
national  or  multinational,  liability  risks  are  high  and  can  quickly  rise  to  several 
million Euros. These liability risks combined with insufficient insurance threaten the 
sustainability and competitiveness of the statutory audit market structure, since they 
may  deter  statutory  auditors  from  providing  audit  services  for  such  companies. 
European capital markets, which have become much more integrated in the last few 
years and which collectively represent the second largest capital market in the world 
(after the  US), need a sustainable  and competitive market for  audit services, where 
audits  for  multinational  companies  can  still  be  provided.  Auditors'  liability  is  the 
subject of debates not only in Europe, but also in the US. 

2. 

PROCEDURAL ISSUES AND PUBLIC CONSULTATION 

2.1. 

EU Directive on Statutory Audit 3 and its follow-up 

Although the Commission did not include the issue of liability in its initial proposal 
for  the  EU  2006  Directive  on  Statutory  Audit,  the  European  Parliament  requested 
that this issue be addressed in the Directive. Accordingly Article 31 of the Directive 
invited the Commission to present a report on: 

•  the impact of the current national liability rules for carrying out statutory audits on 

European capital markets; and  

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Fourth  Council  Directive  78/660/EEC  of  25  July  1978  on  the  annual  accounts  of  certain  types  of  companies; 
Seventh Council Directive 83/349/EEC of 13 June 1983 on consolidated accounts; Council Directive 86/635/EEC 
of  8  December  1986  on  the  annual  and  consolidated  accounts  of  banks  and  other  financial  institutions;  Council 
Directive 91/674/EEC of 19 December 1991 on the annual and consolidated accounts of insurance undertakings. 

85% of investors assert that the annual audit adds value to them, see: ICGN (International Corporate Governance 
Network;  representing  main  international  investors)  /  GPPC  (Global  Public  Policy  Committee;  representing  6 
major audit networks): "Survey of investor attitudes on financial reporting and auditing", 2007 (hereafter, referred 
to as the ICGN/GPPC survey). 

Directive  2006/43/EC  of  the  European  Parliament  and  of  the  Council  of  17  May  2006  on  Statutory  Audits  of 
Annual  Accounts  and  Consolidated  Accounts,  amending  Council  Directives  78/660/EEC  and  83/349/EEC  and 
repealing Council Directive 84/253/EEC 

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•  the  insurance  conditions  for  statutory  auditors  and  audit  firms,  including  an 

objective analysis of the limitations on financial liability.  

In  the  light  of  the  above  report,  the  Commission  may  submit  recommendations  to 
Member States.  

Against this background, the Commission mandated, as a preparatory step, London 
Economics  to  conduct  an  independent  study4  on  the  economic  impact  of  auditors' 
liability  regimes.  The  study  also  focused  on  the  insurability  of  major  audit  firms. 
Simultaneously,  the  Commission  set  up  a  European  Forum  of  market  experts  (the 
Auditors' Liability Forum5) in November 2005 in order to assist in the preparation of 
the study, as data on this issue was not readily available in all Member States. The 
Forum  comprises  twenty  market  experts,  with  varying  professional  backgrounds, 
(e.g. auditors, bankers, investors, companies, insurers and academics), with particular 
experience  and  knowledge  of  the  subject.  The  London  Economics  study  was 
completed and published in October 2006. The study considers the different options 
for limiting auditor liability. 

In January 2007, the Commission Services launched a public consultation process to 
ascertain whether there is a need to reform auditors' liability and to examine possible 
ways forward for reforming auditor liability rules in the Member States. On the draft 
consultation document, SG, LS, DG COMP, DG ECFIN, DG SANCO and DG JLS 
were consulted. The Commission services invited stakeholders to give their views on 
the issues involved by March 2007 and presented four possible options for a potential 
reform. The four options were: 

•  One single monetary cap at EU level 
•  Cap depending on the company’s size 
•  Cap depending on the audit fees charged to the company 
•  Proportionate liability 

The  Commission  Services  also  presented  an  overview  of  the  legal  situation  in 
Member States.  

85 replies were received from various stakeholders located in 15 Member States, and 
included replies from the audit profession, insurers, companies, investors, academics, 
banks  and  regulators  (see  Annex 1).  66%  of  all  respondents  (of  which  35%  come 
from  audit  profession,  representing  all  respondents  from  audit  profession,  and  31% 
from outside the audit profession) support a limitation on auditors' liability, whereas 
29%  rejected  the  possibility.  Most  of  respondents  also  expressed  a  deep  concern 
about lack of choice in the international audit market6.  

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London  Economics  in  association  with  Professor  Ralf  Ewert,  Goethe  University,  Frankfurt  am  Main,  Germany: 
"Study  on  the  Economic  Impact  of  Auditors'  Liability  Regimes",  September  2006  (hereafter,  referred  to  as  the 
London Economics study): http://ec.europa.eu/internal_market/auditing/liability/index_en.htm 

For  further  information  on  the  composition  and  role  of  the  Forum,  see  press  release  on  DG  MARKT  website: 
http://europa.eu/rapid/pressReleasesAction.do?reference=IP/05/1420&format=HTML&aged=0&language=EN&gu
iLanguage=en 

For  further  information  on  the  results  of  the  public  consultation,  see  summary  report  on  DG  MARKT  website: 
http://ec.europa.eu/internal_market/auditing/docs/liability/summary_report_en.pdf 

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In parallel to the public consultation, the Commission mandated OXERA to carry out 
a  further  study.  The  study  focussed  more  on  other  topics,  such  as  ownership  and 
capital  structures  of  audit  firms  evaluating  the  current  situation.  One  of  its 
conclusions  is  also  relevant  for  this  impact  assessment:  it  confirmed  that  liability 
risks for audit firms acts as barrier for mid-tier audit firms entering the market for the 
audit of listed companies at international level.  

2.2. 

Study on civil liability systems of statutory auditors in the EU 

From a legal side, the issue of auditors' liability was already examined in a study for 
the Commission7 in 2001. The purpose of the study was to determine to what extent 
the  different  civil  liability  systems  for  auditors,  which  exist  in  the  Member  States 
could  constitute  an  obstacle  to  the  development  of  a  European  single  market  for 
auditing  services.  The  study  found  the  differences  between  the  legal  regimes  to  be 
significant, but did not recommend that changes be made at that time. However the 
audit  market  has  changed  since  the  publication  of  the  study  (in  particular,  Arthur 
Andersen,  one  of  the  then  five  audit  networks,  collapsed  in  2002),  and  these 
conclusions may no longer be appropriate.  

2.3. 

Inter Services Steering Group 

An  Inter  Services  Steering  Group  was  convened.  The  following  services  were 
consulted:  SG,  SJ,  DG  JLS,  COMP,  ECFIN  and  DG  SANCO.  DG  COMP  and  SG 
made contributions which have been taken into account. In addition, DG COMP, DG 
ECFIN  and  JLS  were  consulted  on  the  draft  terms  of  reference  for  a  study  on  the 
economic  impact  of  auditors'  liability  regimes  and  the  draft  report  of  the  London 
Economics study. 

2.4. 

Impact Assessment Board 

This Impact Assessment was reviewed by the Impact Assessment Board (IAB). The 
recommendations for improvements have been accommodated and a revised version 
of the report was resubmitted to the Board. The following changes were made: 

•  The  problem  statement  was  amended  to  present  more  the  market  barriers  and 
public interest issues being addressed (changes made to sections 3.1 and 3.2). 

•  More  references  have  been  added  to  include  evidence  of  relevant  experiences 
from Member States and also from the USA (changes made to sections 6.1.3 and 
6.1.4. Sections 6.2, 6.3, 6.4 and 6.5 also include evidence of such experiences). 

•  Developing  the  options  in  greater  details.  Section  5.2  has  been  expanded. 
Additional  text  was  added  to  section  6.4.2  to  make  the  legal  and  institutional 
differences between implementing option 4c via a Directive or a Recommendation 
clearer. 

7 

Thieffry & Associates: "A study on systems of civil liability of statutory auditors in the context of a Single Market 
for auditing services in the European Union", Report to the European Commission. Update by DG Internal Market 
and Services in January 2007. 

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•  The  section  on  Monitoring  and  Evaluation  has  been  expanded  to  provide 
indicative timing and more detail on the sort of data which it would be useful to 
monitor.  The  Commission  would  propose  the  collection  of  information  every  4 
years.  

•  The Commission will review this information and discuss it with Member States. 
Further  debate  with  private  stakeholders  (audit  firms,  investors,  companies, 
insurers) will take place on the basis of this information. 

In general, the opinion on the revised draft of the Impact Assessment was positive, 
and  the  amended  version  was  welcomed  for  having  identified  the  market  failures, 
presented the public interest in question and for having well defined the objectives. 

3. 

PROBLEM DEFINITION 

3.1. 

The public interest 

It  is  in  the  public  interest  to  ensure  a  sustainable  audit  function  and  accordingly  a 
competitive market for audit firms. Investments or divestments on European capital 
markets  would  otherwise  be  seriously  constrained.  Many  decades  ago,  it  became 
mandatory for companies to have their financial statements audited. It was decided in 
many jurisdictions, including those in the European Union, that audit services should 
be  supplied  by  private  audit  firms  and  not  by  public  authorities  or  regulatory 
agencies.  

The  purpose  of  a  statutory  audit  is  to  give  reasonable  assurance  that  financial 
statements are free from material misstatements and provide a true and fair view of 
the  company’s  financial  position.  Regulators  acknowledge  that  the  opinion  of  a 
statutory  auditor  cannot  provide  an  absolute  assurance  but  should  offer  reasonable 
assurance to the public, notably to shareholders or other investors.  

The market for the provision of audit services is based on two simple premises. On 
the  one  hand,  companies  should  be  able  to  choose  their  auditors  according  to  their 
needs and at a reasonable cost. On the other hand, investors should have the benefit 
of an independent audit opinion based on a high quality audit8. On balance, private 
audit  firms  should  therefore  be  offered  a  workable  framework  for  providing  high 
quality audit services, in particular for capital markets where investors invest in large 
multinational companies.  

Listed companies often demand (and need) an auditor present or represented in more 
than 50 jurisdictions in the world or even more. However, there is a market failure on 
the  supply  side  as  they  are  just  four  networks  (the  so-called  Big  49)  capable  of 
meeting the demand for international audit services for listed companies. Compared 
to 2000/2001, there is an increasing real risk that one of  these networks disappears 
for many reasons. Prospects that another major player on the supply side enters the 
market  are  however  very  low.  It  takes  time  and  resources  to  build  a  large 

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85% of investors assert that the annual audit adds value to them, see: ICGN/GPPC survey 

PWC, KPMG, Deloitte, Ernst & Young 

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international network able to respond to the demand of listed companies. Networks 
of  audit  firms  are  not  global  international  companies  but  rather  associations  of 
independent local audit firms. The reason for such organisation is the unwillingness 
of local audit firms to share unpredictable liability risks for which no insurance cover 
is available with other audit firms in other jurisdictions.  

Existing  networks  or  new  players  are  unwilling  to  invest  in  the  audit  firms  and 
develop new networks structures able to compete with one of the Big 4. One of the 
reasons might be strict ownership rules for audit firms, requiring that majority of the 
voting  rights  in  an  audit  firm  is  held  by  the  auditors.  The  prevailing  reason  is  that 
high liability risks render any new investments into audit firms not attractive.  

As  a  consequence,  there  is  a  fear  that  the  international  audit  market  for  listed 
companies might not be sustainable over time.  

3.2. 

Issues in the international audit market 

3.2.1.  The demand side: listed companies 

Capital  markets10  can  no  longer  be  viewed  purely  from  a  domestic  perspective.  A 
much  more  integrated  European  capital  market  is  about  to  emerge  due  to  the 
successful implementation of the Financial Services Action Plan between 2001 and 
2005 as part of the Lisbon agenda. Investors today invest in multinational companies, 
the securities of which are listed and traded at different stock exchanges in the EU or 
around  the  world11.  To  this  end,  investors  rely  on  audited  financial  statements  to 
assess the merits of investing in multinational companies12.  

Confidence in the financial statements is essential for investors to be able to decide 
where  to  allocate  their  capital  to  listed  companies  across  borders.  In  2005 
international financial reporting standards (IFRS) were introduced in the EU for the 
financial  statements  of  all  listed  companies  in  Europe.  They  establish  a  common 
accounting framework enabling investors to compare financial statements throughout 
the European Union and even at a global level. The role of the statutory auditor is to 
contribute to the credibility of these financial statements. 

As  at  June  2006,  the  number  of  large  companies  listed  on  Europe's  prime  stock 
exchange  indexes  was  58513.  The  number  of  companies  listed  on  Europe's  main 
national  stock  exchanges  is  estimated  at  between  7.000  and  8.00014  in  2008.  The 

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A capital market is the market for securities, where companies and the government can raise long-term funds. A 
capital market includes the stock market and the bond market. 

The most important stock exchanges worldwide are the NYSE Euronext (market value: US$ 20.7 trillion, Tokyo 
Stock Exchange (market value: US$ 4.63 trillion), NASDAQ (market value: US$ 4.39 trillion) and London Stock 
Exchange  (market  value:  US$  4.21  trillion),  figures  as  of  October  2007,  see  World  Federation  of  Exchanges  – 
Statistics/Monthly. 

Financial analyses based on financial statements are often used by investors and are prepared by financial analysts, 
thus providing them with the basis in making investment decisions. 

London Economics study 

As regards the importance of those companies for the EU economy (in terms of market capitalization and turnover) 
see annex 3 

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market capitalisation of listed entities in the EU-25 countries amounts to nearby € 11 
trillion in 200715 (for details see Annex 2).  

Although there are several thousand audit firms existing in the EU, only a few audit 
firms are appointed by these thousands of listed companies as their statutory auditor. 
Moreover, these companies rarely switch from one audit firm to another so that audit 
firms have few opportunities to gain clients. Due to the organisational structure and 
the  international  reach  of  the  Big  4,  capital  markets  are  effectively  dependent  on 
them  to  supply  the  required  statutory  audits  for  multinational  companies  with 
subsidiaries,  in  some  cases  operating  in  more  than  100  countries  (see  3.2.2.). 
According to London Economics, on average around 4% of listed companies change 
their auditor per year in Europe. Often, companies keep their audit firms for decades. 
The  following  findings  established  by  London  Economics  show  that  1/3  of 
interviewed  companies  keeps  their  auditors  for  more  than  10  years  and  1/2  of 
companies for more than 7 years.  

Number  of  years  the  current  auditor  has  served  as  auditor  of  the 
company 

Number of years 

Share of respondents 

1 to 3 years 

4 to 6 years 

7 to 10 years 

11 to 15 years 

More than 15 years 

Source: London Economics survey of companies 

13% 

33% 

20% 

2% 

31% 

The international companies in essence choose their auditors according to two main 
criteria:  

•  The  first  criterion  relates  to  the  client’s  actual  need  for  its  auditor  to  have  a 
multinational  presence  and  a  corresponding  capacity  to  handle  large  audit 
assignments. This has also been one of the main drivers for mergers of audit firms 
over the last twenty years. As a result, the Big 4 networks16 cover more than 100 
countries.  

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Stock  market  capitalisation  of  the  most  representative  stock  exchanges  in  EU-25  Member  States  in  September 
2007, see European Central Bank: 
http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1996,39140985&_dad=portal&_schema=PORTAL&screen=
detailref&language=en&product=EU_MAIN_TREE&root=EU_MAIN_TREE/economy/main/shorties/euro_mf/mf
090 

The Big 4 are by far the largest auditors both globally and in most individual jurisdictions. They are followed by a 
group of audit firms loosely referred to as the ‘mid-tier’ firms, some of which also have significant international 
networks, but are overall much smaller in size. 

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•  The  second  criterion  relates  to  the  acquired  reputation  of  the  auditor.  Many 
studies  show  that  listed  companies  choose  the  auditor  on  the  basis  of  its 
reputation17. This is particularly true for large listed companies (defined in terms 
of  turnover  exceeding  €  100m,  see  columns  2-4  in  the  following  table).  In 
contrast, the reputation of the audit firm is less important for smaller companies 
(defined  in  terms  of  turnover  less  than  €  100m,  see  column  1  in  the  following 
table). Large listed companies effectively tend to favour the Big 4 firms because 
their  reputation  makes  such  a  choice  easier  to  explain  and  defend  towards 
investors and capital markets in general.  

A  company  survey  organised  by  London  Economics  in  2006  supports  these  two 
findings:  

Importance of factors in choice of a provider of audit services in a 
company’s home country - company responses18 broken down by turnover 
in 2005–  
average rating from 1 (least important) to 5 (most important) 

Factors 

<€100m 

Breakdown by company turnover 

€100m-
€1,000m 

€1,000m-
€10,000m 

>€10b 

Size of the audit firm 

Multinational presence of the 
audit firm 

Reputation of the audit firm 

Previous experience of the audit 
firm 

Audit firm’s knowledge of the 
company 

Audit firm’s knowledge of the 
company’s sector(s) 

Previous experience of the 
company with the audit firm 

References from other about the 
audit firm 

3.8 

3.2 

3.7 

4.0 

3.8 

3.6 

3.3 

2.6 

2.9 

3.9 

4.3 

3.7 

3.5 

3.4 

3.9 

2.4 

4.1 

4.4 

4.7 

3.9 

3.6 

3.4 

3.6 

2.4 

3.7 

3.8 

4.3 

3.8 

3.5 

3.7 

3.3 

2.8 

Source: London Economics survey of companies 

At present, it does not appear that listed and international companies see any other 
audit firms as a possible alternative to the Big 4 networks. The following survey in 
the  largest  audit  market  in  the  EU  (the  UK)  also  indicates  that  mid-tier  audit 
networks are not viewed by companies as a real alternative. 

17 
18 

Oxera Competition study ; London Economics study 

For each of the EU-25 Member States the survey sample includes all companies included in the main index of the 
main  domestic  stock  exchange  as  well  as  a  random  sample  of  other  companies  listed  on  the  stock  exchange.  In 
addition,  in  case  of  Euronext  and  the  London  Stock  Exchange,  a  number  of  firms  listed  on  the  "unregulated 
markets" (Alternext and AIM) were also surveyed. Furthermore, a number of unlisted European companies with an 
annual  turnover  in  excess  of  €  500m  were  also  surv eyed.  Altogether,  146  responses  from  companies  from  all 
Member States (except of Czech Republic, Estonia, Cyprus, Latvia, Slovenia and Slovakia) were received. 

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Likelihood of considering a mid-tier audit firm network for the company’s audit  

(number of companies, based on UK survey) 

30

25

20

15

10

5

0

FTSE Small Cap companies 

FTSE 350 companies

1

4

2

3

3

2

19

5

7

4

Very likely

Fairly likely

Neither likely nor unlikely

Fairly unlikely

Very unlikely

Base: 50 responses by UK audit committee chairs for the whole sample, 32 for FTSE 350 companies and 18 for FTSE Small Cap companies. 

Source: Oxera (2006), op. cit., Figure 3.9. 

3.2.2.  The supply side: the type of players 

a) Need for multinational players operating in an integrated structure 

Audit firms willing to address the demand of international companies forge networks 
at international level under a common brand, such as the names used by the Big 4. 
These international network structures bring together individual member firms which 
are  located  in  many  jurisdictions.  The  integration  of  a  network  is  in  practice 
implemented by an  umbrella organisation. Such an umbrella organisation is a legal 
entity typically owned by member (individual) audit firms. Where firms participate 
in such an umbrella organisation, they are asked to provide a financial contribution. 
However,  the  umbrella  organisation  does  not  provide  any  audit  services  to  any 
outside  clients.  Instead,  it  co-ordinates  the  overall  business  development  and 
manages liability risks across all audit firms belonging to its network. Such networks 
are  the  response  to  the  demand  of  companies,  but  imply  due  to  their  nature  a  high 
degree  of  fragmentation.  Effectively,  auditors  do  not  operate  on  the  basis  of  large 
multinational companies, but a puzzle of local firms within a common network. 

The  2006  Directive  on  Statutory  Audit  (in  particular  Article  2  No  7)  provides  a 
definition for such a network meaning a "larger structure: 

–  which is aimed at co-operation and to which a statutory auditor or an audit firm 

belongs, and 

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11 

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–  which  is  clearly  aimed  at  profit-  or  cost-sharing  or  shares  common  ownership, 
control  or  management,  common  quality  control  policies  and  procedures,  a 
common business strategy, the use of a common brand name or a significant part 
of professional resources." 

Network definitions exist in other jurisdictions in the world. The network definition 
has become necessary to reach two objectives:  

•  First,  the  coordination  of  all  business  activities  across  an  international  network 
should  not  impede  the  independence  of  the  individual  auditor  auditing  the 
financial statements of a company. Article 22 of the 2006 Directive on Statutory 
Audit implements this objective; 

•  Second, local audit firms use the international brand to gain new clients. For this 
reason,  Article  40  of  the  2006  Directive  on  Statutory  Audit  provides  for 
transparency by requiring audit firms of listed companies to provide a description 
of  the  network  to  which  they  belong  as  well  as  of  the  legal  and  structural 
arrangements in the network. 

b) Unwillingness to share liability risks with other audit firms at international level 

There  is  a  contradiction  in  the  current  international  audit  market  caused  by  an 
important  market  failure  on  the  supply  side:  on  the  one  hand,  the  demand  side 
requires the presence of an auditor in all countries where a company has subsidiaries 
in order to provide an integrated service. On the other hand, the supply side structure 
is  fragmented:  independent  ownership  of  domestic  audit  firms  seems  to  prevail 
because  of  the  unwillingness  of  such  firms  to  share  liability  risks  with  other  audit 
firms  in other jurisdictions. This  even  seems to apply to the Big 4 firms, which do 
not  set  up  transnational  firms  offering  audit  services  to  multinational  companies. 
However, the more the networks are integrated, the better they satisfy the companies 
demand for international audits. 

In  addition,  differences  in  liability  regimes  at  international  level  are  an  important 
barrier to cross-border integration of the networks of audit firms19. These differences 
can  make  risk  management  within  an  international  network  (i.e.  by  an  umbrella 
organisation) a very costly task. However, such a cost is easier to manage for the Big 
4  than  for  the  mid-tier  audit  firms.  The  high  level  of  integration  amongst  their 
network  partners  allows  the  Big  4  networks  to  cover  audit  risks  by  captive 
insurances.  

3.2.3.  The supply side: the Big 4 – too few players? 

a) The market share of the Big 4 

Although there are several thousand audit firms operating under different names and 
brands, the statutory audit market for companies listed on capital markets  is highly 

19 

Oxera Ownership Study page 102 and further 

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12 

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concentrated  in  major  economies  in  the  world20  such  as  the  US21,  Japan22, 
Germany23, France24, Italy25 and the UK26.  

Similarly,  the  results  of  London  Economics'  survey  show  that  the  statutory  audit 
market for companies listed on the European capital markets is highly concentrated 
and dominated by the Big 4 networks in all the Member States. In 2004 the market 
share of the four largest audit firms, for companies of the main stock exchange index 
across Member States27, ranged between 83% and 100% (see table in Annex 3). In 
the  EU  financial  services  sector,  the  Big  4  hold  around  90%  of  the  statutory  audit 
mandates  of  financial  institutions  (banks  and  insurance  service  providers).  In  a 
number of countries, the Big 4 firms hold all statutory audit mandates from financial 
institutions. 

The  market  has  become  significantly  more  concentrated  over  the  last  ten  years. 
Specifically, the merger between the second-largest audit firm (Coopers & Lybrand) 
and the fourth largest audit firm (Price Waterhouse) in 1998 reduced the then Big-6 
audit  firms  to  the  Big  5.  Subsequently,  the  demise  of  Arthur  Andersen  in  2002 
(following bankruptcy of the energy company Enron in the US) reduced the number 
of global networks to the current Big 428.  

b) The risk of a Big 3 scenario 

The limited number of players might shrink further for different reasons. The Big 4 
assert  that  a  catastrophic  claim  could  lead  to  the  collapse  of  one  of  them.  Another 
risk  might  be  that  major  audit  firms  could  implode  due  to  an  immediate  loss  of 
confidence and reputation by client companies who become aware of a major audit 
failure  by  an  individual  audit  partner  inside  the  international  network,  as  is 
commonly held to be the reason for the collapse of Arthur Andersen in 2002. A third 

For a general overview, see International Accounting Bulletin, 21.12.2005, IAB survey, "A common interest in the 
future", p. 6ss 

The  Big  4  firms  audit  over  78%  of  all  U.S.  public  companies  and  99%  of  all  U.S.  public  companies  with  sales 
greater than US$ 5 billion; see: US General Accounting Office (GAO): "Public Accounting Firms. Mandated Study 
on Consolidation and Competition. Report to the Senate Committee on Banking, Housing, and Urban Affairs and 
the House Committee on Financial Services", July 2003 

According to Daiwa Securities SMBC, the market share of the Big 4 amounted to 94% in 2005. 

Grothe,  J.:  "Branchenspezialisierung  von  Wirtschaftsprüfungsgesellschaften  im  Rahmen  der  Jahresabschluss-
prüfung.  Ergebnisse  einer  empirischen  Untersuchung  des  deutschen  Prüfungsmarktes",  IDW  Verlag,  Düsseldorf 
2005.  A  study  published  in  September  2007  by  Luenendonk  on  the  German  audit  market  shows  the  5th  largest 
audit network BDO far behind the smallest Big 4 network in terms of turnover: PWC: € 1.2 billion; KPMG: € 1.1 
: http://www.luenendonk.de/presse.php 
billion; E&Y: € 0.9 billion; Deloitte: € 0.5 billion; BDO: € 0.1 billion, see

Study of the Autorité des Marchés Financiers (AMF) in 2005 

M. Longo/A. Macchiati, Quality in Corporate Auditing, Banca, Impresa e Societa, 1999, p. 259 i 

Oxera: "Competition and choice in the UK audit market. Report prepared for Department of Trade and Industry and 
Financial Reporting Council", April 2006 (hereafter referred to as the Oxera Competition study) 

instance, 

in  2004,  971  companies 

For 
in  Germany  were  audited  by  198  audit  firms;  see 
Wirtschaftsprüferkammer:  "Anbieterstruktur  und  Mandatsverteilung  im  Wirtschaftsprüfermarkt",  WPK-Magazin 
1/2006.  Meanwhile,  the  number  of  audit  firms  present  in  this  market  has  dropped  to  150;  see  WPK-Magazin 
2/2007. 

listed 

Oxera Competition study 

20 

21 

22 
23 

24 
25 
26 

27 

28 

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risk might be an indictment or removal from a register in a major country harming 
the brand of the entire network. 

Other  recent  examples  confirm  the  threat  of  a  Big  3  scenario.  KPMG,  under 
investigation  in  the  US  for  selling  questionable  tax  shelters,  was  at  the  brink  of  an 
indictment  action  by  the  US  Department  of  Justice,  but  finally  paid  a  fine  in  2005 
and accepted an outside monitor of its operations under terms of an agreement that 
heads off prosecution. In 2006, ChuoAoyama, the former PwC representative firm in 
Japan  had  its  auditing  license  suspended  for  July  and  August  as  punishment  for  its 
involvement in the accounting scandal at Kanebo; ultimately PwC decided to leave 
the Japanese market and to wind up ChuoAoyama.  

At the international level, the International Organisation of Securities Commissions 
(IOSCO)  initiated  a  debate in  2007  around  issues  related  to  audit  quality  and  audit 
market, including scenarios for contingency planning should one of the major audit 
firms  fail.  Along  the  same  line,  the  new  International  Forum  of  Independent  Audit 
Regulators (IFIAR) has been discussing since 2007 if and what emergency planning 
should be put in place to deal with a situation where one of the Big 4 audit networks 
is no longer available for large international audit assignments. This means that these 
organisations  believe  that  the  risk  of  a  Big  3  Scenario  is  sufficiently  tangible  as  to 
warrant further consideration. 

c) Choice can be even more limited due to independence rules 

In  the  last  decades,  audit  networks  have  developed  a  wide  range  of  additional  non 
audit services (business consulting, IT services, bookkeeping …) in order to increase 
their  profitability.  This  is  a  natural  development  for  private  business.  However, 
regulators  intervene  where  the  independence  of  an  individual  auditor  towards  the 
company  to  be  audited  might  be  impaired.  The  auditor's  opinion  on  financial 
statements should in particular not be biased by conflicts of interests due to the fact 
that  they  also  provided  other  services,  such  as  IT  or  consulting,  to  the  same 
company: in such a case the auditor could even be obliged to step down and not carry 
out  the  audit  for  the  company  in  question.  As  audit  business  activities  are  co-
ordinated across a network, independence rules have been extended to the networks 
to which auditors belong. 

Independence rules have been reinforced in the last years both in the European Union 
(under  the  2006  Directive  on  Statutory  Audit)  and  in  the  US  (under  the  2002 
Sarbanes-Oxley-Act)  in  order  to  prevent  auditors  to  provide  non  audit  services  to 
their audit clients.  

The  consequence  however  is  that  companies  in  practice  do  not  have  a  choice 
between four major suppliers but between even fewer. International companies also 
select  Big  4  firms  for  the  provision  of  these  non  audit  services  (tax  advisory, 
consulting,  …)  and  are  therefore  prevented  from  appointing  the  same  firm  as  their 
auditor.  If  more  networks  were  available  on  the  supply  side,  there  would  be  fewer 
problems. Again, this is a new development since the legal situation was reviewed in 
2001  when  the  Commission  decided  not  to  take  action  on  auditor  liability  (see 
chapter 2.1) 

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14 

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Opening  up  the  independence  rules  would  certainly  promote  wider  choice  amongst 
the  Big  4  audit  networks.  However,  it  is  not  likely  to  be  an  acceptable  (nor 
appropriate)  way  of  addressing  the  market  failure.  Independence  rules  were 
strengthened in 2002 to respond to major public concerns arising in recent years that 
too  flexible  independence  rules  effectively  led  to  audit  failures  and  corporate 
scandals such as Enron in the US.  

3.2.4.  Failures preventing the entry of new players 

a) Ownership rules and capital structures  

In order to develop well integrated network structures able to compete with the Big 
4, mid-tier audit firms or completely new entrants would need to significantly invest. 

One  of  the  key  findings  of  the  OXERA  study29  is  that  external  ownership  (owners 
which are not auditors) might contribute positively to a decision by a mid-tier audit 
firm to expand into the larger audit market for international listed companies. 

However, Article 3 of the Directive on Statutory Audit requires that the majority of 
the  voting  rights  in  audit  firms  should  be  held  by  statutory  auditors.  The  Directive 
also requires that auditors control the management body in their firms. Accordingly, 
under these rules, outside investors could only ever hold less than 50% of the voting 
rights  in  an  audit  firm  and  would  be  prevented  from  controlling  the  firm's 
management body. 

One particular solution for mid-tier audit firms might be to open up ownership rules 
and control structures within an audit firm. This would also require modification of 
the 2006 Directive on Statutory Audit, to allow external parties throughout the EU to 
invest  and  provide  the  necessary  capital  for  sharing  liability  risks  whilst  increasing 
profits  when  auditing  listed  companies.  However,  there  are  significant  potential 
downsides,  relating  to  issues  such  as  the  independence  of  auditors  and  the  need  to 
attract and retain human capital in such audit firms. DG Internal Market has therefore 
decided  to  launch  a  public  consultation  on  the  issue  of  ownership  rules  for  audit 
firms.  

b) Negative impact of liability risk and insurance conditions on investment in mid-
tier audit firms 

Another  finding  of  Oxera  was  that  any  change  of  ownership  rules  would  however 
still be dependent on how liability risks for new investors are addressed. If these risks 
are  not  insurable,  investments  in  an  audit  firm  will  not  be  attractive  for  investors 
coming both from outside and inside the audit profession. 

The Oxera study stresses that liability risk is a barrier to audit firms raising external 
and  internal  capital.  To  the  extent  that  large  statutory  audits  are  associated  with 
substantially greater liability risks, potential investors and partners in mid-tier audit 
firms would judge liability risks to be too high. The impact of liability risks on the 
cost of capital might be significant and lead to capital rationing.  

29 

Oxera Ownership study 

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15 

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London Economics30 also found that liability risks, combined with the very limited 
insurance capacity are barriers for major mid-tier firms seeking to enter the statutory 
audit market for large companies listed on capital markets. 

The barriers to entry to the market for large audits have also been at the centre of a 
recent  debate  about  choice  in  the  audit  market,  launched  by  the  regulator  for  audit 
firms  in  the  United  Kingdom,  the  Financial  Reporting  Council  (FRC)31.  Their  first 
recommendation was to encourage opening up ownership rules. This debate was only 
launched after the UK's decision in 2006 to introduce under its national company law 
act a possibility for auditors to limit their liability by contract. 

To  conclude,  the  risk  exposure  of  the  audit  profession  and  the  lack  of  insurance 
coverage  are  key  for  explaining  the  current  shortages  on  the  supply  side.  These 
issues are explained in more detail below. 

3.3. 

Risk exposure for the audit profession 

Both  London  Economics32  and  Oxera33  found  that  liability  risks  combined  with  a 
very limited insurance capacity are barriers for major mid-tier firms or other players 
seeking  to  enter  the  statutory  audit  market  for  large  companies  listed  on  capital 
markets.  

3.3.1.  The liability regimes  

The  statutory  auditor  is  liable  to  his  client  for  damages  caused  by  the  auditor's 
negligence or even wilful misconduct. In general, liability actions might be either in 
contract34, tort35 or both. However, auditors might also be liable to other parties. 

Auditors  are  liable  for  their  audits  in  case  of  fault.  Strict  liability  for  auditors  does 
not  apply  in  relation  to  their  audit  work.  In  the  overwhelming  number  of  claims 
against auditors, the issue is whether the auditors have been negligent. Accordingly, 
the  discussion  in  this  impact  assessment  does  not  seek  to  address  the  question  of 
limiting  liability  where  there  has  been  wilful  misconduct  of  an  auditor  (which 
includes collusive behaviour with management in committing corporate fraud).  

a) Liability towards third parties 

30 
31 

32 
33 

34 

35 

London Economics study, P.xxviii 

Financial  Reporting  Council:  "Choice  in  the  UK  Audit  Market.  Final  Report  of  the  Market  Participants  Group", 
October 2007 

London Economics study, P.xxviii 

Oxera Ownership study, section 7.2.5., P. 174 

A contract is a legally binding exchange of promises or agreement between parties that the law will enforce. Breach 
of  contract  is  recognised  by  the  law  and  remedies  can  be  provided.  Under  contractual  law,  a  statutory  auditor  is 
liable for a breach of his duties under a contract (e.g. of the audit contract concluded between the statutory auditor 
and the audited company). 

The tort law applies, when one harms another's legal rights, or breaches a duty owed under statutory law. Under tort 
law, a statutory auditor is liable for a breach of his duties under statutory or common law of individual jurisdictions 
(e.g. breaches of the professional standards set under Community or national law). 

EN 

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Individual shareholders, creditors and prospective purchasers of an audited company 
rely on the statutory auditor’s report and may, as a result, suffer damages.  

In a majority of Member States, any third party could seek to recover damages from 
the  statutory  auditor  upon  proving  the  elements  of  the  liability  claim,  usually  fault 
(intentional conduct or negligence in any degree), damage and causation. This causal 
link between the damage and the fault might sometimes be difficult to establish for 
the  third  parties.  In  a  minority  of  Member  States,  actions  by  third  parties  are 
restricted:  the  statutory  auditor  has  to  owe  a  duty  of  care  to  the  third  party  in 
question, i.e. the auditor knew or ought reasonably to have known that his work or 
report  would  be  relied  on  by  the  claimant  for  a  particular  purpose.  (The  different 
regimes relating to third party claims are presented in more detail in Annex 4).  

b) Joint and several liability  

The  liability  of  the  auditor  and  the  audited  company  towards  third  parties 
(shareholders,  creditors)  and  of  the  advisors  of  the  company  (auditors  and  other 
advisors) towards the company is joint and several in almost all Member States (see 
Annex 4). Under the system of joint and several liability, the auditors might be held 
financially  liable  "in  solidum"  with  other  parties,  towards  the  victim  for  the  whole 
damage. In the case of a failed company, therefore, third parties may decide to sue 
the  directors  of  the  company  (who  carry  legal  responsibility  for  the  financial 
statements  of  the  company).  They  may  also  sue  the  statutory  auditors,  who  have 
provided an unqualified audit report for the company prior to its collapse, even if the 
auditor's  fault  and  contribution  to  the  damage  is  of  minor  importance.  In  contrast, 
under  proportionate  liability,  damages  are  only  allocated  among  wrongdoers  in 
proportion to their level of responsibility.  

c) Liability risks in a cross-border context 

Cross-border  liability  risks  stem  primarily  from  client  companies:  multinational 
companies are commonly organised as a group having separate subsidiaries in many 
countries. The auditor of the group financial statements is required to co-operate with 
other  auditors,  who  perform  the  audit  work  on  the  financial  information  of  many 
foreign subsidiaries. The group auditor may therefore face risks arising not from the 
work at the group audit, but as a result of being accountable in certain circumstances 
for the audit of those foreign subsidiaries spread over 50 to 100 countries. 

A further liability risk at international level comes from the investor side: investors 
are located in different jurisdictions and therefore may not be in the same jurisdiction 
where  the  company  and  its  auditor  are  located.  Accordingly,  there  is  a  risk  that 
auditors can be sued in different jurisdictions by different plaintiffs in relation to the 
same audit and the same company.  

3.3.2.  Deep pocket syndrome  

Unlimited liability is often considered by potential plaintiffs as insurance against any 
and every deficiency detected in financial statements. Yet, auditors can only give a 
reasonable, and not an absolute assurance to the public that the company's financial 
statements provide a true and fair view of the company’s financial position (see Art. 
51  1  (a)  of  the  4th  Company  Law  Directive).  This  is  due  to  the  fact  that  financial 

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17 

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statements,  which  are  prepared  by  the  audited  companies,  include  inherent 
limitations36 which cannot be overcome by the statutory auditor. 

A  liability  regime  under  which  a  statutory  auditor  is  perceived  to  be  liable  for  any 
damage  caused  by  the  failure  of  the  audit  client  creates  the  expectation  amongst 
potential plaintiffs that statutory auditors are gatekeepers against any corporate fraud 
or other corporate malpractice. Joint and several liability reinforces this “expectation 
gap” for plaintiffs. Thus, statutory audit firms frequently risk being viewed as having 
“deep pockets”37.  

3.3.3.  Predictability of litigation costs  

In the 59 cases concluded between 1998 and 2005 for which relevant information is 
publicly available, the average settlement was slightly less than 12% of the damages 
sought by a plaintiff. In almost one fifth of the cases, the award or settlement ratio 
ranged from about 25% to almost 40% of the initial claim38. This could imply that 
plaintiffs simply attempt to claim large amounts, but are restricted to more "realistic" 
amounts in the actual settlements.  

It  is  however  not  only  the  final  settlement  costs  which  are  significant.  The  costs 
involved in dealing with claims are also considerable, as liability claims may take a 
very long time to be resolved. It is not uncommon for larger claims to take between 
five  to  ten  years  to  finalise.  Litigation  costs  increase  over  time  and  may  fluctuate 
considerably from year to year. 

Between 1999 and 2004, the gross costs of awards and settlements incurred by Big 4 
firms in the U.S. (where data is available) rose from 7.6% to about 11% of total audit 
revenues.  Net  costs  in  the  US,  including  insurance  premiums  and  recoveries  from 
insurance  companies,  rose  even  more  sharply,  almost  doubling  from  7.7%  of  total 
audit fee revenues in 1999 to 14.2% in 200439.  

The  London  Economics  Study40  stated  that  it  had  not  been  possible  to  obtain 
comparable data for the European audit firms in individual countries. On the basis of 
interviews  with  audit  firms41,  it  has  been  estimated  however,  that  the  total  costs  of 

36 

37 

38 
39 
40 
41 

The  preparation  of  financial  statements  in  accordance  with  the  entity’s  applicable  financial  reporting  framework 
involves judgement by management in applying the requirements of that framework to the facts and circumstances 
of that entity. Further, certain financial statement assertions may be of such a nature that the related audit evidence 
available  can  only  be  persuasive  rather  than  conclusive,  or  involve  subjective  decisions  or  assessments  by 
management or a degree of uncertainty relating to the reliability of their measurement. For example, the estimation 
of  the  outcome  of  uncertain  events  that  may  only  be  confirmed  in  the  future,  as  may  also  be  the  case  with  the 
estimation of amounts reported on the basis of fair value. 

Under the “deep pocket” syndrome, the audit firm is typically viewed by plaintiffs as having the largest resources 
and is therefore the target of complaints irrespective of the contribution and responsibility of the firm to the event 
giving  rise  to  the  complaint.  Similarly,  wealthy  individuals  or  large  corporations  are  often  referred  to  as  having 
"deep pockets", since it is assumed that their wealth will not be affected materially if the risk event occurs.  

London Economics Study, p. 83 

London Economics Study, p. 83 

London Economics Study, pages 84 and 85  

The survey sample includes firms belonging to the Big 4 networks as well as 20 mid-tier networks. In addition, a 
number of larger independent audit firms in France, Germany, Italy, Netherlands, Sweden and UK were surveyed. 

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awards and settlements as percentage of revenues is probably lower in the EU than in 
the US. Over the period 1981 to 2003, the average cost of individual claims42 against 
EU  firms  amounted  to  € 3.9  m  (US$  4.8  m).  However,  the  total  cost  for  liability 
claims faced by the major EU audit firms by policy year shows a very slight upward 
trend and considerable fluctuations in this period, reaching a peak of almost € 400 m 
(US$ 600 m) in 1991: 

Total cost of claims against Big543/4 in the EU by policy year  
–millions of US$ at 2005 prices 

700

600

500

400

300

200

100

0

5
7
9
1

7
7
9
1

9
7
9
1

1
8
9
1

3
8
9
1

5
8
9
1

7
8
9
1

9
8
9
1

Years

1
9
9
1

3
9
9
1

5
9
9
1

7
9
9
1

9
9
9
1

1
0
0
2

3
0
0
2

Source: AON 

3.4. 

Lack of insurance capacity 

The extent of liability risks can best be measured by assessing their insurability. Any 
unlimited civil financial liability claim is basically manageable if the parties who are 
potentially  liable  can  obtain  adequate  insurance  coverage.  However,  statutory 
auditors do not have access to such insurance coverage.  

3.4.1.  Professional indemnity insurance for smaller audits  

In nearly all Member States, professional indemnity insurance is required by law or 
under  the  membership  rules  for  professional  associations  of  statutory  auditors  (see 
Annex 5). Such mandatory insurance is coupled with additional voluntary insurance. 
Such  insurance  remains  widely  available  but  only  for  statutory  audit  mandates  for 
entities which are not listed on a capital market. Statutory auditors do not appear to 
have  major  difficulties  in  finding  insurance  cover  for  these  audits.  However,  this 
category of insurance does not offer effective cover against the risks associated with 

42 

43 

EN 

In  total,  154  responses  were  received,  of  which  90  emanate  from  firms  belonging  to  the  Big  4  networks  and  64 
from mid-tier firms and a few large, independent firms. 

Such costs cover both actual payments and the reserve set aside by insurance companies in Europe to cover claims 
of audit firms which have not been yet been resolved (figures at 2005 prices). 

Comprises the existent Big 4 firms (Deloitte, E&Y, KPMG, PwC) and Arthur Andersen (demised in 2002) 

19 

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statutory  audits  for  large  and  listed  companies,  particularly  those  involving 
international audits. 

3.4.2. 

Self-insurance 

For  large  audit  assignments,  the  Big  4  audit  networks  organise  insurance  cover 
themselves inside each of the networks. The difficulty in obtaining insurance cover 
from  outside  began  in  the  mid  1980s  when  the  re-insurer  (Munich  Re)  who  had 
provided  most  of  the  reinsurance  capacity  for  the  auditors'  professional  indemnity 
insurance market (especially the then Big 644), withdrew from the market following 
big losses.  

From  1981  to  1992,  there  were  only  two  years  during  which  underwriting  auditor 
liability, in the world (excluding the U.S.), was profitable. In the U.S., there was only 
one  profitable  year  during  this  period45.  The  commercial  insurance  market,  having 
sustained losses in excess of US$ 3 billion up until 1992 alone, no longer provided 
adequate  professional  indemnity  insurance  cover  for  statutory  auditors  in  the 
international  audit  market  on  a  conventional  "risk  transfer"  basis.  The  main  reason 
has been that liability claims have become impossible to predict.  

In the 1990s, the then Big 5 (including Arthur Andersen), faced with this situation, 
established  "captive"  insurance  companies  to  cover  international  audit  mandates. 
"Captives"  are  mutual  insurance  entities  owned  by  the  member  firms  of  an 
international network, who share risk by pooling premiums to meet their individual 
claims  over  a  long  period  of  time.  The  captives  are  licensed  and  regulated  by 
recognised EU (e.g. Ireland and Malta) and international (e.g. Bermuda and Cayman 
Islands)  insurance  regimes  which  are  amongst  the  principal  insurance  domiciles  in 
the  world.  Each  individual  firm  insured  by  the  captive  covers  the  lower  levels  of 
risks itself, through its own contributions to the captive. At higher levels of liability 
all the participating firms help meet claims from other firms belonging to the same 
network.  Thus,  significant  claims  adversely  impact  all  member  firms  regardless  of 
their  individual  record  of  claims.  However,  even  these  captives  can  no  longer 
provide the levels of insurance cover needed in today's international audit market.  

Previous studies carried out in the U.K. confirm such two-tier phenomenon, with the 
larger audit firms receiving only limited insurance cover for particular bands of risk 
and  a  second  tier  for  which  the  audit  firms  can  receive  effectively  full  insurance46. 
Today, the current level of commercial insurance is such that it would cover less than 
5%  of  the  larger  claims  which  some  firms  face  in  some  EU  Member  States47. 
Moreover,  the  lack  of  predictability  of  future  claims  -  in  terms  of  both  probability 
and  magnitude  –  makes  it  difficult  to  assess  the  risk  that  would  be  assumed  by 
insurance companies potentially interested in this market. Given these characteristics, 

44 

45 
46 

47 

Deloitte, E&Y, KPMG, Price Waterhouse and Coopers and Lybrand (which merged in 1998: it is called PwC after 
the merger), and Arthur Andersen (demised in 2002) 

Information received from AON, see: London Economics study, p. 101 

Moizer, P., Hansford-Smith, L.: " UK Auditor Liability: An Insurable Risk?", in: International Journal of Auditing 
197-213, 1998 

Information received from Swiss Re Sigma, see: London Economics study, p. xxi 

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insurers  have  difficulty  in  pricing  audit  liability  risk  and,  hence,  in  providing 
adequate insurance coverage.  

3.4.3.  Reducing audit risks by imposing higher audit fees?  

One  might  assume  that  higher  audit  fees  would  allow  audit  firms  to  pay  higher 
insurance premiums to obtain the required insurance coverage. Insurance premiums 
have to be sufficient to cover the expected cost of claims and all other overheads of 
the insurer and still leave a small profit. Insurance capacity might be possible, even 
for high sums, if the liability situation is clear and the price appropriate. But in the 
case of auditors, due to the long tail exposure of the underwritten risk (i.e. the risk of 
a claim can exist for many years after the audit was carried out), insurers would have 
to  provide  an  extremely  long  commitment  of  equity.  The  loss  data  of  auditing 
companies  relating  to  litigation  are  helpful  only  to  a  limited  extent.  Although  the 
number  of  claims  is  low,  the  severity  of  the  settlement  is  very  high.  There  is  an 
absence of reliable statistics with a clear split between the management cost (legal & 
appraisal fees) of claims and the pure liability costs. Indeed, in many historical cases, 
the insurance cover has been used to pay additional audit and legal fees in order to 
demonstrate  that  the  original  (insured)  auditors  were  not  liable  rather  than  to 
compensate the actual loss as a result of negligence. 

In particular, new players willing to enter the international audit market would not be 
in  a  position  to  charge  such  high  fees,  corresponding  to  the  liability  risks,  to  their 
clients. There would have to be a tailored pricing system for each client to reflect the 
level  of  business  risk  that  an  auditor  assumes  when  taking  on  a  new  client. 
Otherwise,  in  the  absence  of  risk-adjusted  billing  rates,  low-risk  clients  must 
subsidise high-risk clients48. German insurers estimate that if the remuneration asked 
by  auditor  was  adjusted  to  include  the  compensation  for  risks  incurred,  this  would 
require  such  an  increase  in  audit  fees  that  it  could  not/would  not  be  borne  by 
principal  clients.  German  insurers  estimate  that  the  volume  of  all  audit  fees  would 
need to be increased by at least 30%, which is not realisable. 

Accordingly,  it  is  not  feasible  to  obtain  a  premium  that  truly  reflects  the  loss 
exposure or the premiums are disproportionate to the work undertaken by the auditor. 

3.4.4.  Financial capacity of the audit firm and the individual audit partner  

The limited company structure for audit firms is allowed in Europe49 and audit firms 
in general use this structure. An exception is the UK, where the large firms are set up 
as  limited  liability  partnerships.  Nevertheless,  partnership-like  corporate  structures 
are  also  commonly  adopted  by  audit  firms  across  the  EU  Member  States.  For 
example, a firm having a limited liability company legal form often have ownership 
distributed  among  senior  managers  with  no  outside  shareholders,  as  in  the  case  of 

48 

49 

Moizer, P., Hansford-Smith, L.: " UK Auditor Liability: An Insurable Risk?", in: International Journal of Auditing 
197-213, 1998 

See  Annex  1  to  the  2007  OXERA  study  on  ownership  structures  which  provides  an  overview  for  18  Member 
States:  Austria,  Belgium,  Cyprus,  Czech  Republic,  Denmark,  France,  Germany,  Greece,  Hungary,  Italy, 
Luxembourg, Netherlands, Poland, Portugal, Ireland, Spain, Sweden, United Kingdom; Oxera Consulting Limited, 
Oxford,  UK:  "Ownership  rules  of  audit  firms  and  their  consequences  for  audit  market  concentration  ",  October 
2007 (hereafter, referred to as the Oxera Ownership study) 

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partnerships. In fact the majority of audit firms in the EU are employee-owned50. The 
ownership of audit firms is typically evenly distributed between the senior employees 
of the firm. 

However, the limited company structure only helps in protecting the personal assets 
of  individual  auditors.  It  is  not  a  means  for  ensuring  that  an  audit  firm  and  even  a 
network can survive a major audit claim. 

Audit firms have limited financial resources51. They do not possess a capital base for:  

•  coping with significant liability claims; and  

•  building a financial buffer against the volatile liability exposures. 

Instead,  firms  may  have  to  ultimately  rely  on  contributions  by  individual  partners. 
However,  would  such  partners  still  have  an  incentive  to  pay  contributions, 
particularly if there were to be a very significant claim or would partners let the audit 
firm  collapse?  London  Economics  concluded  that  the  risk  that  such  a  catastrophic 
claim could wipe out an audit firm is real. Whilst an audit network might be able to 
deal  with  one  claim,  a  second  claim  of  sufficient  magnitude  might  not  be  covered 
soon afterwards, as it would take time to build up the necessary reserves and hence 
the  audit  network  might  fail.  London  Economics  presented 
the  following 
simulation52:  

50 
51 
52 

Oxera Ownership study 
See Oxera ownership study.  

London Economics Study section 17, page 106 

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Estimates  of  award/settlement  threshold  above  which  a  major  UK  firm53 
would fail – in € millions 

Threshold 
assumptions54 

cut 

15% 
in 
Partner income 
over  3  years 
10% 
and 
reduction 
in 
profitability 

cut 

in 
20% 
Partner income 
over  4  years 
no 
and 
in 
reduction 
profitability 

Source: London Economics 

Deloitte 

E&Y 

KPMG 

PwC 

Hypothetical 
firm with €200m 
in turnover 

325 

170 

240 

365 

28 

480 

255 

355 

540 

42 

Against this background, audit firms in the EU report that they face  a considerable 
number of high-value, actual or potential claims for damages arising from statutory 
audits.  These  claims  would  put  audit  firms  at  risk  if  they  materialise.  As  of  31st 
October  2005,  EU  audit  firms  from  the  six  biggest  networks  (the  Big  4  as  well  as 
Grant  Thornton  and  BDO)  indicated  that  their  risk  managers  were  dealing  with  28 
outstanding matters that could give rise to individual claims each in excess of € 75 
million;  16  of  these  claims  each  exceeded  €  160  million  and  in  five  cases,  the 
individual amounts being demanded were  in excess  of  €  750 million.  According  to 
the  audit  firms,  six of  the  28  outstanding  matters  fell  under  US  jurisdiction.  The 
remaining matters originated from cases within the EU55. 

53 

54 

Representatives  of  the  Big  4  firms  informed  London  Economics  that  it  would  be  reasonable  to  assume  that  the 
capacity of absorption of each firm is broadly proportional to the number of partners in the firm. Thus, for example, 
in case of PwC, the capacity of absorption of the German firm would be about half of that of the UK firm and that 
of the French firm about a tenth of the UK firm. 

In the first scenario, in which the partners accept to take an income cut of 15% for 3 years and the profitability of 
the  firm  falls  by  10%,  estimates  of  the  capacity  of  absorption  of  a  Big  4  firm  range  from  €  170m  to  €  365m 
depending  on  the  firm.  This  would  be  the  maximum  amount  (either  one  single  claim  or  multiple  claims  not 
exceeding  this  amount  in  total)  which  a  firm  could  afford  to  pay  in  award  or  settlement  without  gravely 
endangering its survival once the limited insurance cover provided through the captive is exhausted. It would not be 
able to sustain a second claim of such size in the immediate period following the settlement of the first claim, as its 
resources and that of the captive would need to be rebuilt over a number of years. In the second scenario in which 
partners make a greater contribution, the absorption capacity ranges from € 255m to € 540m. Such funds would be 
available to settle any number of claims, but obviously, the larger the number of claims to settle, the smaller the 
amount per claim a firm can afford. Currently, in the UK, there are six claims or potential claims in excess of € 
250m. 

55 

AON – Actual Claim Data by policy year – 1975-2005, EU figures by policy year 1975-2005, 2005 

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Significant  claims  against  European  auditors  reported  in  the  past  were  Lernout  & 
Hauspie  (KPMG  Belgium)56,  Postabank  (Deloitte  and  Andersen  Hungary),  Finance 
Credit  (KPMG  Norway),  Banque  Cantonale  de  Genève  (E&Y  Switzerland)  and 
Equitable Life (E&Y UK) and the Parmalat case (Deloitte Italy57). 

Respondents to the Commission consultation paper were much more divided on the 
existence  of  the  risk  of  catastrophic  claims  facing  audit  firms.  Some  of  them 
accepted the issue, noting that catastrophic claims can drive settlements58, which is 
clearly an unattractive feature for insurers. However, others were not convinced that 
catastrophic claims might actually lead to the failure of an audit firm. For instance, in 
their opinion the ultimate failure of Arthur Andersen resulted not from its financial 
liabilities,  but  because  companies  switched  to  other  major  audit  firms  as  they 
immediately  lost  confidence  in  Arthur  Andersen  and  its  reputation59.  But  either 
which way, loss of reputation or catastrophic claim, or a mix of both could reduce the 
Big 4 to Big 3 and that would affect the choice of some international companies.  

3.5.  Which market participants are affected? 

Audit profession  

The high audit risk exposure, combined with a lack of insurance cover for statutory 
audits  of  large  companies  makes  the  audit  profession  less  attractive60.  In  particular 
the  major  audit  firms,  which  are  exposed  to  high  audit  risks,  have  experienced 

56 

57 

58 

59 

60 

In October 2004 it was reported that KPMG US and its Belgium affiliate had agreed to pay US$ 115m to settle a 
shareholder lawsuit related to the audit of Lernout & Hauspie Speech Products (L&H), a once high-flying global 
speech recognition software firm which was based in Belgium but traded on the Nasdaq. When the settlement was 
announced, it was reported that two other suits remained pending. KPMG's US and Belgian firms have reportedly 
been  sued  in  the  US  Bankruptcy  Court  in  Delaware  for  US$  340m  by  the  trustee  charged  with  helping  L&H's 
creditors pursue legal claims. Also still pending was a separate claim by L&H's Belgian liquidator for US$ 427m 
against KPMG's Belgian affiliate.  

Parmalat, an Italian dairy group, filed for insolvency in December 2003, with about US$ 17.3 billion of debt, after 
realizing there was a massive US$ 4.9 billion discrepancy in its books. Its auditor, Deloitte, was facing four claims 
in connection with allegations that they helped to prolong fraud at Parmalat prior to its collapse. In January 2007, 
Deloitte  reached  an  accord  with  Parmalat,  agreeing  to  pay  US$149m  (€115m)  to  settle   those  allegations.  see: 
http://search.ft.com/ftArticle?queryText=parmalat&page=2&id=070113005661&ct=0 

Settlements are often higher than they might be because it is safer for audit firms to agree a large amount than run 
the risk of losing in court and being fined a much larger amount or, even more importantly, a firm may settle to 
avoid further reputational damage. 

Morley Fund Management: "Bringing Audit Back from the Brink (Auditor liability and the need to overhaul a key 
investor protection framework)", February 2004.  

According to a MORI survey, recruitment and trust are seen as the top two challenges facing the profession. When 
asked  to  rate  a  number  of  issues  on  a  one  to  ten  scale,  90%  gave  a  rating  of  seven  or  above  to  the 
recruitment/retention  of  high  quality  staff.  This  was  closely  followed  by  85%  who  placed  similar  emphasis  on 
restoring trust/confidence in the audit profession. Of particular concern to partners was the question of unlimited 
liability. Almost half (45%) gave this a rating of ten.  

Two-thirds (67%) of auditors saw a career as an auditor as less attractive than it was two years ago, a particular 
concern among more senior staff, with 78% of partners and directors stating this was the case. Just 6% of partners 
said it was more attractive. The survey results cast some light on the reasons for this concern. Two-thirds (68%) – 
and 83% of partners – believed potential liability in cases of corporate wrong-doing was making the profession less 
attractive, while half (49%) disagreed that changes to the regulation of the profession would not affect the ability to 
recruit quality auditors. See results of MORI, Auditor career and working life survey, January 2005. 

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difficulties  in  retaining  talented  professional  staff,  who  can  then  go  on  to  become 
partners61.  

Companies 

For  companies  listed  on  European  capital  markets,  the  principal  influence  in  the 
selection  of  the  statutory  auditor  is  the  Board's  Audit  Committee62.  However,  in 
practice,  the  company's  Finance  Director  (CFO)  also  plays  an  important  role63. 
Therefore, it is these two parties that are most directly affected by the limited choice 
of  statutory  auditors64.  In  certain  sectors  (primarily  in  the  banking  and  insurance 
sector)  companies  have  little/no  effective  choice  of  statutory  auditors.  Companies 
feel  that  this  increased  concentration  reduces  competitive  pressure  in  the  statutory 
audit market for large listed companies65. As a result, the limited choice may impair 
the ability of audit committees/boards to change statutory auditors and their ability to 
effectively negotiate audit fees with statutory auditors66.  

Currently  statutory  auditors  and  management  can  be  (in  most  European  legal 
regimes)  jointly  and  severally  liable  for  a  company's  failure.  Whereas  management 
can  limit  their  risks  by  obtaining  Directors  and  Officers  Liability  Insurance  (D&O 
insurance),  statutory  auditors  face  a  lack  of  insurance  cover  for  audits  of  large 
companies. In contrast to the situation facing major audit firms, the liability risk of 
directors  and  officers  can  be  spread  amongst  many  D&O  policy  holders  in  several 
thousand listed companies in the EU67.  

Investors 

Investors  (shareholders,  bondholders)  rely  on  the  independent  audit  opinion  on  a 
company's  financial  statement68.  Therefore,  investors  are  affected  by  the  lack  of 

61 

62 

63 
64 

65 
66 

67 
68 

According to the U.S. Bureau of Labour Statistics, the demand for accounting graduates is predicted to grow 18-
26% through 2014, see: US Advisory Committee on the Auditing Profession, Working Discussion Outline, October 
2007 

According to Art 41 of the 8th Directive, the decision to appoint an auditor will be based on the recommendation of 
the  Audit  Committee.  Based  on  this  recommendation,  the  auditor  will  be  appointed  by  the  company's  board  or 
shareholders. 

London Economics study, P. 54 

For instance, over one-third of the FTSE 350 audit committee chairs in the UK do not feel that their company has 
sufficient  choice  of  auditor.  See  Oxera:  "Competition  and  choice  in  the  UK  audit  market.  Report  prepared  for 
Department of Trade and Industry and Financial Reporting Council", April 2006 

Oxera Competition study, P. V 

For instance in the US, audit fees have increased 271% between 2001 and 2006; However, this increase was also 
driven by the implementation of the requirements under the Sarbanes-Oxley Act. The figures stand in stark contrast 
to the UK, where audit fees for major companies (ranked in the FTSE 100) increased by just under 1% between 
2003 and 2006. See: 
http://www.accountingweb.co.uk/cgibin/item.cgi?id=171453&d=1025&h=1024&f=1026&dateformat=%25o%20
%25B%20%25Y 
In France, audit fees for companies listed in the CAC 40 increased in the period 2005-2006 by 11%. However, a 
major part of this increase was related to US-listed French companies, which were obliged to apply Sarbanes Oxley 
requirements the first time in 2006. See: 
http://www.amf-france.org/documents/general/7874_1.pdf 

London Economics study, P. 102 

85% of investors perceive the annual statutory audit adds value; 73% of investors believe that the added value is 
due to the independent process and opinion thereby reducing investor risks; see: ICGN/GPPC survey 

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choice between statutory auditors in the international audit market69. Lack of choice 
could affect investor confidence in the effective operation of the audit market, due to 
a  perception  that  the  major  players  have  too  much  market  power70.  On  the  other 
hand, institutional investors consider the “Big 4” audit networks as a guarantee and 
even as an insurance of last resort against corporate malpractice.  

An  even  more  significant  impact  on  investor  confidence  may  come  from  concerns 
that  the  current  level  of  concentration  is  undesirable.  The  experience  following  the 
dissolution of Arthur Andersen has led to a perception that the audit market is close 
to the point where the loss of another large audit firm is possible. Such a loss would 
compound existing market dynamics and could lead to a crisis of confidence in the 
financial status of a large number of ‘high-risk’ companies71. As a consequence, the 
potential  damage  to  investor  confidence,  in  particular  to  institutional  investor 
confidence, could result in an increase in the cost of capital72.  

Insurers 

Insurers are unwilling to offer insurance cover in the international audit market due 
to  the  potentially  high  risks  associated  with  statutory  audits  for  large  listed 
companies, and the fact that this risk cannot be adequately diversified (i.e. a portfolio 
comprising of only four audit networks).  

Public Oversight 

The  new  Directive  on  Statutory  Audit  requires  Member  States  to  establish  and 
organise independent public oversight of the audit profession. These new European 
audit regulators have to monitor statutory audits for compliance with the professional 
duties73  thereby  ensuring  adequate  audit  quality.  In  the  past,  audit  quality  was 
controlled by the audit profession through processes such as peer review, or was not 
controlled at all. Therefore, the risk of liability law suits and investigations were two 
of the principal mechanisms for ensuring audit quality.  

Other stakeholders 

In general, an increase in the cost of capital, due to a loss of investor confidence in 
capital markets, could lead to less efficient listed companies, which in theory at least, 
would have a negative effect on employment. Obviously, should one Big 4 audit firm 
disappear  for  whatever  reason,  the  impact  on  the  firms'  employees  would  be  direct 
and substantial74.  

69 

70 
71 

72 

73 

74 

80% of investors assess the level of choice to be insufficient; 65% of investors perceive the level of competition to 
be insufficient; see: ICGN/GPPC survey 

Oxera Competition study, P. V, 86 

Oxera: "Competition and choice in the UK audit market. Report prepared for Department of Trade and Industry and 
Financial Reporting Council", April 2006, P. V, 86 

In contrast, it is rather unlikely that cost of capital is affected by even a sharp increase in audit fees, as the share of 
audit fees in company's total operating costs is relatively small. 

In particular the 4th and 7th Company Law Directives as well as the banks and insurance companies Directives. 

The Big 4 member firms employ in total more than 500.000 professionals around the world. 

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3.6. 

Does the EU have the right to act? 

The  market  for  the  provision  of  audit  services  and  the  related  liability  risks  has 
global  significance,  given  the  importance  of  the  audit  function  to  the  smooth 
functioning of capital markets.  

The  major  audit  networks  not  only  lack  adequate  international  insurance  cover  for 
their activities, but there is also a question of "lack of choice" which cannot be solved 
solely by individual Member States. There is a need to assess what action - if any - 
should  be  taken  at  the  EU  level.  In  Europe,  only  a  few  Member  States  have  some 
form  of  limitation  on  auditors'  liability  and  only  seven  Member  States  offer 
mechanisms  mitigating  the  current  excessive  unlimited  litigation  risks,  and  the 
consequential difficulties that major audit firm networks face in obtaining insurance. 
The  European  Parliament  requested  the  Commission  to  address  the  liability  aspect 
under the 2006 Directive on Statutory Audit. Article 31 of the Directive accordingly 
invited the Commission to prepare a further analysis and, if appropriate, take action. 
Any action on auditors' liability should be limited to the cases of a statutory audit of 
the  consolidated  or  the  annual  accounts  of  a  company  which  is  registered  in  a 
Member  State  and  the  securities  of  which  are  admitted  to  trading  on  a  regulated 
market in a Member State. 

4. 

OBJECTIVES 

Trust in capital markets is a necessary condition to enable those markets to allocate 
capital  efficiently.  It  is  necessary  to  ensure  the  efficient  functioning  of  financial 
markets  and  to  preserve  investor  confidence  in  financial  statements.  The  general 
objectives  for  this  impact  assessment  are:Reduce  the  risk  to  capital  markets  that 

statutory auditors might no longer be available to audit listed companies; and 

•  Facilitate access to the international statutory audit market (in order to encourage 

more auditors to audit large and listed companies) 

To achieve these general objectives, the following specific objectives are defined: 

•  Achieve fairer liability risk exposure for statutory auditors  

•  Facilitate access to professional indemnity insurance for statutory auditors  

•  Encourage investments into the expansion of audit firms  

•  Reduce differences in liability regimes across the EU.  

5. 

POLICY OPTIONS 

5.1. 

No EU action (Option 1) 

This option would leave it to market forces and Member States to take autonomous 
action thereby addressing also any cross-border problems within the EU. 

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Keeping  the  status  quo  means  that  Commission  would  be  of  the  view  that  liability 
risks are considered to be a purely domestic problem. However, the insufficient level 
of professional insurance available for international audits is not expected to improve 
considerably  in  view  of  the  existing  litigation  risk  exposure.  Thus,  statutory  audit 
firms would continuously face risks of large claims that would have to be covered by 
themselves,  either  through  their  network  captives  or,  once  such  limited  cover  has 
been  exhausted,  by  the  partners  within  the  audit  network.  Without  any  EU  action 
towards limiting liability, mid-tier audit firms would continue to be reluctant to enter 
the  international  audit  market.  Other  players  would  also  continue  to  refuse  to 
consider investing in audit firms. Major claims could even threaten the survival of an 
audit firm thus reducing the number of few players on the supply side. 

Accordingly,  the  structure  in  the  international  audit  market  would  continue  to 
solidify.  

5.2. 

Possible options in substance 

A reform in this area is primarily aimed at facilitating access by (new) entrants to the 
international  audit  market.  Policy  action  will  not  deal  with  competition  regulation 
issues, since the Commission has already examined the impact of previous mergers 
between  audit  firms  on  European  markets,  for  example  the  merger  of  Price 
Waterhouse  and  Coopers  &  Lybrand  in  199875  and  the  mergers  between  Arthur 
Andersen and Ernst & Young / Deloitte Touche in 200276. The following options are 
put forward as possible steps which could be taken to achieve the objectives: 

5.2.1.  Compulsory insurance for all auditor liability risks (Option 2) 

As outlined above, commercial insurers currently do not provide sufficient insurance 
cover for statutory auditors in the international audit market. This is due to the lack 
of mutualisation (diversification) of audit liability risks (since there are only a limited 
number of participants in this market), the lack of predictability of such liability risks 
(in  terms  of  both  probability  and  magnitude)  and  the  differences  between  liability 
rules.  Given  these  characteristics,  insurers  have  difficulty  in  pricing  the  risks  at 
international level and as a result in providing adequate insurance cover77.  

Since  the  insurance  market  is  not  able  to  close  this  "insurance  gap",  one  policy 
option  could  be  to  make  insurance  of  all  liability  risks  compulsory  using  new 
legislation  at  EU  level.  As  the  risk  exposure  for  statutory  auditors  would  remain 
unchanged,  the  audit  profession  would  not  be  able  to  pay  the  necessary  premiums. 

75 

76 

On  1st  July  1998,  the  merger  between  Price  Waterhouse  and  Coopers  &  Lybrand  received  formal  regulatory 
clearance from the Commission. See COMMISSION DECISION of 20 May 1998 declaring a concentration to be 
compatible  with  the  common  market  and  the  functioning  of  the  EEA  Agreement  (Case  No  IV/M.1016  -  Price 
Waterhouse/Coopers & Lybrand). 

Following the demise of the Arthur Andersen audit network, most of its country practices around the world were 
sold to members of other Big 4 audit networks, notably Ernst & Young globally and Deloitte & Touche in the UK. 
In 2002, the Commission examined the impact of such mergers in several important Member States, in particular in 
UK, Germany and France. After examining these cases, the Commission concluded that the mergers did not raise 
serious  doubts  as  to  their  compatibility  with  the  common  market  and  the  EEA  Agreement.  See:  Commission 
Decisions  on  Deloitte  &  Touche  /  Andersen  (UK)  of  1  July  2002,  Ernst  &  Young  /  Andersen  Germany  of  27 
August 2002, Ernst & Young France / Andersen France of 5 September 2002. 

77 

London Economics study, P. 102 

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The economy at large would be called upon to finance such a compulsory insurance 
system. As a consequence, the insurance risks would be transferred to and diversified 
over a much broader base. The following possibilities are conceivable: 

•  investors might be required to pay a levy on every security transaction78, or 

•  companies could be forced to buy insurance cover for the auditor79.  

The  premiums  could  be  allocated  to  a  compensation  fund  or  an  insurance  pool  at 
international  level.  An  alternative  route  could  be  to  securitise  audit  failure  risk; 
securities could hence be packaged in a way to reflect underlying cash flows – e.g. 
premiums and the related risks of audit failure.  

As  a  last  resort,  one  might  even  consider  the  possibility  that  governments  (and 
effectively tax payers) take over liabilities for the part of any claim exceeding a pre-
agreed threshold80. 

A governmental scheme would reinforce even further the moral hazard argument for 
the audit profession, whilst taxpayers, companies and the investor community would 
not appear to derive any benefit.  

5.2.2.  Establishing “safe harbours” (Option 3) 

Another option could focus on reducing the risks of auditing activities by excluding 
certain activities with a higher risk profile from the auditors' liability. A mechanism 
to achieve this outcome would be to introduce so-called safe harbour provisions. A 
safe harbour is a provision that reduces or eliminates a party's liability under the law, 
provided  that  the  party  has  acted  in  good  faith.  Legislators  include  safe  harbour 
provisions to protect legitimate or excusable violations. For instance, in the US safe 
harbour provisions were introduced in 1995 for certain forward-looking information 
provided by companies in the management's discussion and analysis ("MD&A") that 
is  included  with  filings  with  the  US  Security  Exchange  Commission  (SEC) 
containing a financial statement81.  

Another  example  in  the  EU  of  a  safe  harbour  type  provision  is  the  limited 
responsibility of the statutory auditor for information contained in the annual report 
("Management Report") under the 4th Directive82. The statutory auditor has to verify 
only  whether  the  management  report  is  consistent  with  the  financial  statements  for 
the same financial year. The auditor is not obliged to conduct a full scope audit on 

78 
79 

80 
81 

82 

London Economics study, p. 113/4 
London Economics study, p. 114; Lawrence A. Cunningham, Securitizing Audit Failure Risk: an alternative to caps 
on damages, 49 William&Mary Law Review 3 (2007), http://ssrn.com/abstract=1012919 
Terrorism insurance and nuclear insurance are or were provided under schemes in similar form. 

The US Private Securities Litigation Reform Act of 1995 adopted a statutory "safe harbour". In order to minimize 
an auditors' exposure to legal liability, the safe harbour protects "any reports issued by an outside reviewer retained 
by an issuer who address a forward-looking statement by the issuer". See: Paul Munter: "Safe Harbor" under the 
private securities litigation reform act of 1995; in: The CPA Journal, August 2000 

According  to  the  Fourth  Council  Directive  78/660/EEC  of  25  July  1978,  the  annual  report  must  include  a  fair 
review of the development of the company's business and of its position. It must also provide information on any 
important events that have occurred since the end of the financial year, the company's likely future development 
and activities in the field of research and development. 

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the  management  report.  Consequently,  the  auditor  can  only  be  held  liable  in  cases 
where  the  management  report  contains  inconsistent  or  contradictory  information 
compared to the financial statements. 

Minimising  audit  risks  associated  with  management  reports  can  be  justified  by  the 
fact  that  they  include  predominantly  forward-looking  information,  which  can  be 
verified  only  to  a  very  limited  extent  by  external  auditors.  Safe  harbour  provisions 
encourage companies to disclose more useful information to investors which would 
otherwise (i.e. under full liability risk exposure) not be disclosed. 

By way of contrast, financial statement assertions are determined fundamentally on 
the  basis  of  objective  and  verifiable  facts  (i.e.  historical  information).  Introducing 
safe  harbour  provisions  for  the  application  of  the  auditor's  professional  judgement 
with regard to certain, "risky" financial statement assertions83 (e.g. fair value based 
assertions)  would  create  a  situation  of  moral  hazard.  The  auditor  would  no  longer 
feel  fully  responsible  for  the  correctness  of  financial  statement  assertions.  This 
"responsibility gap" could not be adequately closed by other parties (e.g. regulators), 
leaving  investors  with  the  concern  that  particular  assertions  in  financial  statements 
might not be reliable.  

An  important  downside  would  be  that  international  standard  setting  in  accounting 
and auditing could  no longer  be based  on principles which companies and auditors 
should apply on the basis of sound professional judgment. Instead, standards would 
become  a  target  for  liability  driven  “safe  harbour”  provisions  containing  a  great 
degree  of  detail  and  working  as  arbitrary  shields  for  preparers  and  auditors  of 
financial statements. Furthermore, such a result would defeat the overall policy of the 
European  Union  to  follow  international  standards  in  accounting  (introduced  by  the 
IAS-Regulation in 2002) and to perhaps introduce international standards on auditing 
(an option foreseen under Article 26 of the Directive on Statutory Audit). 

5.2.3.  Limiting auditors' liability (Option 4) 

Two main methods for limiting liability are currently in force in the Member States - 
a  cap  and  proportionate  liability  (liability  proportionate  to  the  extent  of  the 
contribution of the auditor to the damage caused). The main difference between these 
methods  is  that  a  cap  (the  maximum  settlement  amount)  is  known  in  advance 
whereas  under  proportionate  liability  there  is  no  maximum  and  the  actual  amount 
remains  unknown  until  a  final  decision  is  taken  by  courts.  However  proportionate 
liability is linked directly to the degree of fault associated with each “guilty” party, 
whereas  a  cap  can  be  seen  as  a  more  arbitrary  figure  allowing  predicting  the 
maximum to be paid by an audit firm. 

An  initiative  for  limiting  liability  could  be  therefore  approached  in  three  main 
different ways: 

83 

E.g.  financial  projections,  future  management  plans  and  objectives,  or  statements  of  the  future  economic 
performance 

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30 

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5.2.3.1.  Harmonisation on the basis of capping liability (Option 4a) 

This option focuses on introducing liability caps throughout the EU. The most radical 
solution  would  be  to  introduce  a  uniform  fixed  monetary  cap  at  EU  level  (for 
example  a  cap  up  to  €10m  or  €100m).  Nevertheless,  it  would  be  difficult  to  set  an 
amount  of  cap  or  a  method  to  calculate  a  cap  which  would  suit  all  the  Member 
States. Due to different economic conditions and legal traditions in Member States, 
the "fairness" of a uniform liability cap on EU level might be perceived by Member 
States and market players unequally. Whilst countries with a cap for many decades 
might  prefer  keeping  "their  cap"  at  a  more  modest  level  of  €4m  or  €12m 84,  other 
Member  States  might  want  to  have  a  much  higher  fixed  cap  of  perhaps  €100m  or 
even more. 

Alternatively,  one  could  accordingly  fix  a  range  of  methods  for  limiting  liability 
amongst which the Member States should choose (e.g. determining a liability cap by 
a  formula,  depending  on  the  company's  size  or  on  the  audit  fees  charged  to  the 
company). 

If  liability  were  to  be  capped  by  an  EU  instrument,  the  results  of  the  public 
consultation  show  a  preference  within  the  audit  profession  to  determine  a  cap  that 
would be based on a multiple of audit fees. Nevertheless, there are arguments against 
this option. The main fears of mid-tier audit firms and investors would be that a cap 
based on audit fees could lead to "fee dumping" as it would be an incentive for audit 
firms  to  negotiate  fees  down  in  order  to  minimise  liability.  Auditors  could  charge 
lower  audit  fees  and  recover  their  costs  from  fees  for  non-audit  services.  Imposing 
such  a  method  might  therefore  be  unacceptable  for  many  Member  States.  It  would 
also oblige Member States who already have a cap to change their system.  

Therefore  this  option  would  consist  of  introducing  a  cap  but  would  not  set  a  fixed 
amount of cap at EU level nor a single method for calculating one. 

Liability  caps  might  be  either  implemented  by  law  (as  in  Germany,  Austria  or 
Belgium)  or  possibly  by  contractual  arrangements  (like  in  the  UK85).  However,  an 
EU-wide harmonisation by contractually arranged caps would not be feasible, as in 
many Member States the liability of auditors is based on tort law and not on contract. 
Moreover, such contractual solutions would not be effective everywhere, as unlike in 
the  UK  case  law,  shareholders  which  are  not  bound  by  the  contract,  can  introduce 
claims against statutory auditors in the majority of Member States86. Consequently, a 
harmonisation of liability regimes could effectively be implemented only by law and 
not by contracts allowed under national law. Harmonisation on the basis of statutory 
caps would address all the objectives described in section 4. A cap would reduce the 
magnitude of potential settlements for auditors and thereby achieve reduced liability 
risk  exposure  for  auditors.  Furthermore,  capping  the  magnitude  of  potential  claims 

84 
85 

86 

For example Germany or Austria (see Annex 3)  
See FRC consultation paper of December 2007. However, the consultation paper notes that a cap might probably 
not obtain the required shareholder consent as UK investors oppose a cap. 

The  contractual  solution  is  workable  in  the  UK  where,  in  the  case  of  statutory  audit  of  annual  accounts,  claims 
against  auditors  can  be  introduced  only  by  the  company  and  not  by  the  individual  shareholders  or  other  third 
parties. 

EN 

31 

   EN 

 
                                                 
would  enable  insurers  to  better  ascertain  liability  risks  and  thus  improve  insurance 
coverage. Finally, the introduction of a cap at the EU level would reduce differences 
of  the  liability  regimes  across  the  EU.  However,  it  depends  on  the  individual  cap 
whether  the  risk  exposure  would  be  sufficiently  reduced  and  partners  of  mid-tier 
audit  firms  or  new  players  would  feel  encouraged  to  invest  into  the  expansion  of 
audit firms. 

5.2.3.2.  Harmonisation on the basis of proportionate liability (Option 4b) 

This  option  focuses  on  introducing  a  uniform  liability  "principle"  i.e.  proportionate 
liability throughout the EU. If proportionate liability were to be applied audit firms 
would be only liable to the extent of their contribution to the damage caused, without 
being financially liable "in solidum" with other parties. 

In theory, proportionality might be implemented either by law (like in Hungary) or 
possibly  by  contractual  arrangements  (like  in  UK).  However,  as  described  under 
Option  4a,  an  EU-wide  harmonisation  by  contractual  limitations  would  not  be 
feasible in many Member States.  

Harmonisation  on  the  basis  of  proportionality  would  address  all  the  objectives 
described  under  section  4.  Some  stakeholders  (in  particular  investors)  might  even 
perceive proportionality to be a "fairer" method to limit liability, compared to a fixed 
liability  cap,  because  the  liability  risk  of  auditors  would  not  be  limited  to  a  certain 
amount,  but  to  the  proportion  of  their  contribution  to  the  damage.  Whilst 
harmonisation based on proportionate liability could not fully address the concerns of 
insurers  in  terms  of  the  magnitude  and  predictability  of  potential  claims,  it  would 
reduce differences in the liability regimes across the EU. 

5.2.3.3.  Convergence of national liability regimes (Option 4c) 

To  date,  cap  and  proportionate  liability  are  the  methods  used  in  Member  States. 
Other  methods  for  limiting  liability  could  also  be  appropriate  under  some 
circumstances.  For  example,  the  UK  has  allowed  under  its  company  law  for  a 
limitation  of  liability  of  auditors  by  contract  in  2006  and  is  currently  considering 
giving  guidance  to  the  markets  how  to  apply  the  new  law  in  practice.  Contractual 
arrangements  limiting  liability  will  be  possible  as  from  June  2008  onwards.  One 
possibility considered is a general test of fairness that would be performed by a court. 
A  mix  of  different  methods  of  limitation  of  liability  (for  example  cap  plus 
proportionality) is also conceivable.  

(1) 

Therefore  as  an  alternative  to  harmonisation  (options  4a  and  4b),  Member 
States  could  be  first  encouraged  to  introduce  a  limitation  into  their  liability 
regimes. The EU measure would only fix the objective of having a limitation 
but not the precise method of achieving the limitation. This objective could be 
implemented by introducing high-level principles to ensure that the limitation 
is fair both for the auditors and for the other stakeholders. 

(2)  Member  States  would  have  the  choice  between  measures  such  as  a  cap  or 
proportionate liability or other methods as they see fit. This could include the 
possibility for auditors to negotiate the limitation of their liability by contract 
or by a mixture of different methods. In this way, every Member State would 

EN 

32 

   EN 

 
be  invited  to  introduce  a  liability  limitation,  taking  into  account  their  own 
systems  and  circumstances.  Limitations  should  again  not  apply  in  cases  of 
intentional misconduct by the auditor. 

This solution, which should encourage the convergence of national liability regimes, 
would  address  the  first  three  specific  objectives  for  the  same  reasons  as  described 
under  options  4a  and  4b.  However,  since  Member  States  might  opt  for  different 
solutions, the impacts on the objectives might vary. This option would give Member 
States the opportunity to converge over time and learn from each other (evolutionary 
approach). It would reduce differences of the liability regimes across the EU to some 
degree,  as  all  Member  States  would  have  some  limitation,  but  this  could  be 
calculated by different methods. 

5.3. 

Screening of the options 

Under section 5.2, a number of policy options have been presented. However, some 
of the options will not satisfactorily achieve the objectives as set out in section 4. 

•  Option  2:  focuses  on  insuring  liability  risks  by  parties  other  than  auditors.  This 
would certainly increase the number of interested audit firms to enter the market. 
Option 2 would however not meet the objectives set in section 4. As it is already 
impossible to price liability risks in audit fees, it would equally not be workable 
for insurers to price their risks under option 2. Accordingly, this option would not 
facilitate  the  access  to  professional  indemnity  insurance.  Even  if  that  objective 
were achieved, option 2 would impose significant additional costs on companies, 
investors or – what is the likely outcome – taxpayers via governmental action. As 
a result, liability risks would be shifted from auditors to the public at large. The 
current model of a private audit firm on the supply side would be broken. Market 
failure on the supply side would be repaired by the demand side or even the public 
(i.e.  taxpayers)  at  large.  On  the  other  hand,  this  policy  option  would  be  a  major 
concession to the audit profession currently in this business. They would receive 
considerable  relief  from  the  need  to  seek  insurance  coverage.  Furthermore,  the 
proposal would have the potential to expose the audit firms to a significant risk of 
moral hazard87 as there would be far fewer consequences of audit failure. Such an 
insurance  regime  would  insulate  the  auditor  from  any  risks  related  to  his  or  her 
professional  behaviour.  The  auditor  would  be  much  less  concerned  about  the 
negative  consequences  of  the  risks,  when  compared  to  today.  As  a  result,  this 
might have negative effects on audit quality. 

•  Option 3: might limit the risk exposure for auditors, since it focuses on "carving-
out"  certain  liability  risks  from  the  audit  activity  (“safe  harbour”).  However, 
negative  trade-offs,  particularly  with  regard  to  quality  in  financial  reporting  and 
auditing,  would  be  significant.  In  addition,  “safe  harbours”  would  need  to  be 
anchored in international standards thereby defeating the generally acknowledged 
aim that such standards should remain principles-based. Minimising audit risks by 
safe  harbour  provisions  would  certainly  reduce  the  risk  exposure  for  statutory 
auditors,  particularly  when  carving  out  certain  audit  activities  from  liability. 

87 

Moral  hazard  refers  to  the  prospect  that  a  party  insulated  from  risk  (such  as  through  insurance)  will  be  less 
concerned about the negative consequences of the risk than they might otherwise be. 

EN 

33 

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However,  insurers  might  find  it  difficult  to  assess  in  which  case  a  specific  safe 
harbour  provision  limits  the  magnitude  of  potential  liability  claims.  Therefore, 
such an option could be expected to have only a limited impact on improving the 
insurability  of  the  audit  profession.  Due  to  the  likely  limited  impact  of  safe 
harbour  provisions  on  the  auditor's  risk  exposure,  such  an  option  would  not  be 
particularly effective in assisting new entrants into the international audit market.  

In contrast, options 4a, 4b and 4c appear to address all the objectives, although the 
impacts of the individual options would differ. Therefore, these three options will be 
further compared to Option 1 "No action at the EU level".  

5.4. 

Legal instruments 

•  It  is  difficult  to  imagine  how  liability  risks  could  be  addressed  by  self  or  co-
regulation. Firstly, self-regulation works best where there are a limited number of 
stakeholders  with  similar  interests  -  auditors'  liability  typically  involves  a  large 
number  of  stakeholders,  often  with  divergent  interests  (e.g.  auditors  and  their 
regulators,  companies,  insurers,  investors).  Secondly,  the  assessment  of  the 
current  situation  demonstrates  a  degree  of  market  failure  where  market  forces 
have  not  been  able  to  address  the  issue  on  their  own.  Relying  upon  self  or  co-
regulation  would  therefore  be  an  ineffective  mechanism  to  achieve  the  best 
outcome. Also, given the many national legal differences, self  and co-regulation 
are unlikely to succeed and in such cases developing recommendations is perhaps 
a  more  reasonable  alternative88.  Finally,  liability  is  determined  by  law,  for 
example tort law; and such self or co-regulation seems to be an inappropriate tool 
in this context. 

•  For  Option  4a  and  4b:  These  options  could  possibly  be  achieved  by  a  non-
binding instrument (e.g. a recommendation). However, a binding legal instrument 
(e.g. a directive) would bring about measurable effects within a specific timeframe 
and would be the best, if not the only way to achieve harmonisation at EU level. 
In  contrast,  Member  States  could  at  any  moment  decide  not  to  follow  a 
recommendation. Therefore a directive appears to be the most suitable instrument 
to implement options 4a and 4b.  

•  For  Option  4c:  A  recommendation  would  be  an  appropriate  instrument,  as  it  is 
non-binding  on  Member  States,  but  should  act  to  stimulate  action  in  this  area. 
Many  respondents  to  the  public  consultation  emphasise  that  any  Commission 
action  should  give  maximum  flexibility  to  Member  States.  It  could  also  be 
envisaged that the content of the option 4c could be implemented by a directive. 
This  would  ensure  that  all  Member  States  would  have  to  limit  liability  in  some 
way,  but  they  would  each  decide  for  themselves  the  method  of  limitation. 
Therefore two ways of implementing the option 4c, by a recommendation or by a 
directive, appear to be feasible and will be considered further.  

88 

See the recommendations, page 6 of EIM study in 2006 for DG ENTR on self and co-regulatory practices in the 
European Union  

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6. 

ANALYSIS OF IMPACTS  

6.1. 

No EU action at the EU level (Option 1) 

This  option  would  continue  the  approach  of  leaving  the  resolution  of  the  issues 
outlined  in  section  3  to  market  forces.  However,  the  structure  of  the  international 
audit  market  would  appear  unlikely  to  improve  in  the  coming  years  should  this 
option be adopted89.  

6.1.1. 

Impact of market forces in the future 

Responding to the demands of the companies (reputation, capacity and geographical 
spread  of  audit  firms)  needs  time  and  resources.  Mid-tier  networks  would  have  to 
undertake  significant  investments  in  this  regard.  Due  to  their  superior  financial 
capacities, Big 4 firms could continuously strengthen their market position over this 
period  by  significant  investments  into  their  brand,  human  capital  and  geographical 
spread90.  

Barriers  (liability  risks/lack  of  insurance)  are  still  likely  to  constrain  the  scope  and 
breadth  of  the  presence  of  mid-tier  firms  in  the  market  for  larger  audits  over  the 
coming  years.  If  such  failures  are  not  addressed,  it  is  unlikely  that  mid-tier  audit 
firms, even if merged or consolidated, could ever become a major alternative to the 
Big 4 audit networks in the foreseeable future. 

Due  to  the  volatility  of  the  market  capitalisation  of  the  audited  companies,  audit 
firms  would  continue  to  face  increasing  litigation  risks  when  auditing  such 
companies.  Since  the  current  insurance  market  does  not  already  provide  sufficient 
professional indemnity insurance coverage for these risks, successful liability claims 
would need to be covered by the firms themselves, either through network captives 
or, once the limits of such cover had been exhausted, by the partners within the audit 
network. 

As  there  is  little  likelihood  of  insurers  being  better  able  to  mutualise  and  diversify 
liability risks across more audit firms, the inadequate level of professional insurance 
available to statutory auditors is not expected to improve materially. 

One  might  argue  that  there  would  perhaps  be  no  need  for  liability  reform  if  the 
insurance  capacity  to  cover  the  risks  related  to  major  international  audits  could  be 
restored by market forces. However, for example, in Belgium, the lack of domestic 
insurance  capacity  drove  liability  reform  in  2005  (see  section  6.1.3  below).  This 
strongly  indicates  that  limiting  auditors'  liability  would  be  a  necessary  first  step  to 
also solve the problem of the lack of suitable insurance.  

89 

90 

EN 

London Economics study, P. 209 

In 2007, all Big 4 audit firms have reported again a significant growth in revenue, particularly to the strong growth 
in  emerging  markets  like  China. KPMG  reported  global  revenues  of  $19.8bn,  up  12.7  per  cent  in  local currency 
terms. This compared with a 12.6 per cent increase to $23.1bn at Deloitte, 11 per cent to $21.1bn at Ernst & Young 
while PwC grew 10.5 per cent to $25.2bn. 

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6.1.2.  The Big 3 scenario and its consequences for the capital markets 

Constantly high liability risks might be one of the reasons for a future collapse of one 
of the Big 4 networks (see also section 3.2.3 above). 

Self  insurance  of  audit  firms  has  only  limited  capacities.  As  mentioned  above, 
London Economics estimated that the maximum absorption capacity of a Big 4 firm 
ranges from € 170m to € 365m depending on th
e firm. A firm would not be able to 
sustain  a  subsequent  large  claim  (or  series  of  smaller  significant  claims)  in  the 
immediate  period  following  settlement  of  the  first  claim  before  its  resources  had 
been rebuilt, which would take several years. Such a scenario is possible - in 2005, 
EU  audit  firms  from  the  six  biggest  audit  networks  were  faced  with  16  claims 
exceeding € 160 million and five cases exceeding € 750 million.  

One  might  question  whether  the  risk  of  such  a  successful  claim  only  reflects  a 
theoretical "doomsday" scenario. If no action is taken, the fact that this risk is a real 
one would be ignored. 

Based  on  the  information  available,  (see  predictability  of  litigation  costs  section 
3.3.3),  the  average  settlement  amount  for  one  of  these  five  cases  should  be  around 
€90m (= 12% of a claim exceeding €750m). Ho wever, in one fifth of the cases, the 
settlement  amount  could  be  higher  -  between  25-40%  of  the  claim.  So  for  one  of 
these five cases it is probable that the settlement will range between €188m (= 25% 
Looking  at  the  table  summarising  the 
of  €750m)  and  €300m  (=40%  of  €750m). 
London Economics threshold simulations (section 3.4.4), it is clear that settlements 
of  this  order  would  be  far  outside  the  reach  of  mid-tier  firms  (in  3.4.4  table:  firms 
with an annual turnover of around €200m) . Depending on the threshold assumptions, 
even one or two of the Big 4 firms might also be unable to pay the higher (25-40% of 
claim) settlements and would have to call on  the support of  partners in its network 
but located in other countries. There is no reason to suppose that firms in many other 
Member  States  would  be  better  placed.  Given  the  figures  available  on  the  (not 
always final) settlements being proposed for certain large claims e.g. Parmalat, L&H, 
such high payments can clearly not be ruled out. 

The loss of another  major  audit network  would  have serious  consequences for the 
European  and  global capital  markets both in terms of  auditor choice and  the  actual 
availability of audit. The completion of statutory audits could be delayed, especially 
if  the  failure  occurred  close  to  the  year-end,  as  the  Transparency  Directive  will 
require audited financial statements  to be published no later than  four  months after 
the  end  of  a  company's  financial  year.  More  importantly,  it  is  possible  that  some 
companies would no longer be able to find a firm with the degree of specialisation 
required  to  undertake  their  audit.  Financial  institutions  in  particular  could  face 
serious  transition  problems  as  the  special  skills  their  audits  require  could  severely 
restrict their range of choice for a new auditor.  

Many  leading  mid-tier  accountancy  firms  have  already  confirmed  that  in  these 
circumstances  they  would  not  be  prepared  to  move  into  the  Big  4’s  current  audit 
market due the liability risks. The remaining largest firms would be constrained both 
by  independence  rules  (see  section  3.2.3)  and  their  ability  to  bear  audit  risk  in  the 
aftermath of the loss of one of the Big 4. The Big 3 scenario could lead to calls to 

EN 

36 

   EN 

 
open up the independence rules, although the regulatory world decided to strengthen 
them after the Enron debacle in 2002.  

Audit  fees  have  not  increased  significantly  over  the  recent  years  in  the  EU91. 
According  to  London  Economics'  survey,  the  audit  risk  is  not  fully  priced  into  the 
fees  as  this  is  difficult  and  some  clients  would  be  forced  to  pay  for  risks  which 
should be carried by other clients. In the case that one of the Big 4 audit firms would 
leave  the  market  in  future,  audit  fees  would,  according  to  the  London  Economics 
Study, also increase due to an even more limited number of market players. In such a 
case,  the  remaining  Big  3  would  have  an  even  more  dominant  position.  Whilst 
liability risks might still not be priced into audit fees, the usual competition would be 
severely  constrained.  For  instance,  insurers  currently  use  mainly  only  2  out  of  the 
Big 4 audit networks92. If one of these two disappeared, the remaining audit network 
would be almost the only available auditor for all insurers in Europe. A competitor 
would not be immediately available to respond to the demand for an auditor with the 
specialisation but also a presence in many jurisdictions in the world. 

If more players were in a position to compete, this Big 3 scenario would not occur.  

6.1.3.  Current situation in the Member States 

If  no  action  is  taken  at  the  EU  level,  the  current  situation  in  Member  States  will 
remain.  Auditors'  liability  will  be  limited  in  some  countries  whereas  it  will  remain 
unlimited in the majority of the Member States.  

•  Auditor’s  liability  is  currently  capped  in  five  Member  States  (Austria,  Belgium, 
Germany,  Greece  and  Slovenia:  see  Annex  6).  Hungary  has  introduced 
proportionate liability by law as from 1st January 2008. In 2006, the UK allowed 
for negotiation of contractual limitations of liability as from June 2008. 

•  Some examples are presented below: Belgium, UK, Austria and Germany (these 
latter  two  introduced  limitations  in  1931).  The  local  liability  reforms  have 
however one major problem in common: they address local liability risks and fail 
to address the international dimension. If an investor sues an auditor in a different 
jurisdiction, the local liability limitation will not apply. 

Belgium 

Since 2006 (law of 23 December 2005), Belgium has had caps on liability: €3m 93 for statutory 
audits of non-listed companies and €12m for stat utory audits of listed companies. The main 
reason for their introduction was to solve the problem of domestic insurance capacity. 

91 

92 

93 

EN 

In UK, audit fees for major companies (ranked in the FTSE 100) increased by just under 1% between 2003 and 
2006. See: 
http://www.accountingweb.co.uk/cgibin/item.cgi?id=171453&d=1025&h=1024&f=1026&dateformat=%25o%20
%25B%20%25Y 

KPMG and PwC 

Per damages per year (can be extended to more damages per year) 

37 

   EN 

 
                                                 
The  increasingly  litigious  environment  had  forced  insurers  to  terminate  the  collective 
insurance policy which was concluded between the insurers and the Professional Institute of 
Auditors (IBR/IRE) on behalf of its members. This liability reform enabled insurers to renew 
their  collective  policy  at  no  higher  cost,  under  conditions  that  were  more  flexible  to  the 
auditors and for insured amounts substantially higher than before (insurance coverage before 
the  reform  was  €  1,9m 94  whereas  now  the  coverage  is  €3m  and  €12m 95 respectively for the 
audit of unlisted and listed companies). According to the information received from Belgian 
Big  4  firms,  the  premiums  paid  have  not  been  influenced  by  this  reform.  In  other  terms,  a 
domestic liability reform has had no significant effect for the insurability for the international 
audits as other countries did not follow the example of Belgium.  

The other reasons for introducing the cap were: 

•  Unlimited  civil  liability  was  not  seen  as  strengthening  the  quality  of  the  audit.  A  certain 
level of liability is recommended but it is not reasonable to expect that the auditor should 
bear the full cost of a fraud committed by the directors or by the management or resulting 
from an internal accounting error; 

•  There were concerns about the concentration of the audit market for listed companies with 

international audit firms and the risk of an audit firm disappearing; 

•  In  addition,  an  underlying  preoccupation  was  to  keep  the  audit  profession  sufficiently 

attractive for trainees and practitioners. 

UK 

In  2006,  the  UK  introduced  the  possibility  for  auditors  to  negotiate  with  their  clients  a 
limitation of liability by contract. This new law will apply from June 2008. The UK opted for 
this policy for two main reasons:  

•  The limitation should allow maintenance of a strong audit market characterised by at least 
the  existing  levels  of  competition.  The  UK  authorities  recognised  auditors  have  faced  an 
increasing  number  of  claims,  including  many  that,  if  they  were  successful,  would  be 
beyond their financial capacities. 

•  The  second  reason  was  the  expectation  that  liability  limitation  agreed  by  contract  could 
lead to the reduction of audit fees 96. In 2007, a working group was established by the FRC 
in order to produce guidance on the use of agreements to limit liability of auditors of public 
companies.  In  December  2007,  the  working  group  published  a  consultation  paper.  The 
draft  guidance  provides  for  four  possible  methods  to  limit  the  liability  by  contract:  i) 
proportionate liability; ii) a pure reference to a "fair and reasonable test" that would be later 
on assessed by the courts; iii) a cap on liability, expressed either as a monetary amount or 
calculated on the basis of an agreed formula or; iv) a combination of some or all of those 
methods. The consultation paper also proposes guidance on other aspects of the limitation 
agreements and offers examples of such agreements to the markets. The paper makes clear 
that  the  major  investors  in  UK  are  however  not  ready  to  accept  a  contractual  cap.  Final 
guidance is expected for May 2008. 

94 

95 

96 

EN 

Per loss per year (possibility to extend, but rare in practise) 

Per damages per year (can be extended to more damages per year) 

See  for  example:  Company  Law  Reform  Bill  REGULATORY  IMPACT  ASSESSMENT:  November  2005,  p  15 
http://www.berr.gov.uk/files/file29023.pdf  

38 

   EN 

 
                                                 
Germany 

Since  1931,  there  has  been  a  statutory  limit  (cap)  on  auditor’s  liability  which  has  been 
continuously  up-dated  over  the  years.  The  cap  today  is  €1  million  for  statutory  audits  of 
unlisted  companies  and  €4  million  for  statutory  audits  of  listed  companies.  Although  the 
market segment for the largest listed companies (top 20) is highly concentrated, Germany in 
general  shows  relatively  low  concentration  rates  in  the  market  segments  for  smaller  listed 
companies (see Annex 3, Table 3). Particularly, in the market segments for the "top 200" or 
"top 300" listed companies, the market concentration in Germany is significantly lower than 
e.g.  in  UK  or  Italy.  In  2004,  198  German  audit  firms  conducted  statutory  audits  of  971 
companies  listed  on  the  regulated  German  stock  market97.  Amongst  the  world's  G8 
economies,  Germany  shows  one  of  the  lowest  concentration  rates  in  the  market  for  public 
company  audits98.  Once  again,  the  German  cap  is  not  recognised  in  other  countries.  Major 
international audits are facing considerable uncertainty in terms of liability risks. 

Austria 

Since  1931,  there  has  been  a  statutory  limit  (cap)  on  auditor’s  liability  which  has  been 
continuously adapted over the years. At present, this cap ranges between to €2m and €12m, 
depending on the size of the audited company (see Annex 6). The concentration rate of Big 4 
audit  firms  in  the  market  for  companies  listed  on  a  regulated  stock  market  is  lower  than  in 
many other countries99.  

6.1.4.  Current situation in the United States 

The problem of liability of auditors is also under discussion in the US. In 1995, the 
US  already  introduced  some  liability  reform.  Under  the  PSRLA100,  the  principle  of 
joint  and  several  liability  was  eliminated  and  replaced  by  a  form  of  proportionate 
liability. In addition, damage awards to plaintiffs were limited101 taking into account 
the particularities of US litigation law. However, the US system offers less protection 
for auditors than they currently enjoy in the EU because; i) it includes the possibility 
to award punitive damages (i.e. damages compensating more than the loss) and ii) it 
allows not only shareholders but a much wider range of investors to sue companies 
and auditors. In the US, litigation risks in general are much higher compared to EU, 
in  particular  in  the  area  of  securities  markets.  The  US  Supreme  Court  recently 
endeavoured  to  reduce  liability  risks  for  listed  companies  and  accordingly  the 

97 

98 

99 

100 
101 

See WPK-Magazin 1/2006 

Auditor  concentration  across  the  G8:  Canada  96%,  France  61%,  Germany  83%,  Italy  99%,  Japan  84%,  Russia 
90%, UK 98%, US 97%; see: 
http://www.grant-thornton.co.uk/press/press/PressRoom-g8_economies_creates_systemic_risk.aspx 

According to information received from the Austrian audit profession, the concentration rate of Big 4 audit firms in 
the market for companies listed on a regulated stock market amounts to 78%. 

The Private Securities Litigation Reform Act of 1995 
Damage awards to plaintiffs are accordingly limited to the difference between purchase or sale price and the mean 
trading  price  during  the  90-day  period  starting  on  the  date  the  market  was  made  aware  that  a  misstatement  of 
information has occurred. However, this situation concerns investors at large who sell or purchase securities. Under 
the law of Member States, only securities holders can take legal action against an auditor (see also annex I).  

EN 

39 

   EN 

 
                                                 
 
auditors of such companies102. One of the arguments of the US Supreme Court has 
been that litigation seriously harms the attractiveness of US capital markets.  

There  is  a  wide  public  debate  in  the  US  about  whether  there  is a  need  to  even  cap 
auditors'  liability.  In  January  2006,  the  US  Chamber  of  Commerce103
  called  for  a 
better  definition  of  the  limits  of  an  auditor’s  responsibility  and  ways  to  permit 
companies and auditors to agree reasonable limits on an auditor's liability.  

On 30 November 2006, the Committee on Capital Markets Regulation set up by the 
US Treasury considered in its report whether the US Congress should be invited to 
explore  whether  there  is  still  a  sustainable  and  competitive  audit  market.  The 
Committee suggested a cap based on a multiple of audit fees as a possible reform to 
be considered by the US Congress. 

The  US  is  not  fully  comparable  as  their  legal  system  permits  the  use  of  punitive 
damages,  but  the  EU  has  no  common  view  whereas  the  US  already  introduced 
proportionate liability.  

On the other hand, a report in March 2007 from the US Chamber of Commerce on 
the  regulation  of  US  capital  markets  recommended  that  national  audit  firms  should 
be  allowed  to  raise  capital  from  private  shareholders  other  than  audit  partners.  No 
liability reform was suggested. 

The  most  recent  input  into  the  US  debate  about  choice  and  limitation  of  auditors' 
liability is a study concerning market concentration prepared by the US Government 
Accountability  Office  (GAO)  published  in  January  2008.  According  to  GAO's 
survey, 82% of US large public companies - the Fortune 1000 - saw their choice of 
auditor as limited to three or fewer firms, and about 60 percent viewed competition 
in their audit market as insufficient. Although current concentration does not appear 
to be having a significant adverse effect, the loss of another large firm would further 
reduce  large  companies'  auditor  choice  and  could  affect  audit  fee  competitiveness. 
The GAO study does not recommend capping of liability in the US as there would be 
no consensus amongst business community. 

In October 2007, US Treasury Secretary Paulson set up an advisory committee which 
will examine auditing industry concentration, audit quality, recruitment and retention 
of  auditors  in  audit  firms  as  well  as  the  impacts  of  insurability  and  liability  risks. 
This committee should present recommendations in summer 2008. 

6.2. 

Impact of option 4a on the objectives (Capping liability by a Directive)  

It  might  be  difficult  for  all  Member  States  to  fix  a  uniform  amount  of  cap  or  a 
uniform  method  to  calculate  a  cap  taking  into  account  the  necessity  to  ensure  fair 
protection  of  damaged  parties,  audit  quality  and  the  necessity  to  avoid  anti 
competitive  effects  for  audit  firms  auditing  mainly  smaller  listed  companies. 

102 

103 

EN 

US  Supreme  Court,  ruling  on  15  January  2008  in  the  case  StoneRidge  Investment  Partners  v  Scientific 
Atlanta/Motorola with regard to the causal link between an accounting misstatement and the decision of investors 
for investing  

Auditing : A profession at risk, US Chamber of Commerce, January 2006 

40 

   EN 

 
                                                 
Nevertheless,  once  this  first  difficulty  is  overcome,  all  the  objectives  would  be 
efficiently addressed.  

•  Achieve fairer liability risk exposure for auditors:  

In  Member  States  with  regimes  of  joint  and  several  liability,  liability  caps  would 
effectively protect auditors from excessive claims by plaintiffs and, thereby, address 
the deep pocket syndrome104. In addition, depending on the level of cap, the risk of 
the disappearance of a major audit firm would be reduced. However, a cap might not 
necessarily reflect the degree of negligence or loss the auditor has caused, so might 
still not be “fair”.  

•  Facilitate access to insurance for auditors: 

A cap at the EU level would improve the predictability of claims for insurers as those 
claims would be capped by a fixed amount or a method to calculate an amount. The 
insurance  coverage  should  therefore  be  restored.  For  example  in  Belgium  the 
introduction of a cap has improved the insurance coverage for auditors (see section 
6.1.3).  However,  some  insurers  believe  that  a  cap  would  not  overcome  the  lack  of 
mutualisation  of  risks  amongst  a  large  number  of  players.  These  insurers  might 
slowly act once more audit networks entered the market.  

•  Encourage investment into the expansion of audit firms:  

If the cap were set too high by the Member State, the cap could favour the Big 4 and 
mid-tier audit firms auditing smaller listed companies would not benefit from such a 
high  cap.  Nevertheless,  we  can  assume  that  if  the  cap  is  not  too  high,  it  would  be 
beneficial for mid audit firms wishing to enter the market of large public companies. 
Germany for example, where a cap has existed since 1931, shows one of the lowest 
concentration rates in the market for large public company audit (see section 3.2.2). 
All EU Member States where caps do exist seem to have opted for rather low caps in 
order to let mid-tier audit firms benefit. 

•  Reduce differences in liability regimes across the EU: 

This  option  would  reduce  differences  of  the  liability  regimes  across  the  EU  as  all 
Member States would have a cap. However, differences would not be eliminated, as 
Member  States  would  not  necessarily  apply  the  same  cap  amount.  The  impact  in 
terms  of  the  effort  required  to  change  the  liability  regimes  could  be  quite  high,  as 
each Member State could introduce a cap tailored to its own situation – for example, 
the  chance  of  using  some  standard  text  would  be  low;  the  effort  required  in 
determining the cap could also be large.  

6.3. 

Impact of option 4b on the objectives (Introducing proportionate liability by a 
Directive) 

Currently  only  Hungary  has  introduced  proportionate  liability  as  a  principle 
applicable to statutory audits by law. All other Member States would need to change 
their law in order to implement this option. 

104 

London Economics study, P. xxiii 

EN 

41 

   EN 

 
                                                 
•    Achieve fairer liability risk exposure for auditors:  

This option would contribute significantly to achieving a fairer liability risk exposure 
for  auditors,  as  auditors'  liability  would  be  defined  in  proportion  to  their  level  of 
responsibility. Proportionality by law would reduce the risk of audit firms being used 
last  resort  against  any  corporate  malpractice.  However, 
as 
proportionality  might  not  be  enough  to  protect  auditors  against  excessive  claims, 
since it does not limit absolutely the magnitude of such claims. 

insurance  of 

•  Facilitate access to insurance for auditors: 

As proportionate liability would not limit absolutely the magnitude of liability risks, 
the  insurability  situation  of  audit  firms  would  not  improve  as  effectively  as  in  the 
case of liability caps. There could still be some expectation of an improvement in the 
availability  of  insurance,  as  insurers  would  know  that  auditors  would  not  face  full 
liability for any claim but some lesser amount.  

•  Encourage investment into the expansion of audit firms:  

Respondents to our public consultation coming from the mid-tier audit firms tended 
to consider that proportionate liability is a more appropriate solution compared to a 
cap (option 4a) to reform auditors' liability. Mid-tier audit firms are more concerned 
about a cap as they fear that caps might be set at such high level having no practical 
effects for mid-tier audit firms currently focussing at small listed companies. In the 
UK,  a  reduction  in  the  level  of  market  concentration  was  one  of  the  objectives  for 
introducing  the  possibility  to  agree  on  proportionate  liability  through  contractual 
arrangements. 

•  Reduce differences in liability regimes across the EU: 

This option would effectively eliminate differences in the liability regimes across the 
EU as all Member States would have the same rules i.e. proportionate liability. The 
effort  required  to  introduce  such  a  change  into  the  different  legal  regimes  would 
depend on the existing legal basis – in some countries it would be quite low, in others 
it  would  be  quite  high.  However,  as  all  Member  States  would  be  introducing  the 
same  rules  (the  principle  of  proportionate  liability),  a  similar  approach  could  be 
found in all countries. 

6.4. 

Impact of option 4c on the objectives (convergence of liability limitations) 

This  option  should  address  the  first  three  objectives  to  a  large  extent,  whilst  also 
permitting  Member  States  to  choose  the  most  suitable  solution  according  to  their 
legal,  economic  and  insurance  systems.  The  fourth  objective,  i.e.  reducing 
differences in liability regimes across the EU, would be addressed to a lesser degree. 
The  changes  needed  in  national  law  would  obviously  depend  on  the  individual 
solutions being adopted. The impacts of this option are also affected by the different 
legal instruments proposed. The following sections consider the impacts according to 
the legal instrument.  

EN 

42 

   EN 

 
6.4.1.  Reaching convergence by a Recommendation 

A  possible  downside  of  a  Recommendation  could  be  that  not  all  Member  States 
would  take  action.  Therefore,  the  following  analysis  considers  two  scenarios: 
implementation  by  all  Member  States  (the  "full  implementation  scenario")  and 
implementation  only  by  some  Member  States  (the  "partial 
implementation 
scenario"). 

a) Full implementation scenario 

Under  this  scenario,  all  Member  States  would  follow  an  EU  recommendation  by 
introducing  a  certain  method  or  system  of  auditors'  liability  limitation  in  their 
national  legal  regimes.  Compared  to  the  current  situation,  any  movement  from  the 
current position which ranges between known limits and infinity, to a more bounded 
situation, could be viewed as a considerable improvement for the audit market and as 
a consequence for capital markets. 

Introducing a recommendation containing high-level principles for limiting auditors' 
liability in the EU would address all objectives described under section 4.  

Since  Member  States  might  realistically  be  expected  to  opt  mainly  for  a  cap  or 
proportionality, the impacts of this option should by and large be similar on the first 
three  objectives  as  those  of  the  options  4a  (cap)  and  4b  (proportionality). 
Nevertheless,  the  magnitude  of  the  impacts  will  depend  on  the  ratio  of  Member 
States  adopting  a  cap,  proportionate  liability  or  a  mix  of  the  two.  The  option  4c 
would  allow  individual  Member  States  the  possibility  to  assess  which  method  they 
consider as the most appropriate under their given legal regimes. Each Member State 
would implement the recommendation in a way which best suits its environment, its 
legal  tradition  and  the  expectation  of  shareholders.  This  is  the  case  today  -  some 
Member  States,  e.g.  Germany  or  Belgium,  have  introduced  modest  caps  since  they 
are concerned about the negative impact of higher caps on competition on the audit 
market but are convinced that there is no negative impact on audit quality. By way of 
contrast,  other  Member  States,  e.g.  Hungary,  might  favour  proportionate  liability 
rather  than  a  cap  as  they  consider  that  confidence  into  audits,  where  liability  is 
capped against the will of shareholders, might be negatively affected105. 

Hence, the main difference is that like 4a (caps), this option would not fully remove 
the  differences  in  liability  regimes  across  the  EU,  as  could  occur  under  4b 
(proportionality).  Hence  audit  firms  would  still  need  to  deal  with  different  rules 
across the EU. But it should at least improve (i.e. make more level) the playing-field 
for  audit  firms  across  all  Member  States  as  all  Member  States  would  have  some 
known way of limiting liability. Currently, in the Member States where a limitation 
exist,  as  analysed  above  in  section  6.1.3,  the  impact  on  the  objectives  is  positive, 
regardless of the method of limiting liability retained in these Member States. One of 
the  main  reasons  is  that  these  methods  are  well  adapted  to  the  national  legal 
environment.  The  impacts  are  expected  to  be  much  more  positive  if  a  limitation 
exists  in  all  the  Member  States,  even  if  there  is  no  uniform  method  for  limiting 
liability across the EU. 

105 

See the study of the UK Office of Fair Trading of 2005 

EN 

43 

   EN 

 
                                                 
b) Partial implementation scenario 

The  magnitude  of  the  impacts  obviously  depends  on  how  many  Member  States 
decide to introduce limits to liability, on the forms that such limits take and on the 
timing, as a recommendation does not have a given implementation date. Under the 
worst case scenario, it could not be excluded that none of the Member States which 
currently  have  unlimited  liability  introduce  changes.  For  instance,  some  Member 
States do not see any need for action at this stage. 

Finland 

The Finish Ministry of Trade and Industry informed the Commission Services during 
the  public  consultation  early  2007  that  they  had  commissioned  research  on  the 
necessity to limit auditors' liability in Finland. This research, published in December 
2006,  found  no  reasons  to  introduce  further  limits  to  liability  in  Finland,  since  an 
important safeguard limiting liability already exists: compensation for damages may, 
according to Finnish legislation, be adjusted if the liability is deemed unreasonably 
onerous  in  view  of  the  financial  status  of  the  person  causing  the  damage  and  the 
person suffering the same and other circumstances.  

France/Denmark: joint audits 

France  shows  comparable  or  even  slightly  lower  audit  market  concentration  rates 
than  Germany,  which  are  due  to  the  implementation  of  "joint  audit"-regulations 
which were imposed in 1966. These regulations commit listed companies to mandate 
two statutory auditors. As a consequence, mid-tier audit firms often participate in the 
statutory audits of listed companies. According to a recent study of the French audit 
market106, the Big 4 market share in the audit market for companies listed in the main 
stock  exchange  index,  based  on  number  of  audit  engagements,  amounts  to  83%. 
However, the concentration rate based on audit fees is significantly higher (94%). In 
addition,  the  study  found  a  continued  concentration  trend  in  France  towards  joint-
audits carried out by two Big 4 audit firms. Amongst listed companies, the Big 4 are 
by far at least one of the two joint auditors. It is extremely rare that only two mid-tier 
audit firms carry out the joint audit. Effectively, smaller audit firms participate more 
under a kind of "piggy-back" method in the audit of listed companies. Such mid-tier 
audit  firms  do  not  necessarily  see  a  need  to  increase  their  investments,  but  are 
content with the current "piggy-back" situation. As no other Member States follows 
suit,  the  lack  of  international  acceptance  would  neither  allow  the  growth  of  a  new 
international  player  on  the  audit  market  nor  overcome  the  fragmentation  into  local 
firms averse to liability risks from other jurisdictions. 

Denmark,  which  also  has  low  concentration  rate  (see  Annex  3),  dropped  this 
requirement in 2001 as it felt that it was no longer justified against the background of 
audit  quality.  In  the  past,  Denmark  felt  that  joint  audits  would  overcome  previous 
companies'  difficulties  of  finding  audit  firms  with  a  presence  in  all  necessary 
jurisdictions  in  the  world.  Due  to  the  mergers  in  the  1980s  and  1990s,  the  Big  5 

106 

See Autorité des Marchés Financiers (AMF): Study of fees paid by French companies listed in the CAC 40 index to 
statutory auditors and their networks in respect of the 2006-2005 period", July 2007.  

EN 

44 

   EN 

 
                                                 
(today  Big  4)  emerged  and  these  networks  have  been  able  to  meet  the  companies' 
demands for international audits.  

It  is  therefore  not  excluded  at  this  stage  that  a  recommendation  would  not  be 
followed by Finland and France. Such a situation would nevertheless not prevent a 
recommendation having positive effects. 

It is probable that such a recommendation would at least prompt Member States to 
discuss and debate the issue with market participants and to take appropriate action. 
A  clear  signal  would  be  given  that  problems  linked  to  liability  risks  and  high 
concentration are not  only local  problems, but  deserve  international  recognition for 
the  European  capital  markets.  It  should  incite  Member  States  and  the  different 
stakeholders  to  discuss  possible  solutions.  Presented  below  are  some  examples  of 
current debate, from which it could reasonably be expected that some Member States 
would follow the Commission recommendation.  

Sweden 

The  Swedish  Ministry  of  Justice  informed  the  Commission  Services  during  the 
public  consultation  that  the  Swedish  government  has  appointed  a  commission  to 
analyse different models for limiting auditors' liability and to, if appropriate, propose 
new  legislation.  The  work  should  be  concluded  by  September  2008.  The  Swedish 
Ministry  of  Justice  underlined  that  any  recommendation  from  the  European 
Commission  should  only  establish  the  objective  for  developing  national  liability 
solutions without imposing any restrictions for Member States on how to reach this 
objective. 

Ireland 

In  2007  the  Irish  government  asked  the  Company  Law  Review  Group  (CLRG)  to 
examine the matter of auditors' liability. In the event that CLRG would propose that 
reform to the present system is warranted, they were also asked to identify the areas 
in  which  reform  would  be  required,  and  the  means  by  which  this  could  be  best 
achieved. This could include potential methods, including but not limited to, changes 
in the law:  

- for the introduction of statutory liability caps; 

- to permit limitation of liability by contract; 

- to introduce a regime of proportionate liability; 

- to permit auditors to incorporate (i.e. establish limited liability companies). 

The CLRG Report on its activities is scheduled for publication in 2008.  

6.4.2.  Reaching convergence by a Directive (option 4 c implemented via a Directive) 

On that basis, the impact versus the objectives should be the same as the impact of 
full implementation of the option 4c via a Recommendation.  

EN 

45 

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However,  there  are  differences  between  the  two  variants  of  option  4c,  due  to  the 
nature  of  the  instruments  proposed.  The  Directive  is  a  legally  binding  instrument 
requiring a much higher degree of detail. The Commission has the possibility to use 
formal  infringements  procedures  against  Member  States  for  not  having  complied 
with  an  adopted  Directive.  The  costs  of  introducing  implementing  legislation  for 
Member States are potentially higher for a Directive as all the Member States have to 
implement  the  Directive  whereas  for  a  Recommendation  they  are  free  to  choose  to 
which  extent  the  Recommendation  will  be  implemented  taking  into  account  the 
current  measures  they  have  in  place.  Moreover,  the  procedure  for  adopting  a 
Directive is longer compared to a Recommendation. 

6.5. 

Impact on Audit Quality  

6.5.1.  General impact of a liability limitation on audit quality 

The first safeguard should be that the proposed action would not extend to limiting 
liability  in  case  of  an  auditors’  wilful  misconduct,  for  example  in  the  case  of 
cooperation  with  management  in  corporate  fraud.  It  would  concern  only  cases  of 
negligence.  

Opponents  to  liability  reform  often  argue  that  audit  quality  would  nevertheless  be 
affected if auditors' liability were limited. However, there exists a second safeguard: 
audit  regulators  -  not  judges  or  courts  –  will  in  future  play  a  pivotal  role  in 
maintaining the top audit quality which companies and investors deserve.  

The  2006  Directive  on  Statutory  Audit  provides  important  safeguards  aimed  at 
increasing  audit  quality.  It  requires  Member  States  to  implement  an  external 
independent  quality  assurance  system  (inspection  system)  for  all  statutory  auditors 
(Art.  29)  under  independent  public  oversight  (Art.  32).  Such  oversight  should 
prevent  potential  risks  to  audit  quality  compared  to  the  past,  when  the  audit 
profession was self-regulated and self-controlled. The public oversight system should 
organise  independent  inspections107  and  take  sanctions  against  auditors  who  do  not 
follow the professional standards. Such independent inspections linked to appropriate 
sanctions  would  be  a  much  stronger  and  more  appropriate  driver  for  audit  quality 
than civil liability rules. 

In  addition,  the  quality  of  the  audit  staff,  their  training  and  the  internal  quality 
systems of the audit firms could be more important drivers for audit quality than the 
fear of liability claims. It is questionable to what extent imposing potential liability 
claims on auditors would be effective in affecting their behaviour108.  

107 

108 

Regular controls at least every 6 years, for auditors of public interest companies every 3 years  

Accounting and auditing standards leave the auditor with significant latitude of judgement, thus, auditors are not 
able to exactly assess ex-ante whether they have fulfilled the requirements of a certain standard. The actual level of 
auditors' care of duty does not only affect the probability of damage, but also – in a second step – the probability 
that  a  court  ex-post  adjudges  negligent  behaviour  of  the  auditor.  However,  according  to  Ellsberg-Paradoxon, 
individuals are averse to such a two-tiered probability distribution. Consequently, this aversion may under certain 
conditions also result in a reduced level of the auditors' care of duty. See: Prof. Ewert: "Wirtschaftsprüferhaftung 
bei unpräzisen Sorgfaltsstandards and Ambiguitätsaversion", 2007: 
http://www.rewi.hu-berlin.de/jura/ls/knr/WorkshopLawandEco/Bigus.pdf 

EN 

46 

   EN 

 
                                                 
 
Moreover,  auditors  would  still  be  liable  for  their  actions  after  Member  States  have 
implemented  the  proposed  recommendation.  Audit  firms  are  also  unlikely  to 
disregard  audit  quality  as  their  reputation  and  their  business  might  otherwise  be 
damaged. 

Finally, it is important to underline that the quality of an audit service depends on the 
perception of companies and investors and is therefore difficult to assess109. Despite 
evidence suggesting that actual audit quality is high, users may have different views 
of  the  degree  of  audit  quality.  Therefore,  even  if  the  quality  of  the  audits  was  not 
affected  in  reality  by  a  reform  of  liability,  one  might  fear  that  the  investors'  and 
companies' confidence  would be affected. Nevertheless, the new 2006 Directive on 
Statutory  Audit  should  prevent  such  a  negative  impact  on  the  perception  of  audit 
quality.  As  described  above,  it  would  allow  public  authorities  to  control  better  the 
audit  quality  and  therefore  the  perception  of  audit  quality  would  be  linked  more  to 
more objective elements such as the outcome of independent inspections. Moreover, 
Article 40 of the new Directive requires audit firms to provide transparency reports, 
for  example  about  their  internal  quality  systems,  which  should  be  an  element 
improving  the  perception  of  the  audit  quality.  In  addition,  Article  29  allows  more 
transparency on the results of the quality assurance reviews in audit firms. 

6.5.2. 

Impact of each of the options on audit quality 

Many  respondents  to  the  public  consultation  coming  from  outside  the  audit 
profession  expressed  their  opposition  to  an  initiative  if  it  led  to  capping  liability  at 
the  EU  level.  They  claimed  that  this  would  lead  to  moral  hazard  amongst  auditors 
(option  4a).110  However,  the  experience  of  countries  where  a  cap  has  existed  for  a 
long  time  (e.g.  Germany  or  Austria)  shows  that  investors  and  companies  do  not 
believe  that  even  a  low  cap  has  adverse  effects  on  audit  quality.  Belgium  which 
introduced  a  cap  in  2005  did  not  experience  a  deterioration  or  general  negative 
impact on audit quality. This option would in no way prevent Member States setting 
a very high cap, for example, at more than €100 m or even €200 m, far beyond the 
caps  in  use  in  Germany  or  Belgium.  It  would  also  allow  the  application  of  a  more 
flexible solution, such as a cap calculated on the amount of audit fees charged by the 
auditor  or  a  cap  calculated  as  a  percentage  of  the  balance  sheet  figures  in  the 
company's accounts. 

According to the public consultation, stakeholders would be less concerned about the 
possible  effects  of  proportionate  liability  on  audit  quality  (option  4b),  because 
auditors' liability would be linked to the level of contribution to the damage.  

Probably  the  best  solution  would  be  that  the  appreciation  of  the  impacts  on  audit 
quality is left to Member States discretion, given the results of their quality control 

109 

110 

This  is  because the  only  observable  outcome  of the  audit  is  the audit  report  which  is  a  generic  template and  the 
overwhelming majority of reports are standard clean opinions. While it is possible to assess audit quality ex post in 
the  case  of  outright  audit  failures,  these  are  relatively  infrequent  occurrences.  See  Jere  R.  Francis:  "What  do  we 
know about audit quality?", The British Accounting Review 2004 

Audit quality can be defined as the market-assessed probability that the financial statements contain material errors 
and that the auditor will be able to discover and to report such errors to investors. This probability is affected by the 
competence and independence of the auditor. This general understanding has been developed in DeAngelo, L. E. 
(1981b): Auditor size and audit quality: Journal of Accounting and Economics 1981, P. 183-199 

EN 

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systems  (option  4c).  Investors  could  also  better  express  their  local  preference. 
Member  States  which  find  reasons  to  fear  negative  consequences  of  a  cap  could 
chose  proportionate  liability  or  even  develop  a  further  method.  If  shareholders  are 
too  critical,  some  Member  States  could  also  introduce  the  possibility  of  allowing 
contractual  limitation  of  liability.  Such  limitations  would  need  to  be  subject  to  the 
approval of shareholders at shareholders meetings.  

6.6. 

Positive impact mainly for the Big 4?  

Some  respondents  to  the  public  consultation  were  concerned  that  a  limitation  of 
auditors' liability would mainly benefit the Big 4 audit firms.  

Firstly,  a  liability  limitation  should  significantly  benefit  potential  new  entrants  and 
especially the mid-tier audit firms. The limited availability of insurance creates high 
costs  for  any  mid-tier  audit  firms  interested  to  enter  the  market  for  large  audits  as 
these firms may not have the same ability to establish captive insurance, which the 
Big 4 established more than a decade ago. Moreover, mid-tier audit firms may not be 
able  to  diversify  liability  risks  effectively  due  to  the  size  and  selection  of  their 
mandates111. In Belgium, the introduction of a cap favours the access to insurance for 
smaller audit firms112. 

Secondly,  liability  risks  also  affect  the  willingness  of  partners  in  an  audit  firm  to 
provide  more  extensive  funding  allowing  further  expansion  of  the  audit  firm's 
activities. The partners of the audit firms would have no incentive to invest in such 
an expansion if, given the high liability risks, expected returns are likely to be low. 
Therefore lower liability risks would provide a stronger incentive for mid-tier audit 
firms  to  invest  more  and  to  compete  more  with  the  major  audit  networks,  in 
particular with regard to the smaller listed companies. 

Finally, the Big 4 will remain subject to the general market mechanism. Like in the 
case  of  Arthur  Andersen,  a  significant  audit  failure  might  erode  the  reputation  and 
brand  of  a  network.  Accordingly,  such  network  might  implode  as  leading  partners 
would no longer see any benefit in sustaining such eroded brand. In the same vein, 
audit failure within such a network can lead to public investigations and removal of 
licences in major capital markets leading to the collapse of the network as a whole. 
However, some stakeholders defend that there is a risk that the Big 4 are "too big to 
fail" and that liability reform would consolidate, even strengthen this risk. However, 
liability reform as proposed under option 4c will not have this result. The examples 
above demonstrate that a major audit network might fail for other reasons. Member 
States which might have strong concerns could opt for proportionate liability which 
does  not  offer  such  an  immediate  protection  like  a  cap.  Finally,  the  current  audit 
market always remains subject to general competition rules, in particular Articles 81 
and 82 of the EC Treaty. 

111 

112 

EN 

See London Economics study, P. 92 and the Oxera ownership study p 156 and p.174 

See section 6.1.3. 

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6.7. 

Possible up- and down-sides for stakeholders outside audit firms 

The  following  section  describes  the  possible  up-  and  down-sides  of  liability 
limitations for stakeholders outside the audit profession.  

Possible concerns of the different stakeholders are addressed below: 

Companies 

Companies fear that the limitation of auditors' liability would restrict their right for 
compensation in the case of auditors' malpractices. However, as has been made clear, 
any  limitation  would  not  apply  in  the  case  of  a  wilful  misconduct  of  the  auditor. 
Moreover,  a  reform  of  auditors'  liability  would  not  change  the  general  principle:  a 
company  has  always  been  culpable  of  its  own  malpractice.  The  negligence  of 
auditors could only be related to the detection of such malpractice. Accordingly, the 
statutory auditor may always raise the audited company's own fault as a defence in a 
claim brought by this company.  

Some companies are concerned about the possible negative impacts of a limitation of 
auditors'  liability  with  respect  to  the  liability  of  directors  and  company  officers. 
However, any liability risk of directors and officers can, in contrast to the risks faced 
by  statutory  auditors,  be  more  widely  diversified  amongst  many  D&O  policy 
holders113 whereas this a major problem for a few international audit firms. 

Investment banks 

Investment  banks  raised  the  issue  that  they  could  be  co-defendants  together  with 
audit firms in any claim. 

Investment  banks  act  as  underwriters  in  the  context  of  an  initial  public  offering 
(IPO),  when  such  banks  arrange  the  possible  sale  of  securities  by  an  issuer  to  the 
public. The initiative proposed on limiting auditors' liability is not focussing on IPO's 
and the role of auditors in an IPO but on the statutory audit of annual accounts to be 
regularly  published  after  a  company  has  been  listed.  Therefore,  a  limitation  of 
auditors'  liability  would  not  increase  liability  risks  for  investment  banks  in  the 
context of an IPO.  

Banks  can  also act as advisers of a  company  in other cases  (i.e. not just for IPOs). 
Nevertheless  investment  banks  currently  benefit  from  insurance  coverage114  and 
there is a high degree of competition in the market for investment banking services.  

Third parties seeking compensation (in particular investors) 

One of the concerns expressed during the consultation is that the third parties and in 
particular investors, might not be compensated for their full loss. Yet this is already 
the  case  in  practice.  Their  expectations  of  obtaining  compensation  face  practical 
limits, corresponding to the financial capacities of the audit firms. In this respect, the 

London Economics study, P. 103 

See  also  Final  Report  from  the  European  Commission  on  the  continued  appropriateness  of  the  requirements  for 
professional  indemnity  insurance  imposed  on  intermediaries  under  Community  Law  of  11  April  2007  (COM 
(2007) 178 final), P. 10 

49 

   EN 

113 
114 

EN 

 
                                                 
advantage of limiting auditor's liability would be that the rules are fixed in advance 
and hence potential plaintiffs would not expect audit firms to be able to compensate 
them for unlimited amounts.  

Again, it is to be stressed, any limitation of liability should only apply to cases where 
an  auditor  acted  in  a  negligent  manner.  Limitations  would  not  apply  to  wilful 
misconduct  of  an  auditor,  such  as  collusive  behaviour  with  management  in 
committing  corporate  fraud.  This  solution  would  be  consistent  with  legislation  in 
Member States who already limit liability. 

6.8. 

Other impacts (for options 4a, 4b and 4c) 

Impacts at the international level 

Some  respondents  to  the  public  consultation  asserted  that  a  limitation  of  auditors' 
liability  at  EU  level  would  not  be  able  to  address  potential  plaintiffs'  claims  in 
conjunction with statutory audits also relevant for other jurisdictions, such as the US. 
The European Union clearly has no powers addressing liability in other jurisdictions. 
However,  a  limitation  would  at  least  address  the  risks  in  the  EU,  for  instance  in 
conjunction with group audits of multinational companies carried out in Europe. The 
audit  firms  presented  evidence  that  litigation  risks  exist  in  the  EU  (see  section  3.3 
above). 

If  complimentary  solutions  along  the  same  lines  were  adopted  by  major  countries 
outside the EU, the progress at global level would be even more effective 

Social impact on the profession 

Audit  firms,  which  are  exposed  to  high  audit  risks,  have  difficulties  in  retaining 
experienced  professional  staff,  who  might  otherwise  continue  as  partners115.  A  less 
attractive  audit  profession  might  result  in  fewer  talented  professionals  interested  in 
pursuing their career path all the way to partnership level. A limitation of auditors' 
liability  should  improve  the  attractiveness  of  audit  firms  to  hire  and  keep  highly 
qualified professional staff.  

Administrative cost 

for  companies 

According to the 4th and 7th Company Law Directives, financial reporting is already 
mandatory 
in  European  Member  States.  Under  particular 
circumstances,  a  specific  information  requirement  might  be  important:  a  company 
should disclose any contract based limitation of the auditor’s liability in the financial 
statements. The related costs cannot be exactly determined but they should be very 
limited  as  listed  companies  should,  in  any  event,  prepare  financial  statements.  The 
benefit for investors, who might be considering buying shares, is to make them aware 
of such limitation before taking an investment decision. This benefit should clearly 
outweigh  minor  costs  involved  in  adapting  financial  statements.  This  disclosure 
solution  has  also  been  introduced  in  the  UK  when  allowing  contract  based 
limitations.  

115 

See also MORI, Auditor career and working life survey, January 2005 

EN 

50 

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The  administrative  cost  could  be  higher  for  the  options  4a  and  4b  as  those  options 
would require some Member States which already have a limitation to change it in 
order to adapt it to the provisions of the directive.  

7. 

COMPARING THE OPTIONS 

The baseline for the comparison is option 1: "No EU action " whilst at the same time 
an  increase  in  audit  quality  is  expected  through  the  implementation  of  the  2006 
Directive  on  Statutory  Audit,  in  particular  through  more  rigorous  inspections  by 
independent public oversight systems. 

7.1. 

Criterion 1: Effectiveness regarding the objectives 

Objective 1: Achieve fairer liability risk exposure for auditors  

Compared to the current situation of "No EU action", implementation of any of the 
options  would  achieve  fairer  risk  exposure  for  auditors.  Harmonizing  liability 
regimes at an EU level on the basis of proportionate liability (option 4b) is the most 
effective  option  to  achieve  a  fairer  risk  exposure  for  statutory  auditors.  Under  this 
option,  auditors  would  be  financially  liable  only  for  the  consequences  of  their  own 
negligent  behaviour  and  not  for  the  consequences  of  other  parties'  fault.  Limitation 
by a cap (option 4a) would not be linked to the extent of auditors' fault. Nevertheless, 
proportionate  liability  (option  4b)  might  not  protect  auditors  sufficiently  against 
catastrophic claims,116 compared to a cap (option 4a).  

Option 4c allows Member States to choose the most appropriate method or even to 
combine various methods (cap and proportionate liability) to achieve a fair liability 
risk  exposure.  In  some  Member  States  with  legal  regimes  allowing  contractual 
arrangements,  the  liability  could  also  be  limited  by  a  contract  between  the  auditor 
and the company (i.e. on a case by case basis) provided adequate safeguards, such as 
the consent of shareholders, are in place. Consequently, option 4c implemented by a 
Directive or a Recommendation fully followed by the Member States, might achieve 
this  objective  at  least  as  effectively  as  an  EU  wide  harmonisation  based  on 
proportionate liability (4b). This option would be less effective if option 4c was not 
fully implemented.  

Objective 2: Facilitate access to insurance for auditors 

Compared  to  the  current  situation  of  No  EU  action,  implementation  of  any  of  the 
options  would  bring  a  great  improvement  at  international  level.  As  described  in 
section 6, harmonisation using a cap (option 4a) would be the most efficient option to 
achieve  this  objective.  Proportionate  liability  (option  4b)  could  not  limit  absolutely 
the  magnitude  of  liability  risks  and  could  not  improve  the  predictability.  As  a 
consequence the insurability situation of audit firms would not improve as well as in 
the  case  of  using  liability  caps.  Nevertheless,  the  implementation  of  either  of  these 
two options at the EU level could allow better development of insurance coverage for 
the audits conducted in the EU.  

116 

Under  proportionality,  in  the  event  of  a  major  claim  amounting  to  €300m  and  an  assigned  responsibility   to  the 
statutory auditor of 50%, the auditors' liability would be limited to €150m. In contrast, th e liability caps existing in 
Member States are significantly lower (see Annex 3). 

EN 

51 

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The effects of the option 4c should also be effective at the national level as Member 
States  should  be  able  to  find  the  best  solution  possible  taking  into  account  the 
national  insurance  conditions.  Insurers  which  are  also  major  investors  at  the  same 
time might find this flexibility more attractive. 

The  option  4c  introduced  via  a  Recommendation  would  be  less  effective  if  this 
option was not fully implemented by the Member States.  

Objective 3: Encourage investment into the expansion of audit firms 

Again, compared to the current situation of No EU action, implementation of any of 
the  options  would  be  a  positive  step  in  order  to  encourage  new  investments  into 
expansion  of  audit  firms.  If  the  cap  were  set  too  high  by  the  Member  States, 
recommendation  on  auditors'  liability  could  favour  the  Big  4.  Mid-tier  audit  firms 
auditing smaller listed companies would in practice never benefit from such a high 
cap.  Respondents  to  our  public  consultation  coming  from  the  mid-tier  audit  firms 
tend  to  consider  that  proportionate  liability  (4b)  is  a  more  appropriate  solution  to 
reform auditors' liability.  

Nevertheless, we can assume that if the cap is not too high, it would be beneficial for 
mid audit firms wishing to enter the market of large public companies.  

The option 4b could be more effective to attract more players into the market of the 
audits  of  the  smaller  listed  companies  but  could  be  less  effective  for  the  market  of 
big  listed  companies,  as  it  would  not  reduce  absolutely  the  magnitude  of  claims. 
Proportionality  would  have  the  same  impacts  for  both  small  and  big  audit  firms 
whereas  a  cap,  especially  fixed  at  a  high  level  might  privilege  major  audit  firms 
auditing big listed companies. 

The  option  4c  would  allow  the  Member  States  to  choose  the  solution  which  is  the 
most  adapted  to  the  needs  of  the  mid-tier  audit  firms  in  their  country  and  could 
therefore  provide  a  strong  incentive  for  other  audit  firms  to  invest  more  and  to 
compete  more  with  the  major  audit  networks.  Option  4c  introduced  via  a 
Recommendation would be less effective if this option was not fully implemented. 

Objective 4: Reduce differences in liability regimes across the EU  

Option  4b  introducing  harmonisation  of  liability  regimes  on  the  basis  of 
proportionality  would  be  more  effective  than  the  options  4a  and  4c  as  the  same 
liability regime would apply in the whole EU. Option 4a would strongly reduce but 
not  eliminate  the  differences.  There  would  be  a  cap  on  liability  in  all  the  Member 
States  but  it  could  vary  considerably  across  the  EU.  Nevertheless,  the  amounts  of 
caps would be known in advance and they could be easily managed by the networks 
of  the  audit  firms.  That  said,  the  final  cap  would  determine  whether  mid-tier  audit 
firms  can  make  more  inroads  into  the  market.  The  higher  the  cap,  the  less  the 
chances will be for mid-tier audit firms. The option 4c would be the least effective of 
the  three  options  but  it  should  at  least  improve  (i.e.  make  more  level)  the  playing-
field for audit firms across all Member States. It would be therefore more effective 
than the current situation of "No EU action". 

EN 

52 

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7.2. 

Criterion 2: Efficiency 

Efficiency should mainly be assessed in respect to the fragmentation issue described 
in  the  section  3.  If  the  regime  of  liability  is  the  same  in  the  whole  EU,  it  would 
involve  less  costs  for  the  audit  networks  to  deal  with  the  question  of  liability  and 
therefore  audit  networks  could  become  more  integrated.  Options  4a  and  4b 
(harmonisation) would be more efficient than option 4c. The downsides of option 4c 
would be even stronger if it would be implemented only partially by Member States. 
Nevertheless, the option 4c would still be a considerable progress compared to a "No 
EU action" (option 1). 

7.3. 

Criterion 3: Audit quality 

If a cap were set too low by the Member States under option 4a, this might have a 
negative impact on the quality for the audit of major listed companies. In particular, 
investors might see a great risk and loose confidence into the audits. 

Option 4b would steer the conduct of auditors towards audit quality adapted to audit 
risks and might deliver a better balance between audit efforts and liability risks.  

The  option  4c  should  not  have  negative  effects  on  audit  quality  as  Member  States 
should  choose  the  best  possible  method  and  level  of  limitation.  Local  investors' 
perception of audit quality and confidence into the audit could be much better taken 
into  account.  For  example,  in  Germany  a  cap  has  existed  since  1931  and  German 
investors  have  no  concerns  about  this.  Some  Member  States  would  also  be  able  to 
allow the possibility to limit liability by contract to be concluded between the auditor 
and  the  company.  Such  agreements  should  not  have  any  negative  effects  as  they 
would be submitted to the agreement by the shareholders and to the judicial review.  

7.4. 

Criterion 4: Acceptability 

a) Acceptability for Member States/ subsidiarity  

Both  harmonisation  options  (4a  and  4b)  would  today  constitute  a  disproportionate 
intervention into the national civil laws. Countries where one solution is already in 
place would oppose a change to any other method. Germany and Austria have been 
operating  with  relatively  low  caps  for  over  75  years;  Belgium  introduced  such  a 
system  in  2005  –  all  three  countries  find  this  solution  effective  to  their  problems. 
Hungary, having just introduced the system would prefer proportionality rather than 
a cap. Others, such as the UK market place, have a strong preference for limitation of 
liability via contractual arrangements and are highly likely not ready to accept a cap 
imposed by a directive leaving shareholders of a particular company without any say. 
Option  4b,  a  harmonisation  by  introducing  proportionate  liability  would  also 
represent  a  significant  intervention  into  many  existing  legal  regimes,  because  most 
Member States have joint and several liability systems and would have to change to 
proportionate  liability.  Therefore  the  harmonisation  at  the  EU  level  leading  to 
proportionate liability would require many Member States to change core aspects of 
their law, at least for auditors.  

The outcome of the public consultation proved that legal and economic differences 
between Member States are so significant that harmonisation would not be accepted 

EN 

53 

   EN 

 
by Member States. Moreover given that civil liability rules for listed companies with 
regard to their financial statements and accounting failures are not harmonised117, a 
complete  harmonisation  of  liability  rules  for  auditors  would  not  be  accepted. 
Therefore  options  4a  and  4b  are  probably  not  realistic  at  this  stage  despite  being 
highly effective and efficient regarding their impact on the objectives. 

Many respondents to the public consultation also emphasised that any Commission 
measure should give maximum flexibility to Member States.  

limiting 

Introducing  high-level  principles  for 
the  EU  via  a 
Recommendation according to the option 4c would allow individual Member States 
the  possibility  to  assess  which  method  they  consider  as  the  most  appropriate  under 
their given legal regimes. Such an action seems more proportionate at this moment as 
legal regimes and economic conditions are very different in the Member States. This 
option  is  also  more  acceptable  than  a  Directive  as  it  would  leave  the  possibility  to 
Member States not to take action.  

liability 

in 

Introducing a choice of method of limitation via a Directive would also be difficult 
for  Member  States  to  accept  because  of  the  timing  of  the  action.  The  Directive  on 
Statutory Audit was adopted in 2006 and the implementation deadline is June 2009. 
It  is  therefore  difficult  to  impose  a  new  Directive  when  Member  States  are  still 
transposing  the  first  one.  Moreover  Article  31  of  the  Directive  on  Statutory  Audit 
suggests 
liability  should  be  dealt  with  via  a 
recommendation and not via a legally binding instrument. Finally, a directive under 
option 4c introduced at this stage would exacerbate the current divergences between 
cap and proportionate liability in the long run and not really promote convergence of 
liability regimes. Instead, Member States would all insist on their national option and 
would not be ready to reconsider their position in the future. 

issue  of  auditors' 

that 

the 

b) Acceptability for the markets  

The  results  of  the  public  consultation  show  that  the  stakeholders  from  outside  the 
audit profession would today prefer proportionate liability (option 4b) rather than a 
cap (option 4a). For the majority of these respondents, the proportionality should be 
negotiated  by  contract  rather  than  imposed  by  law.  Respondents  from  outside  the 
audit  profession  coming  from  the  UK  wish  to  keep  the  system  allowing  them  to 
agree  on  limitation  by  contract  but  important  academic  voices  (e.g.  Max  Planck 
Institute) also consider such an approach to be the best. Such flexibility would not be 
possible under options 4a and 4b and therefore those options would be unacceptable 
to them.  

Many  of  the  respondents  consider  therefore  that  the  choice  should  be  left  to  the 
Member States (option 4c). According to the results of the public consultation, half 
of  the  respondents  coming  from  outside  the  audit  profession  would  support  a 
Commission initiative on auditors' liability. The views from respondents outside the 
audit profession depend to a large extent on whether or not they come from countries 

117 

See  e.g.  Directive  2004/109/EC  of  the  European  Parliament  and  of  the  Council  of  15  December  2004  on  the 
harmonisation of transparency requirements in relation to information about issuers whose securities are admitted 
to trading on a regulated market and amending Directive 2001/34/EC 

EN 

54 

   EN 

 
                                                 
where  limitation  already  exists.  74.1%  of  respondents  from  countries  where 
limitation  exists  would  support  an  initiative  at  EU  level,  whereas  76.5%  of  the 
respondents  from  countries  without  limitation  reject  a  Commission  initiative.  This 
opposition is mainly related to a scenario where the Commission might recommend a 
harmonisation of liability regimes in Member States based on capping liability. 

In  brief,  if  sufficient  flexibility  is  left  to  the  Member  States,  they  could  be  able  to 
find a system of limitation which is acceptable to stakeholders coming from outside 
the audit profession. Moreover, a recommendation could be adopted quickly and give 
a  strong  signal  to  Member  States.  Therefore  a  recommendation  seems  the  most 
adapted way to find solutions acceptable for all the stakeholders.  

A directive introducing choice of a limitation between different measures would be 
less  acceptable  as  such  a  directive  would  take  time  before  it  is  adopted.  No  clear 
signal could be given quickly to the markets.  

c) Acceptability for other professions  

Some respondents to the public consultation also argued that the Commission should 
avoid  singling  out  auditors  in  contrast  to  other  professional  services  or  other 
economic  players  who  might  ask  for  a  limitation  in  the  same  way.  However,  there 
are important reasons justifying a distinction:  

•  Doctors:  might  also  be  exposed  to  high  risk  activities,  but  only  to  claims  from 
patients  or  their  relatives.  More  importantly,  liability  risks  for  the  activities  of 
doctors do not have cross border effects118. 

•  Tax advisors: act in the purely private interest of their clients. The statutory audit 
function  is  mandatory  and  thus  policy  makers  have  a  genuine  public  interest 
responsibility for ensuring a sustainable audit market.  

•  Lawyers:  the  market  for  their  advisory  services  is  not  as  vulnerable  (i.e.  not  as 
concentrated)  as  the  international  audit  market.  If  a  significant  law  firm  were 
forced to leave the market, the gap could be closed by other market players.  

•  Finally,  compared  to  auditors,  these  professions  lack  an  important  safeguard  to 
control the quality of the services they provide: their activities are not controlled 
by an independent public oversight, as required under the Directive on Statutory 
Audit. 

Option 4c would be preferable to options 4a and 4b as it would be more acceptable 
for the others stakeholders and could be discussed with them. 

7.5. 

Overall comparison 

The following table summarises the arguments for and against all options: 

118 

Any  international  aspects  are  relevant  for  insurance  sector  dealing  with  medical  malpractice.  See  also  Report  of 
OECD of 16 June 2006: Coverage of medical malpractice in OECD countries. 

EN 

55 

   EN 

 
                                                 
7.6. 

Conclusion  
the  Commission  would  propose  a  short  principle  based 
The  Services  of 
recommendation (Option 4c), as the preferred solution, compared to other possible 
options,  to  address  the  general  and  the  specific  objectives.  Although  other  options 
could  achieve  the  objectives  more  efficiently,  they  are  not  politically  acceptable  at 
this time. 

Effectiveness 
 (impact119 over time) 
as regards to 

Objective 1:  

Objective 2:  

Objective 3:  

Objective 4:  

Achieve fairer 
liability risk 
exposure for 
auditors 

Facilitate 
access to 
insurance for 
auditors 

Encourage 
investments into 
the expansion of 
audit firms 

Reduce 
differences in the 
liability regimes 
across the EU 

○ 

○ 

○ 

○ 

+++ 

++ 

○/+ 

+ 

+ 

○ 

○ 

○ 

y
c
n
e
i
c
i
f
f

E

)
s
s
e
n
e
v
i
t
c
e
f
f
e

t
s
o
c
(

○ 

-- 

○ 

y
t
i
l
i
b
a
t
p
e
c
c
A

y
t
i
l
a
u
Q

t
i
d
u
A

○ 

○ 

-- 

-- 

-- 

-- 

+/++ 

+/++ 

+/++ 

++ 

++ 

--- 

○/- 

+++ 

○/+ 

+/++ 

+++ 

+++ 

--- 

○ 

++ 

+ 

++ 

+ 

+ 

+ 

+/++ 

+ 

++ 

+ 

+ 

+ 

++ 

○ 

++ 

○ 

+/++ 

++ 

+ 

- 

○ 

Option 1: 
No EU action 

Option 2: 
Compulsory insurance 

Option 3: "Safe 
harbours" 

Option 4a: 
Liability cap 

Option 4b: 
Proportionate liability 

Option 4c: 
Convergence of liability 
limitations in the EU via 
a Recommendation 

Full implementation of 
the Recommendation 

Partial implementation 
of the Recommendation 

Option 4c  
Convergence of liability 
limitations in the EU via 
a Directive 

119 

+ = Positive Impact; ○ = Benchmark (current situation); - = Negative Impact 

EN 

56 

   EN 

 
                                                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
8. 

MONITORING AND EVALUATION 

The  Commission  would  closely  monitor  and  evaluate  the  impacts  of  the  proposed 
Recommendation on the audit market. As the Recommendation would contain only 
high  level  principles,  Member  States  would  be  able  to  choose  very  different 
solutions.  The  Commission  would  therefore  need  to  carefully  monitor  the  way  the 
Recommendation  was  implemented  by  Member  States  as  well  as  the  effects  of  the 
implementation.  

To this aim, the Commission would propose the collection of information related to 
possible  advantages  and  disadvantages  of  each  of  the  solutions.  For  example, 
information to be collected every four years could include: 

•  General information about the international audit market e.g., concentration rates 
of  audit  firms  in  international  market  in  the  EU,  liability  regimes  in  Member 
States, number of new audit firms entering the international market;  

•  Information  about  insurability  of  liability  risks  e.g.  insurance  availability  and 

source (e.g. from market, via audit firms); cost of insurance premiums; 

•  Information  about  audit  quality  e.g.  in  light  of  the  Directive  on  Statutory  Audit, 
outcome of inspections carried out under the responsibility of the public oversight 
bodies; 

•  Information  about  claims  and  settlement  of  such  claims,  e.g.  compensation 
actually  paid  versus  claimed  versus  cap  in  Member  States  with  a  cap  and  in 
Member States with proportionate liability. 

The  Commission  will  review  this  information  and  discuss  it  with  Member  States. 
Further debate with private stakeholders (audit firms, investors, companies, insurers) 
will take place on the basis of this information. 

The  monitoring  phase  provides  with  the  possibility  of  identifying  further  actions  if 
necessary. It can also lead to the use of another instrument. The general policy of the 
European  Commission  is  to  start  addressing  a  problem  first  by  the  use  of  soft  law, 
when  possible.  But  if  the  expected  results  were  not  achieved  because  of  an 
unsatisfactory implementation of the Recommendation, a binding instrument such as 
a Directive might be considered in the future. 

********* 

EN 

57 

   EN 

 
List of annexes 

Annex 1: 

Results of the Public Consultation on Auditors' Liability 

Annex 2: 
Market capitalisation / turnover of large companies listed on European capital 
markets  Market  capitalisation  /  turnover  of  large  companies  listed  on  European  capital 
markets 

Annex 3: 

Audit market concentration in European Member States 

Annex 4: 
Member States 

Legal  base  (contractual  or  tort  law)  for  auditors'  liability  situation  in  EU-15 

Annex 5: 

Insurance obligations in EU-25 Member States 

Annex 6: 

Liability caps in European Member States 

EN 

58 

   EN 

 
 
Annex 1 

Results of the Public Consultation on Auditors' Liability 

85  replies  were  received120  from  15  Member  States.  Responses  came  mainly  from 
international  based  respondents  (20  responses)  and  from  respondents  based  in  UK, 
Germany and France, with respectively 18, 12 and 10 responses. In addition, replies 
from  12  other  EU-27  Member  States  have  been  received.  The  breakdown  by 
category of respondents is follows:  

Category 

Number

% 

Auditors

30 

35% 

Insurance

10 

12% 

Companies

Investors

Academics

Banks

Miscellaneous

Regulators

Member States

Other financial market 
participants

9 

8 

6 

6 

6 

5 

3 

2 

11% 

9% 

7% 

7% 

7% 

6% 

4% 

2% 

TOTAL

85 

100% 

The  overall  reaction  of  the  respondents  towards  a  possible  reform  of  auditors' 
liability regime was as follows: 

120 

For further information on the composition and role of the Forum, see summary report on DG MARKT website: 
http://ec.europa.eu/internal_market/auditing/docs/liability/summary_report_en.pdf 

EN 

59 

   EN 

 
 
                                                 
Indicative overall reaction of the respondents towards 
a possible reform of auditors' liability regime 

In favour of limitation 

 N° 

% 

yes (audit profession) 

yes (outside the profession) 

no 

neutral 

TOTAL 

30 

26 

25 

4 

85 

35 % 

31 % 

29 % 

5 % 

100% 

Most of the respondents clearly expressed their views in favour or against a possible 
limitation on auditors' liability. 66% of all respondents (35% from audit profession, 
representing  all  replies  from  audit  profession,  plus  31%  from  outside  the  audit 
profession)  support  a  limitation  on  auditors'  liability,  whereas  29%  rejected  the 
possibility. The categories of stakeholders who raise more concerns about a possible 
reform  are  investors  and  companies.  One  argument  often  mentioned  in  their 
responses  is  the  complexity  of  establishing  an  EU-wide  approach  to  auditors' 
liability, given the variety of legal systems in the Member States. 

Moreover,  it  is  important  to  distinguish  between  those  Member  States  which  have 
already  liability  limitations  in  place  and  those  which  have  no  limit.  A  majority 
(74.1%) of respondents from outside the audit profession and from countries where 
limitations exist (e.g. UK, Germany and Austria) support a reform on European basis 
as long as their national regimes are not seriously affected. In contrast, 76.5% of the 
respondents  from  outside  the  audit  profession  and  from  countries  without  any 
limitation reject a Commission initiative.  

All respondents from the category “auditors” agreed unanimously that a limitation on 
auditors’ liability should be introduced. Most of them ask the European Commission 
for a recommendation favouring a cap. 

Respondents from the insurance sector can be divided between those from Member 
States  having  already  a  liability  limitation  in  place,  who  support  the  reform,  and 
those from Member States without a limitation, which support the status quo, i.e. no 
action  to  be  taken  at  Community  level.  A  third  category  of  respondents  are  the 
insurance  brokers,  who  support  a  limitation.  It  is  also  worthwhile  noting  that  some 
insurers  provided  different  replies  reflecting  their  multiple  roles  -  as  underwriting 
insurers,  institutional  investors  and  users  of  audit  services.  These  different  view 
points were often conflicting.  

In terms of the specific options that were examined in the public consultation, 59% 
of all respondents - regardless whether they were in favour for a reform or rejected it 

EN 

60 

   EN 

 
 
  
- considered that the principle of proportionate liability would be the best option to 
limit  auditors´  liability.  Approximately,  38%  of  respondents  would  prefer  a 
combination  of  proportionality  plus  cap.  The  introduction  of  any  sort  of  capping  is 
supported by 62% of those respondents. In relation to the possible caps suggested in 
the consultation paper, option 3 (a cap based on a multiple of the audit fees charged 
by the auditor to its client) is the most supported option (43% of respondents). 

EN 

61 

   EN 

 
Annex 2 

Market capitalisation of companies in main index of national stock exchange in EU-25 – 
largest  company,  median  company  and  smallest  company  by  capitalisation  in  index, 
million of € 

Country 

Size of 
company 

Market 
capitalisation 

Size of a 5% decrease in 
market capitalisation 

Size of a 10% decrease in 
market capitalisation 

Austria 

Belgium 

Cyprus 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Czech Republic 

Median 

Germany 

Denmark 

Estonia 

Greece 

Spain 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

15,151 

3,107 

452 

40,679 

5,617 

853 

3,990 

79 

6.6 

17,188 

56 

25 

68,169 

17,294 

3,738 

26,661 

3,568 

548 

1,054 

111 

43 

15,617 

4,376 

666 

75,740 

8,721 

1,829 

758 

155 

23 

2,034 

281 

43 

200 

3.9 

0.3 

859 

2.8 

1.2 

3,408 

865 

187 

1,333 

178 

27 

53 

5.5 

2.2 

781 

219 

33 

3,787 

436 

91 

1,515 

311 

45 

4,068 

562 

85 

399 

7.9 

0.7 

1,719 

5.6 

2.5 

6,817 

1,729 

374 

2,666 

357 

55 

105 

11.1 

4.3 

1,562 

438 

67 

7,574 

872 

183 

EN 

62 

   EN 

 
 
Market capitalisation of companies in main index of national stock exchange in EU-25 – 
largest  company,  median  company  and  smallest  company  by  capitalisation  in  index, 
million of € 

Country 

Size of 
company 

Market 
capitalisation 

Size of a 5% decrease in 
market capitalisation 

Size of a 10% decrease in 
market capitalisation 

France 

Finland 

Hungary 

Ireland 

Italy 

Lithuania 

Luxembourg 

Latvia 

Malta 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

The Netherlands 

Median 

128,519 

19,722 

3,407 

68,617 

3,096 

919 

9,096 

788 

30 

17,668 

2,434 

777 

96,289 

7,769 

1,229 

1,598 

124 

59 

11,300 

418 

171 

791 

300 

84 

462 

75 

6.8 

180,871 

11,259 

Smallest 

682 

6,426 

986 

170 

3,431 

155 

46 

455 

39 

1.5 

883 

122 

39 

4,814 

388 

61 

80 

6.2 

3.0 

565 

21 

9 

39.5 

15 

4.2 

23.1 

3.7 

0.3 

9,044 

563 

34 

12,852 

1,972 

341 

6,862 

310 

92 

910 

79 

3.0 

1,767 

243 

78 

9,629 

777 

123 

160 

12 

5.9 

1130 

42 

17 

79.1 

30 

8.4 

46.2 

7.5 

0.7 

18,087 

1,126 

68 

EN 

63 

   EN 

 
Market capitalisation of companies in main index of national stock exchange in EU-25 – 
largest  company,  median  company  and  smallest  company  by  capitalisation  in  index, 
million of € 

Country 

Size of 
company 

Market 
capitalisation 

Size of a 5% decrease in 
market capitalisation 

Size of a 10% decrease in 
market capitalisation 

Poland 

Portugal 

Sweden 

Slovenia 

Slovakia 

UK 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

1,607 

367 

335 

11,628 

1,695 

22 

80,721 

10,438 

1,667 

2,274 

214 

68 

1,957 

189 

6.1 

183,935 

9,044 

4,138 

Note: Data as of 17 September 2006. 

Source: Bloomberg Professional Services and websites of national stock exchanges. 

80 

18 

17 

581 

85 

1.1 

4,036 

522 

83 

114 

11 

3.4 

98 

9 

0.3 

9,197 

452 

207 

161 

37 

33 

1,163 

170 

2.2 

8,072 

1,044 

167 

227 

21 

6.8 

196 

19 

0.6 

18,394 

904 

414 

EN 

64 

   EN 

 
Fifty largest listed firms by turnover, 2004 (€million) 

Country 

Size of Company  Total Turnover  5% of Total Turnover  10% of Total Turnover 

Austria* 

Belgium 

Cyprus 

Czech Republic* 

Germany 

Denmark 

Estonia* 

Greece 

Spain 

France 

Finland 

Hungary 

Ireland 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

9,880 

404 

4.6 

40,739 

854 

208 

1,203 

412 

19 

4,088 

189 

0.9 

142,954 

7,699 

2,443 

43,570 

3,379 

814 

163 

34 

0 

4,538 

447 

161 

41,689 

1,734 

537 

122,700 

15,669 

6,172 

29,610 

1,727 

386 

7,784 

11 

1.1 

494 

20 

0.2 

2,037 

43 

10 

60 

20 

0.9 

204 

9.5 

0 

7,148 

385 

122 

2,179 

169 

41 

8 

1.7 

0 

227 

22 

8.1 

2,084 

87 

27 

6,135 

783 

309 

1,481 

86 

19 

389 

1 

0.1 

988 

40 

0.5 

4,074 

85 

21 

120 

41 

1.9 

409 

18 

0 

14,295 

770 

244 

4,357 

338 

81 

16 

3.4 

0 

454 

45 

16 

4,169 

173 

54 

12,270 

1,567 

617 

2,961 

173 

39 

778 

1 

0.1 

30,814 

1,541 

3,081 

EN 

65 

   EN 

 
 
Fifty largest listed firms by turnover, 2004 (€million) 

Country 

Size of Company  Total Turnover  5% of Total Turnover  10% of Total Turnover 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Largest 

Median 

Smallest 

Italy 

Lithuania* 

Luxembourg* 

Latvia* 

Malta* 

The Netherlands 

Poland 

Portugal 

Sweden 

Slovenia* 

Slovakia* 

UK 

472 

10 

54,316 

4,306 

1,686 

2,202 

33 

2 

24 

0 

2,716 

215 

84 

110 

1.7 

0.1 

60,717 

3,036 

1 

4 

178 

9 

0 

126 

91 

3 

67,814 

3,475 

1,005 

10,091 

320 

144 

23,881 

515 

8 

42,281 

3,708 

895 

1,602 

172 

4 

7,784 

248 

0.4 

216,304 

15,268 

7,487 

0 

0.2 

8.9 

0 

0 

6.3 

4.5 

0.1 

3,391 

174 

50 

505 

16 

7 

1,194 

26 

0.4 

2,114 

185 

45 

80 

9 

0.2 

389 

12 

0 

10,815 

763 

374 

47 

1 

5,432 

431 

169 

220 

3 

0.2 

6,072 

0.1 

0 

17.8 

1 

0 

12 

9.1 

0.3 

6,781 

348 

100 

1,009 

32 

14 

2,388 

51 

0.8 

4,228 

371 

89 

160 

17 

0.4 

778 

25 

0 

21,630 

1,527 

749 

EN 

66 

   EN 

 
 
Note: * = Countries in which there are less than 50 companies listed on the main market of the stock exchange. 

Source: Amadeus, annual reports of individual companies and LE calculations 

EN 

67 

   EN 

 
The following tables are based on a range of concentration measures: 

Annex 3 

First, the market share of: 

•  the largest audit firm (C1); 

•  the two largest audit firms (C2); 

•  the four largest audit firms (C4); and, 

•  where relevant, the eight largest audit firms (C8). 

Second, the estimated Herfindahl-Hirschman index (HHI) which is equal to the sum 
of the square of the market shares of all audit service providers. As this concentration 
measure takes account of the market shares of all the suppliers in a given market, it is 

a  more  comprehensive  indicator  of  concentration  than  the  concentration  ratios 
described above and is widely used by competition authorities to assess the structure 
of  a  given  market.  In  the  U.S.  a  HHI  value  of  more  than  1,800  is  viewed  as 
problematic  while  in  the  EU,  in  the  context  of  merger  assessment,  a  HHI  between 
1,000 and 2,000 is not viewed as problematic if a merger increases the HHI by less 
than  250  and  a  HHI  of  more  than  2,000  is  viewed  as  not  problematic  only  if  the 
merger  increases  the  HHI  by  less  than  150  (see  Official  Journal  of  the  European 
Union,  Guidelines  on  the  assessment  of  horizontal  mergers  under  the  Council 
Regulation on the control of concentration between undertakings, 2004/C 31/03, 2nd 
May 2004). 

EN 

68 

   EN 

 
Table 1 Concentration in EU statutory audit markets – companies in main index of main 
national stock exchange 

Country 

Number of companies 

Concentration indices by number of mandates 
(% except HHI) 

BE 

CZ 

DK 

DE 

EE 

EL 

ES 

FR 

IE 

IT 

CY 

LV 

LT 

LU 

HU 

MT 

NL 

AT 

PL 

PT 

SI 

SK 

FI 

SE 

UK 

19 

9 

19 

30 

10 

20 

35 

40 

20 

40 

20 

5 

21 

11 

12 

14 

23 

22 

20 

20 

15 

5 

25 

30 

100 

C1 

25 

40 

26 

53 

30 

40 

50 

30 

45 

35 

50 

40 

29 

31 

64 

43 

32 

42 

44 

50 

40 

40 

56 

34 

43 

C2 

50 

60 

48 

87 

50 

60 

80 

46 

70 

60 

85 

80 

52 

54 

91 

71 

60 

71 

70 

65 

53 

80 

80 

66 

65 

C4 

88 

100 

78 

97 

90 

90 

97 

73 

95 

100 

95 

- 

95 

92 

- 

100 

100 

83 

- 

85 

73 

- 

- 

100 

99 

C8 

HHI 

- 

- 

- 

- 

- 

100 

96 

100 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

2031 

3000 

1833 

4022 

2200 

2550 

4100 

1818 

3000 

2662 

3800 

3600 

2340 

2307 

4876 

3163 

2608 

2743 

3150 

3000 

2000 

3600 

3984 

2792 

2912 

Source: London Economics calculations using data from Amadeus and annual reports of financial institutions and companies included in the main stock market 

indices. Oxera (2006) for the UK. 

EN 

69 

   EN 

 
 
 
 
 
 
Table 2 Concentration in EU statutory audit - all companies listed on regulated national 
stock exchange. 

Country 

Number of 
companies** 

Concentration indexes by number of 
mandates (% except for HHI) 

Concentration indexes by 
revenues audited1 or fees 
received 

C1 

C2 

C4 

C8 

HHI 

C1  C2  C4  C8  HHI 

BE 

CZ 

DK 

 DE* 

EE 

EL 

ES 

 FR 

IE 

IT 

CY 

LV 

LT 

LU 

HU 

MT 

NL 

AT 

PL 

PT 

SI 

SK 

FI 

SE 

135 

36 

175 

541 

16 

292 

115 

489 

65 

276 

141 

40 

43 

27 

36 

14 

140 

44 

236 

52 

15 

7 

148 

272 

27 

29 

21 

19 

33 

34 

44 

15 

25 

27 

30 

13 

23 

30 

25 

43 

25 

40 

15 

42 

40 

29 

43 

30 

43 

50 

40 

36 

60 

48 

70 

24 

51 

53 

57 

20 

44 

48 

44 

71 

50 

58 

23 

62 

53 

57 

70 

56 

EN 

70 

65 

68 

55 

93 

66 

91 

42 

80 

88 

76 

30 

79 

74 

64 

84 

82 

86 

66 

1431 

48 

69 

96 

97 

3119 

1540 

1314 

56 

30 

76 

45 

94 

77 

99 

98 

3754 

1824 

918 

57 

82 

92 

96 

3976 

- 

2444 

34 

61 

94 

- 

2499 

84 

97 

58 

89 

93 

87 

50 

93 

1600 

31 

51 

73 

97 

1784 

2854 

78 

92 

99 

100 

6334 

551 

28 

45 

71 

90 

1577 

1756 

41 

81 

99 

100 

3488 

2053 

34 

62 

100 

- 

2651 

1867 

30 

59 

90 

95 

2465 

500 

30 

53 

81 

93 

1894 

1644 

68 

77 

93 

100 

4802 

- 

1604 

46 

79 

96 

- 

3389 

75 

1280 

60 

80 

99 

99 

4247 

100 

- 

3163 

63 

99 

100 

2147 

29 

57 

100 

- 

- 

5328 

2551 

96 

91 

61 

83 

- 

- 

97 

99 

89 

78 

41 

73 

73 

100 

94 

93 

70 

2212 

43 

78 

93 

96 

3198 

597 

56 

69 

83 

94 

3417 

2300 

64 

81 

93 

99 

4553 

2000 

49 

89 

100 

100 

4073 

2040 

95 

98 

100 

3038 

74 

94 

100 

- 

- 

8998 

5893 

2370 

37 

67 

99 

100 

2766 

   EN 

 
 
 
Table 2 Concentration in EU statutory audit - all companies listed on regulated national 
stock exchange. 

Country 

Number of 
companies** 

Concentration indexes by number of 
mandates (% except for HHI) 

Concentration indexes by 
revenues audited1 or fees 
received 

UK 

316 

37 

61 

98 

100 

2654 

36 

59 

100 

- 

2660 

Notes: (1) Revenues audited are the gross revenues of companies being audited as reported in the companies’ annual reports. *= figures based on fees received by 

the auditing company in 2005 as reported in the annual reports of the companies. ** = number of companies for which information could be found. UK FTSE 350 

only, Germany Frankfurt All Share list only. 

Source: London Economics calculations using data from Amadeus and annual reports of companies and financial institutions listed on the respective national stock 
exchange. Oxera (2006) for the UK. 

EN 

71 

   EN 

 
Table 3: HHI in EU statutory audit market by size turnover of companies 
-  all  companies  listed  on  regulated  national  stock  exchanges-  2004  – 
countries with and without a cap on auditor liability. 

Top 20 

Top 50 

Top 100 

Top 150 

Top 200 

Top 300 

BE2 

CZ 

DK 

DE 

 EE3 

EL 

ES 

FR 

IE 

IT 

CY 

LV 

LT 

LU 

HU 

MT4 

NL 

AT 

PL 

PT 

SI5 

SK 

FI 

SE 

UK 

2650 

2325 

2218 

3325 

2200 

1750 

5150 

1951 

3400 

2650 

2250 

1000 

1950 

2100 

2575 

3163 

2925 

3100 

2400 

3225 

2977 

- 

5550 

3150 

2850 

EN 

2288 

1843 

- 

1817 

1600 

- 

1528 

3568 

1480 

2288 

2640 

2016 

- 

- 

- 

- 

- 

- 

1492 

1249 

- 

1452 

3003 

1252 

- 

2614 

1625 

- 

- 

- 

- 

- 

2971 

2488 

- 

1576 

2080 

- 

- 

4104 

2556 

2776 

- 

- 

- 

- 

3328 

2647 

2854 

- 

- 

- 

1046 

- 

- 

- 

- 

919 

- 

1587 

1823 

- 

1082 

- 

- 

844 

- 

2535 

2462 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

2628 

2882 

2202 

2798 

72 

1084 

848 

- 

- 

- 

838 

- 

- 

- 

669 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

- 

2659 

   EN 

 
 
 
 
Notes: (1) HHI based on number of mandates. (2) Since December 2005, Belgium has a cap on auditor liability. But, as the data refer to market concentration in 

2004 , Belgium is not shown as having a cap in the table; (3) Estonia = 10 companies, (4) Malta = 14 companies, (5) Slovenia = only 15 companies are listed on the 

stock exchange. 

Source: London Economics calculations using data from Amadeus and annual reports of companies. 

EN 

73 

   EN 

 
Legal base (contractual or tort law) for auditors' liability in EU-15 Member States  

Annex 4 

Country 

Austria 

Belgium 

Denmark 

Finland 

France 

Germany 

Greece 

Ireland 

Italy 

Luxemburg 

Netherlands 

Portugal 

Spain 

Sweden 

Audited company  Third party 

Contractual121 

Contractual/tort122 

Contractual/tort 

Tort 

Contractual 

Tort 

Tort 

Tort 

Tort 

Tort 

Contractual/tort 

Contractual/tort 

Contractual 

Tort 

Contractual/tort 

Tort 

Contractual 

Contractual 

Contractual 

Tort 

Tort 

Tort 

Contractual/tort 

Contractual/tort 

Contractual 

Contractual 

Tort 

Tort 

United Kingdom 

Contractual/tort 

Tort 

121 

122 

Under  contractual  law,  a  statutory  auditor  is  liable  for  a  breach  of  his  duties  under  a  contract  (e.g.  of  the  audit 
contract concluded between the statutory auditor and the audited company). 
Under tort law, a statutory auditor is liable for a breach of his duties under statutory law of a certain jurisdiction 
(e.g. of the professional standards set under Community or national law). 

EN 

74 

   EN 

 
 
 
                                                 
Annex 5 

Insurance obligations for auditors in EU-25 Member States 

These tables show whether the legal entity or the individual auditor is obliged to maintain the legal obligation of 
insurance in case the statutory auditor is the audit firm. 

COUNTRY 

LEGAL OBLIGATION OF INSURANCE 

LEGAL ENTITY 

INDIVIDUAL AUDITOR 

BOTH 

AUSTRIA 

BELGIUM 

CYPRUS 

CZECH REPUBLIC 

DENMARK 

ESTONIA 

FINLAND 

FRANCE 

GERMANY 

GREECE 

HUNGARY 

IRELAND 

ITALY  

LATVIA 

LITHUANIA 

LUXEMBOURG 

MALTA 

NETHERLANDS 

x 

-- 

-- 

-- 

-- 

-- 

-- 

-- 

x 

-- 

-- 

-- 

-- 

x 

x 

-- 

-- 

x 

(for auditors practising 
in a public limited 
liability company or a 
limited liability 
company) 

(for auditors practicing in a 
civil law association) 

-- 

-- 

x 

x 

x 

x 

-- 

-- 

x 

-- 

x 

(the insurance of the firm 
can also be accepted under 
certain circumstances) 

-- 

-- 

-- 

-- 

-- 

-- 

-- 

-- 

x 

x 

x 

-- 

-- 

-- 

x 

-- 

x 

-- 

-- 

-- 

-- 

-- 

-- 

x 

-- 

EN 

75 

   EN 

 
COUNTRY 

LEGAL OBLIGATION OF INSURANCE 

LEGAL ENTITY 

INDIVIDUAL AUDITOR 

POLAND 

-- 

PORTUGAL 

SLOVAK REPUBLIC 

SLOVENIA 

SPAIN 

SWEDEN 

UNITED KINGDOM 

-- 

-- 

x 

x 

-- 

x 

-- 

x 

-- 

-- 

-- 

-- 

-- 

BOTH 

x 

(but 
the  obligation  of 
insurance  does  not  rest 
with  an  auditor  who 
delivers  audit  services  on 
behalf  of  an  audit  firm, 
not  acting 
in  his  own 
name and on his account) 

-- 

x 

(but there is no obligation 
for the individual auditor 
if he delivers audit 
services on behalf of an 
audit company) 

-- 

-- 

x 

-- 

See:  Thieffry  &  Associates:  "A  study  on  systems  of  civil  liability  of  statutory  auditors  in  the  context  of  a  Single  Market  for  auditing  services  in  the  European 

Union", Report to the European Commission. Update by DG Internal Market and Services in January 2007 

EN 

76 

   EN 

 
Annex 6 

Liability caps 

Auditor's  liability  is  currently  capped  in  five  Member  States.  Liability  caps  do  not  apply  in 

case of intentional conduct of the auditor (see table below).  

COUNTRY 

CALCULATION 

AMOUNT OF THE CAP 

CONDITIONS 

AUSTRIA 

 Per  audit  (audits  of 
and 
accounts 
group 
accounts 
individual 
being 
counted 
separately) 

€2  million : statutory audit 
of a small or medium sized 
company (§ 221 (2) HGB) 

Scale  not  applicable  to  intentional 
conduct;  applicable  to  claims  by 
the audited company and claims of 
third parties  

€4  million : statutory audit 
of  a  large  company  (§  221 
(3) HGB) 

if 

€8  million:  statutory  audit 
of  a  company; 
the 
fivefold  of  one  of  the  size 
characteristics expressed in 
Euro of a large company is 
exceeded 

if 

€12 million: statutory audit 
of  a  company, 
the 
tenfold  of  one  of  the  size 
characteristics expressed in 
Euro of a large company is 
exceeded 

Special  amounts  apply  to 
banks 
insurance 
companies 

and 

BELGIUM 

Per mandate 

million 

€3 
company)  

(unlisted 

 No  cap 
intentional conduct  

in  case  of  fraud  or 

million 

€12 
company) 

(listed 

GERMANY 

Per  audit  or  per  group 
audit  

million 

€1 
company)  

(unlisted 

Cap  not  applicable  to  intentional 
conduct 

GREECE 

Per breach 

million 

€4 
company) 

(listed 

Five  times  the  total  of  the 
annual  emoluments  of  the 
President  of  the  Supreme 
Court  or  the  total  of  the 
fees  of  the  liable  Certified 
Auditor 
the  previous 
financial year provided that 
the 
latter  exceeded 
the 
former limit 

in 

shareholder 

In  case  of  audit  firm  cap  refers  to 
each 
partner 
separately;  cap  not  applicable  to 
intentional conduct  

or 

SLOVENIA 

N/A 

€150,000  

Cap  applicable  only  to  audited 
company and shareholders. In case 
tort  or  gross 
of 
negligence the court may disregard 

intentional 

EN 

77 

   EN 

 
 
 
COUNTRY 

CALCULATION 

AMOUNT OF THE CAP 

CONDITIONS 

the cap 

EN 

78 

   EN