According to an article in the December 21, 2004 issue of the American Banker trade paper, banking regulators are considering imposing a ban early next year on clauses that auditors have been inserting (or at least, trying to insert) in auditing engagement letters with banks, that attempt to limit the auditor's liability for losses incurred by the bank in the event of accounting problems. Among the examples cited by the regulators who were interviewed for the story was a clause that attempted to disclaim all liability except that arising out of the intentional misconduct or fraudulent behavior of the auditing firm.
In light of our most recent post on the failure of Superior Bank, and the losses suffered by that bank's auditor as a result of that failure, it is understandable that auditors would be gun shy. On the other hand, as is the case with attorneys and other professionals, the regulators expect that professionals who render services to a bank (especially services of such critical importance) will stand behind their work. To the extent that an auditor is not willing to do so, then the regulators seem to be approaching the adoption of a position that the bank may not retain the services of that auditor.
Watch out for various other methods that auditors (and other service providers) may employ to attempt to limit their liability, in addition to the disclaimer of liability for ordinary negligence already mentioned. One we have seen recently is an attempt by an auditing firm to limit damages, in the event of its negligence, to the amount of fees paid by the bank to the auditor in the course of the engagement. Inasmuch as actual losses to the bank may far exceed the amount of such fees paid during an annual engagement (not to mention losses caused by regulatory sanctions and shareholder lawsuits), the bank should be cautious about agreeing to such exclusions, disclaimers and limitations. The existence of such limitations, even if not specifically banned by the regulators, might be considered to be an unsafe and unsound banking practice. As such, officers and directors, and even controlling shareholders, might be subject to regulatory sanctions, including civil money penalties. When faced with such clauses, and with a recalcitrant auditor who will not back off of such clauses, it may be wise to "shop around" for an equally competent audit firm that will be more accommodating to the bank's need for protection.
---Kevin Funnell