FDIC Federal Register Citations

[Federal Register: February 9, 2006 (Volume 71, Number 27)]

[Notices]

[Page 6847-6855]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr09fe06-116]

-----------------------------------------------------------------------------------------------------------------------------------------

Correction

DEPARTMENT OF THE TREASURY

FEDERAL RESERVE SYSTEM

FEDERAL DEPOSIT INSURANCE CORPORATION

NATIONAL CREDIT UNION ADMINISTRATION

[No. 2006-04]

Office of the Comptroller of the Currency

Office of Thrift Supervision

Interagency Advisory on the Unsafe and Unsound Use of Limitation

of Liability Provisions in External Audit Engagement Letters

AGENCIES: Office of Thrift Supervision (OTS), Treasury; Board of

Governors of the Federal Reserve System (Board); Federal Deposit

Insurance Corporation (FDIC); National Credit Union Administration

(NCUA); Office of the Comptroller of the Currency (OCC), Treasury.

ACTION: Issuance of Interagency Advisory.

-----------------------------------------------------------------------------------------------------------------------------------------

SUMMARY: The OTS, Board, FDIC, NCUA, and OCC (collectively, the

``Agencies''), have finalized the Interagency Advisory on the Unsafe

and Unsound Use of Limitation of Liability Provisions in External Audit

Engagement Letters (``Advisory''). The Advisory informs financial

institutions'' boards of directors, audit committees, and management

that they should not enter into agreements that incorporate unsafe and

unsound external auditor limitation of liability provisions with

respect to engagements for financial statement audits, audits of

internal control over financial reporting, and attestations on

management's assessment of internal control over financial reporting.

DATES: Effective Date: The Advisory is effective for engagement letters

executed on or after February 9, 2006.

FOR FURTHER INFORMATION CONTACT: OTS: Jeffrey J. Geer, Chief

Accountant, at jeffrey.geer@ots.treas.gov or (202) 906-6363; or

Patricia Hildebrand, Senior Policy Accountant, at

patricia.hildebrand@ots.treas.gov or (202) 906-7048.

Board: Terrill Garrison, Supervisory Financial Analyst, at

terrill.garrison@frb.gov or (202) 452-2712; or Nina A. Nichols,

Assistant Director, at nina.nichols@frb.gov or (202) 452-2961.

FDIC: Harrison E. Greene, Jr., Senior Policy Analyst (Bank

Accounting), Division of Supervision and Consumer Protection, at

hgreene@fdic.gov or (202) 898-8905; or Michelle Borzillo, Counsel,

Supervision and Legislation Section, Legal Division, at

mborzillo@fdic.gov or (202) 898-7400.

NCUA: Karen Kelbly, Chief Accountant, at kelblyk@ncua.gov or (703)

518-6389; or Steven Widerman, Trial Attorney, Office of General

Counsel, at widerman@ncua.gov or (703) 518-6557.

OCC: Zane Blackburn, Chief Accountant, at

zane.blackburn@occ.treas.gov or (202) 874-4944; or Kathy Murphy, Deputy

Chief Accountant, at kathy.murphy@occ.treas.gov or (202) 874-5675.

SUPPLEMENTARY INFORMATION:

I. Background

The Agencies have observed an increase in the types and frequency

of provisions in financial institutions' external audit engagement

letters that limit the auditors' liability. These provisions take many

forms, but can generally be categorized as an agreement by a financial

institution that is a client of an external auditor to:

Indemnify the external auditor against claims made by

third parties;

Hold harmless or release the external auditor from

liability for claims or potential claims that might be asserted by the

client financial institution; or

Limit the remedies available to the client financial

institution.

Reliable financial and regulatory reporting supports the Agencies'

risk-focused supervision of financial institutions by contributing to

effective pre-examination planning and off-site monitoring and

appropriate assessments of an institution's internal control over

financial reporting, capital adequacy, financial condition, and

performance. Audits play a valuable role in ensuring the reliability of

institutions' financial information.

The Agencies believe that when financial institutions agree to

limit their external auditors' liability, either in provisions in

engagement letters or in provisions that accompany alternative dispute

resolution (ADR) agreements, such provisions may weaken the external

auditors' objectivity, impartiality, and performance. The inclusion of

such provisions in financial institutions' external audit engagement

letters may reduce the reliability of audits and therefore raises

safety and soundness concerns.

On May 10, 2005, the Federal Financial Institutions Examinations

Council (FFIEC) on behalf of the Agencies published in the Federal

Register a proposed Interagency Advisory on the Unsafe and Unsound Use

of Limitation of Liability Provisions and Certain Alternative Dispute

Resolution Provisions in External Audit Engagement Letters (70 FR

24576) and sought comments to fully understand the effect of the

proposed Advisory on financial institutions.

II. Scope of Advisory

The Advisory applies to engagement letters between financial

institutions and external auditors with respect to financial statement

audits, audits of internal control over financial reporting, and

attestations on management's assessment of internal control over

financial reporting (collectively, ``Audit'' or ``Audits''). The

Advisory does not apply to:

Non-audit services that may be performed by financial

institutions' external auditors;

Audits of financial institutions' 401K plans, pension

plans, and other similar audits;

Services performed by accountants who are not engaged to

perform financial institutions' Audits (e.g., outsourced internal

audits, loan reviews); and

Other service providers (e.g., software consultants, legal

advisors).

The Advisory applies to all Audits of financial institutions,

regardless of whether an institution is a public or a non-public

company, including Audits required under Section 36 of the Federal

Deposit Insurance Act, OTS regulations, or Section 202 of the Federal

Credit Union Act, Audits required by any of the Agencies, and voluntary

Audits.

[[Page 6848]]

III. Summary of Comments

Overview

The Agencies received 44 comment letters from auditors, financial

institutions, trade organizations, attorneys, arbitration associations,

and other interested parties. While public comments were requested on

all aspects of the Advisory, the Agencies specifically sought comments

on seven questions. Less than one third of all commenters addressed all

seven questions.

Most financial institutions and industry trade groups supported the

proposed Advisory and commended the Agencies' efforts. A number of the

commenters explained that limitation of liability provisions in audit

engagement letters originate with external auditing firms rather than

financial institutions.

Most of the letters from external auditors opposed the proposal.

External auditors explained that limitation of liability provisions are

risk management tools commonly used in audit engagement pricing as well

as in other business transactions. They asserted that such provisions

allocate risk and facilitate a timely and cost effective means to

resolve disputes while minimizing litigation expenses. Further,

auditors stated that they should not be liable for losses resulting

from knowing misrepresentations by the client's management.

A number of commenters asked for clarification on the scope of the

Advisory and on the application of the Advisory to ADR agreements

(e.g., arbitration) and waivers of jury trials. The Agencies have

addressed these comments in the Advisory.

A number of commenters stated that the U.S. Securities and Exchange

Commission (SEC), the Public Company Accounting Oversight Board

(PCAOB), and the American Institute of Certified Public Accountants

(AICPA) have established auditor independence rules and requirements;

therefore, they asserted, the Advisory is not needed. Other commenters

expressed a need for the SEC, PCAOB, and AICPA to clarify their

guidance. On September 15, 2005, the AICPA published for comment its

proposed interpretation of its auditor independence standards. In that

proposal, the AICPA specifically identified limitation of liability

provisions that impair auditor independence under its standards. Most

of the provisions cited as unsafe and unsound in the Agencies' Advisory

were also deemed to impair independence in the AICPA's proposed

interpretation.

Comments

A. Application to Non-public Companies

A number of commenters expressed concern that the Agencies were

applying SEC and PCAOB auditor independence rules to Audits of non-

public companies. The Agencies' audit rules for financial institutions

generally reference both the AICPA and SEC auditor independence

standards and already apply to many non-public institutions. Therefore,

the concept of applying SEC auditor independence standards to non-

public financial institutions is in place under existing bank and

thrift audit regulations and is not the result of the issuance of the

Advisory. Since safety and soundness concerns apply equally to all

institutions' Audits, the Advisory does not establish different

requirements for public and non-public financial institutions.

B. Risk Management and Business Practices

Auditors asserted that to the extent the Advisory would limit an

auditor's ability to use risk allocation tools such as: (1) Capping

damages; (2) restricting the time period to file a claim; (3)

restricting the transfer or assignment of legal rights by an audit

client; or (4) otherwise limiting the allocation of risk between

contracting parties, the Advisory would result in auditors assuming

more risk, which would lead to economic costs with no countervailing

showing of benefits, such as improved audits.

Auditors further stated that the Advisory largely ignores the

interest that financial institutions have in obtaining professional and

independent audit services within a framework of allocated risk.

Further, auditors stated that the Advisory attempts to use safety and

soundness as a means for setting auditor independence standards and

limits the use of accepted business practices to manage disputes. In

addition, the auditors and some financial institutions expressed

concerns that the Advisory may result in an increase in costs and be a

disincentive for financial institutions to continue to engage an

auditor when not required to do so.

The Agencies continue to believe that certain limitation of

liability provisions reduce the auditor's accountability and thus may

weaken the auditor's objectivity, impartiality, and performance. In the

Agencies' judgment, concerns about potential increased costs or

restrictions on the ability of the parties to an audit engagement

letter to allocate risk do not outweigh the need to protect financial

institutions from the safety and soundness concerns posed by such

limitation of liability provisions. Furthermore, any disincentive for

financial institutions to obtain Audits when not required should be

limited because Audits represent best practices and are strongly

encouraged by the Agencies.

In addition, these limitations on external auditor liability may

not be consistent with the auditor independence standards of the SEC,

PCAOB, and AICPA. All financial institution Audits must comply with the

independence standards set by one or more of these standard-setters.

C. Management's Knowing Misrepresentations

Many auditors asserted that the information provided to outside

auditors is management's responsibility and that audit firms should not

be liable unless fraudulent behavior or willful misconduct exists on

the part of the auditor. Further, if management knowingly misrepresents

significant facts to the external auditor, it is sometimes impossible

for the auditor to uncover the true facts of a situation. The auditors

asserted that they should be allowed to limit their liability when

knowing misrepresentations of management contribute to the loss.

Those commenters further stated that indemnification for

management's knowing misrepresentations communicates a commitment that

financial institution management and its governing board understand

their responsibilities to perform honestly and legally. These

commenters rejected the assertion that indemnifying auditors for

management's knowing misrepresentations might cause an auditor to lose

independence or to perform a less responsible audit. They also stated

that protections that the client may provide against the client's own

knowing misrepresentations do not preclude third parties from suing the

auditor.

Nevertheless, a clause that would release, indemnify, or hold an

external auditor harmless from any liability resulting from knowing

misrepresentations by management is inappropriate under the SEC's

existing guidance on auditor independence (see Appendix B of the

Advisory). The inclusion in external audit engagement letters of

limitation of liability provisions that are prohibited by the auditor

independence rules and interpretations of the SEC, PCAOB, or AICPA is

considered an unsafe and unsound practice for financial

[[Page 6849]]

institutions. Provisions not clearly addressed by authoritative

guidance may also raise safety and soundness concerns when there is a

potential impairment of the external auditors' independence,

objectivity, impartiality, or performance.

The AICPA's Professional Standards, AU Section 110:

Responsibilities and Functions of the Independent Auditor state: ``The

auditor has a responsibility to plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of

material misstatement, whether caused by error or fraud.'' The Agencies

believe that including an indemnification or limitation of liability

provision for the client's knowing misrepresentations, willful

misconduct, or fraudulent behavior in an Audit engagement letter may

not be viewed as consistent with the auditor's duty and obligation to

comply with auditing standards.

The Agencies acknowledge that management bears the responsibility

for its conduct and representations. Nevertheless, the auditor has a

responsibility to obtain reasonable assurance that the financial

statements are free from material misstatements, including

misstatements caused by management fraud. A limitation of liability

provision in external Audit engagement letters for management's knowing

misrepresentations, willful misconduct, or fraudulent behavior could

act to reduce the auditor's professional skepticism. Limited liability

could lead to inadvertent consequences such as an auditor not fully

considering the possibility that management fraud exists. This might

result in less robust challenges to and over-reliance on management's

representations rather than performance of appropriate audit procedures

to corroborate them.

The Agencies believe that the auditor's potential liability related

to material misstatements due to management's misrepresentations should

be decided by a trier of fact in a legal or other proceeding and should

not be predetermined in the engagement letter. The trier of fact would

take into account whether the Audit was properly conducted in

accordance with applicable auditing standards.

D. Auditor Independence and Performance Standards

Many auditors contended that various limitation of liability

provisions addressed in the proposed Advisory would not impair their

independence. For example, a large accounting firm stated, ``* * * the

Proposal goes far beyond the independence standards established by the

SEC, PCAOB, and AICPA.'' Another large accounting firm stated, ``Of the

specific contractual terms identified for criticism in the proposal,

some are already prohibited by the SEC for those entities subject to

SEC regulation. Other contractual terms, however, are fully permissible

and widely in use as tools to allocate risk.''

In contrast, other commenters contended that all of the provisions

in the proposal impair an auditor's independence. This view was most

clearly expressed in the comment letter from an independent proxy and

financial research firm, which stated, ``We believe audit engagement

letters containing liability limitations impair the auditor's

independence and reduce audit quality to an unacceptable level.'' They

further stated, ``We believe it is inappropriate for an audit contract

between a company and its auditor to limit the auditor's liability

including (1) Any limitations on rights to trial, (2) limits on

compensatory or punitive damages, or (3) limits on discovery, including

in arbitration.''

A number of commenters discussed the auditor's requirement to

comply with auditing standards and stated that the failure to comply

with such standards would result in the violation of the requirements

of the SEC, PCAOB, AICPA, and/or state licensing authorities. Some

commenters stated that adherence to professional auditing standards is

further assured by periodic peer reviews and by PCAOB inspections.

Commenters noted that auditors are subject to possible disciplinary

action by state boards of accountancy, the SEC, the PCAOB, and the

AICPA. These commenters concluded that the auditor's performance is

controlled by professional standards and is not influenced by

provisions in audit engagement letters that limit the auditor's

liability. Consequently, they believed that the Advisory is

unnecessary.

The Agencies' observations lead them to conclude otherwise. Their

concern is that limitation of liability provisions may adversely impact

the reliability of Audits whether related to disincentives for auditor

performance or impairment of auditor independence in fact or

appearance. The Agencies have not attempted to categorize limitation of

liability provisions that adversely affect safety and soundness as

either matters of performance or independence.

The Agencies acknowledge that the SEC, PCAOB, and AICPA set

independence and performance standards for auditors. The Advisory does

not purport to affect those standards. Regardless of whether limitation

of liability provisions are permissible under auditor independence

standards, the Agencies have a separate obligation to evaluate their

impact on the safety and soundness of financial institutions.

Some commenters questioned whether the Agencies have adequate

evidence that limitation of liability provisions adversely affect

auditor independence, objectivity, and performance. The Agencies

acknowledge that it is inherently difficult to prove links from

circumstances to states of mind and from there to performance.

Nevertheless, the Agencies cannot wait for proof of harm before

establishing guidance to ensure the safety and soundness of financial

institutions. The Agencies must make judgments about circumstances that

may render Audits less reliable. The Agencies' concern with the

potential impact of such provisions is not only that an auditor might

intentionally act less than appropriately, but might unconsciously do

so.

A reasonable person may believe that limitation of liability

provisions create circumstances that may adversely affect Audit

reliability. For example, a reasonable person may conclude that if the

auditor faces less potential liability for the Audit, the auditor may

be less thorough. Further, that knowledge may erode the auditor's

independence of mind.

The Agencies observe that the SEC has addressed limitations of

liability in its independence rulings for more than 50 years. The AICPA

also addresses limitations of liability in its independence standards

and related interpretations. Additionally, many commenters stated that

limitations of liability impair an auditor's independence.

Auditors, in their comments, expressed inconsistent interpretations

of the meaning and scope of the SEC, PCAOB, and AICPA auditing

standards relating to limitations of liability. The Agencies have

concluded that supervisory guidance in addition to the existing

auditing standards is necessary to carry out their safety and soundness

mandate. Because the Agencies rely on Audits to help ensure the safety

and soundness of financial institutions, they are necessarily concerned

with provisions that could affect the auditor's judgment and

professional skepticism. Thus, the Agencies have concluded that since

the limitation of liability provisions may adversely affect Audit

reliability, such provisions are considered unsafe and unsound.

[[Page 6850]]

E. Waivers of Punitive Damages

The comment letters included much discussion on punitive damage

waivers. Some commenters stated that the Advisory should not prohibit

these waivers. The AICPA's comment letter typified the views of the

commenters advocating punitive damage waivers. The AICPA asserted, ``*

* * limiting an auditor's liability to the client for punitive damage

claims will not impair independence or objectivity, provided the

auditor remains liable for actual damages--that is, the auditor remains

exposed to clients, and also to lenders, shareholders, and other non-

clients, for damages for any actual harm caused.'' Others noted that a

waiver of punitive damages by the client has no bearing on punitive

damages that may be sought by a third party. Several commenters stated

that a financial institution's agreement to not seek punitive damages

has no effect on the safety and soundness of a financial institution.

Due in part to the extensive comments regarding client agreements

not to seek punitive damages from their auditors, the Agencies have

decided to take the issue under advisement. Accordingly, at this time,

provisions that waive the right of financial institutions to seek

punitive damages from their external auditor are not treated as unsafe

and unsound under the Advisory. Nevertheless, the Agencies have

concluded that agreements by financial institutions to indemnify their

auditors for third party punitive damage awards are deemed unsafe and

unsound.

To enhance transparency and market discipline, public financial

institutions that agree to waive claims for punitive damages against

their external auditors may want to disclose annually the nature of

these arrangements in their proxy statements or other public reports.

F. Alternative Dispute Resolution Agreements and Waiver of Jury Trials

The Advisory encourages all financial institutions to review

proposed Audit engagement letters presented by audit firms and

understand any limitations imposed by mandatory pre-dispute alternative

dispute resolution agreements (ADR) (including arbitration agreements)

or jury trial waivers on the institution's ability to recover damages

from an audit firm in any future litigation. The Advisory also directs

financial institutions to review rules of procedure referenced in ADR

agreements to ensure that the potential consequences of such procedures

are acceptable to the institution and to recognize that ADR agreements

may themselves incorporate limitation of liability provisions.

A number of commenters stated that the Advisory addresses mandatory

ADR mechanisms and the waiver of jury trials in a way that will

discourage financial institutions from agreeing in advance with their

auditors to use these widely accepted, efficient, and cost effective

means of resolving disputes. A few commenters noted that ADR and waiver

of jury trial provisions do not take away rights; they merely reflect

the parties' choice of a method for resolving a dispute. Further,

commenters stated that the Agencies have previously issued

pronouncements that recognize and even encourage the use of ADR, for

example, the FDIC's Statement of Policy on Use of Binding Arbitration

(66 FR 18632 (April 10, 2001)). The Interagency Policy Statement on the

Internal Audit Function and its Outsourcing (issued by the OTS, Board,

FDIC, and OCC in March 2003) provides that all written contracts

between vendors and financial institutions shall prescribe a process

(arbitration, mediation, or other means) for resolving disputes and for

determining who bears the costs of consequential damages arising from

errors, omissions, and negligence. Commenters also stated that ADR is

commercially reasonable because it creates certainty and reduces

litigation-related costs and, therefore, should be encouraged.

The Agencies observed that limitation of liability provisions

frequently accompanied ADR or waiver of jury trial agreements contained

in or referenced by Audit engagement letters. The Agencies do not

oppose ADR or waiver of jury trial agreements. However, the Agencies do

object to the practice of including unsafe and unsound limitation of

liability provisions in these agreements.

In response to the comments received, the Agencies clarified that

ADR or waiver of jury trial provisions in Audit engagement letters do

not present safety and soundness concerns, provided the agreements do

not incorporate limitation of liability provisions. Institutions should

carefully review ADR and jury trial provisions in engagement letters,

as well as any agreements regarding rules of procedure. ADR agreements

should not include any unsafe and unsound limitation of liability

provisions. The Advisory does not change or affect previously issued

policies referencing ADR and does not encourage or discourage the use

of ADR in Audit engagement letters.

G. Legal Considerations

Four commenters addressed legal aspects of the proposed Advisory.

Two of the four commented that state and Federal laws explicitly permit

limitation of liability or indemnification provisions. They indicated

that these clauses are a common feature in many business and consumer

contracts in wide use today. The Agencies note that Audits by their

nature require a uniquely high level of objectivity and impartiality as

compared to other types of business arrangements. Therefore, some

commonly used limitation of liability provisions that may be acceptable

for other business contracts are inappropriate for Audits of financial

institutions.

Another commenter stated that certain jurisdictions prohibit claims

against auditors where management fraud is imputable to the client. The

Advisory is not intended to override existing state or Federal laws

that govern the types of damages that may be awarded by the courts. It

advises financial institutions' boards of directors, audit committees,

and management that they should not agree to any Audit engagement

letters that may present safety and soundness concerns, including

provisions that may violate the auditor independence standards of the

SEC, PCAOB, or AICPA, as applicable.

One commenter stated that the Agencies have not complied with the

legal constraints on Federal agency rulemaking (e.g., the

Administrative Procedures Act (APA) and Executive Order 12866) with the

Advisory. The APA prohibits agency action that is, among other things,

arbitrary and capricious. Executive Order 12866 provides that when a

Federal agency engages in rulemaking, it must first determine whether a

rule is necessary.

The Agencies have authority to issue safety and soundness guidance

without engaging in a formal rulemaking procedure. Under 12 U.S.C.

1831p-1(d)(1), the Agencies issue standards for safety and soundness by

regulation or by guideline. The Advisory is issued under that authority

and the supervisory authority vested in each of the Agencies. The

Agencies have determined that there is a significant need for guidance

based on their review of actual auditor engagement letters, the

comments from financial institutions that strongly expressed a need for

guidance, and the likely benefits as compared to the possible costs.

[[Page 6851]]

H. Other Considerations

Several commenters expressed concern that, since the Advisory does

not apply to other industries, financial institutions will not have a

level playing field with other audit clients when negotiating audit

engagement terms. In the Agencies' judgment, any concerns about

potential increased costs or restrictions on the ability of financial

institutions, as compared to other audit clients, to negotiate Audit

engagement terms do not outweigh the need to protect financial

institutions from safety and soundness concerns posed by limitation of

liability provisions.

Other commenters stated that auditors should only be liable for

audits they perform. The commenters believed that a financial

institution's engagement letter covers only the period under audit and

that auditors should not be held responsible for losses arising in

subsequent periods in which the auditor was not engaged. Further,

losses that arise in subsequent periods that may be related to matters

that existed during periods previously audited by another audit firm

should not result in a liability to the successor audit firm.

The Agencies concur with the concept that auditors are not

responsible for the work of others. The Agencies object to provisions

that are worded in a way that may not only preclude collection of

consequential damages for harm in later years, but that may also

preclude any recovery at all. For example, the Agencies observed

provisions where no claim of liability could be brought against an

auditor until the audit report is actually delivered, and then these

provisions limited any liability thereafter to claims raised during the

period covered by the audit. In other words, the auditor's liability

may be limited to claims raised during the period before there could be

any liability. Read more broadly, the auditor would be liable for

losses that arise in subsequent years only if the auditor continued to

audit subsequent periods.

Several commenters asked the Agencies to provide examples of losses

sustained by financial institutions as a result of limitation of

liability provisions discussed in the Advisory. The Agencies' charge is

to identify and mitigate the risk of loss to financial institutions,

not merely to react after losses occur. Therefore, the appropriate

standard to be applied in the Advisory is the risk of loss created by

limitation of liability provisions, and not losses sustained by reason

of such provisions.

I. Questions, Comments, and Responses

1. The Advisory, as written, indicates that limitation of liability

provisions are inappropriate for all financial institution external

audits.

a. Is the scope appropriate? If not, to which financial

institutions should the Advisory apply and why?

b. Should the Advisory apply to financial institution audits that

are not required by law, regulation, or order?

Comments and Responses: The vast majority of commenters stated that

the Advisory should apply uniformly to audits of financial statements

for all financial institutions. A few commenters stated that voluntary

audits should not be subject to the provisions in the Advisory. Several

commenters stated that the Advisory should apply to audits of all

entities, not just financial institutions.

Since the Agencies are concerned with the safety and soundness of

all financial institutions, the Advisory applies to all Audits of

financial institutions including voluntary Audits. Regarding the

comments relative to the broader application of the Advisory, the

Agencies do not have the authority to apply the Advisory to entities

other than financial institutions.

2. What effects would the issuance of this Advisory have on

financial institutions' ability to negotiate the terms of audit

engagements?

Comments and Responses: Several commenters stated that the Advisory

will harm financial institutions' ability to negotiate the terms of

audit engagements and therefore either result in higher audit costs or

a lessened ability to negotiate on usual business terms. Other

commenters stated that negotiations would be easier because auditors

would not be able to force undesirable terms into engagement letters.

The Agencies believe that the Advisory does not unduly affect the

negotiating positions of the parties or pose undue burdens on auditors

because these clauses did not exist in the majority of the engagement

letters reviewed by the Agencies.

3. Would the Advisory on limitation of liability provisions result

in an increase in external audit fees?

a. If yes, would the increase be significant?

b. Would it discourage financial institutions that voluntarily

obtain audits from continuing to be audited?

c. Would it result in fewer audit firms being willing to provide

external audit services to financial institutions?

Comments and Responses: The majority of commenters stated that

audit fees would increase; however, the range of increase was judged to

be anywhere from ``insignificant'' to ``dramatic.'' A few commenters

stated that fees would remain the same because many auditors have

performed audits without limitation of liability provisions for a very

long period of time. Most commenters stated that an increase in audit

fees would not discourage financial institutions from engaging auditors

because Audits represent best business practices and because the

benefits of Audits would continue to outweigh the costs.

A few commenters said that the increase in fees would reduce the

number of financial institutions that voluntarily obtain audits. More

than half of the commenters expressed concern about the number of

auditors willing to perform audits of financial institutions because of

the inability to include limitation of liability provisions in the

engagement letters.

Several commenters noted that the use of such clauses furthers the

public interest in reducing dispute resolution costs and ensures the

availability of reasonably affordable audit services and the equitable

distribution of financial risk. Commenters also noted that audit fees

are determined by a variety of factors and engagement risk is a

significant component.

In the Agencies' judgment, any concerns about potential increased

costs or restrictions on the ability of the parties to an Audit

engagement letter to allocate risk do not outweigh the need to protect

financial institutions from safety and soundness concerns posed by

limitation of liability provisions. Furthermore, any disincentive for

financial institutions to obtain Audits when not required should be

limited because Audits represent best practices and are strongly

encouraged by the Agencies.

The Agencies do not believe that the Advisory would significantly

affect the number of audit firms willing to provide external Audit

services to financial institutions because limitation of liability

provisions were not present in the majority of the engagement letters

reviewed by the Agencies.

4. The Advisory describes three general categories of limitation of

liability provisions.

a. Is the description complete and accurate?

b. Is there any aspect of the Advisory or terminology that needs

clarification?

Comments and Responses: The vast majority of commenters found the

three general categories of limitation of liability provisions complete

and accurate and did not express a need for

[[Page 6852]]

the Advisory or terminology to be clarified. It was apparent from the

comments received that the discussion of ADR was unclear; the Agencies

have clarified their position in the Advisory.

5. Appendix A of the Advisory contains examples of limitation of

liability provisions.

a. Do the examples clearly and sufficiently illustrate the types of

provisions that are inappropriate?

b. Are there other inappropriate limitation of liability provisions

that should be included in the Advisory? If so, please provide

examples.

Comments and Responses: The vast majority of commenters found the

examples of limitation of liability provisions to clearly and

sufficiently illustrate the types of provisions that are inappropriate.

A number of commenters stated that permitting an auditor and a client

to agree to a release from or indemnification for claims resulting from

knowing misrepresentations by management is fundamentally fair to the

client and is a significant deterrent to management fraud. As discussed

in section C. Management's Knowing Misrepresentations, the Agencies are

not persuaded by the commenters' arguments.

6. Is there a valid business purpose for financial institutions to

agree to any limitation of liability provision? If so, please describe

the limitation of liability provision and its business purpose.

Comments and Responses: Very few commenters directly responded to

this question. Those commenters indicated there is not a valid business

purpose for financial institutions to agree to any limitation of

liability provision in audit engagements.

7. The Advisory strongly recommends that financial institutions

take appropriate action to nullify limitation of liability provisions

in 2005 audit engagement letters that have already been accepted. Is

this recommendation appropriate? If not, please explain your rationale

(including burden and cost).

Comments and Responses: The vast majority of commenters stated that

accepted audit engagement letters containing limitation of liability

provisions should not require nullification for a number of reasons,

including the fact that a contract negotiated in good faith should not

be subject to renegotiation.

The Agencies agreed with these comments. The Advisory applies to

Audit engagement letters executed on or after February 9, 2006.

Financial institutions are not required to nullify Audit engagement

letters executed prior to February 9, 2006. If a financial institution

has executed a multi-year Audit engagement letter prior to February 9,

2006 (e.g., covering years ending in 2007 or later), the Agencies

encourage financial institutions to seek to amend the engagement letter

to be consistent with the Advisory for any Audit periods ending in 2007

or later.

IV. Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.

Chapter 35), the Agencies have reviewed the Advisory and determined

that it does not contain a collection of information pursuant to the

Act.

Text of Interagency Advisory

The text of the Interagency Advisory on the Unsafe and Unsound Use

of Limitation of Liability Provisions in External Audit Engagement

Letters follows:

Interagency Advisory on the Unsafe and Unsound Use of Limitation of

Liability Provisions in External Audit Engagement Letters

Purpose

This Advisory, issued jointly by the Office of Thrift Supervision

(OTS), the Board of Governors of the Federal Reserve System (Board),

the Federal Deposit Insurance Corporation (FDIC), the National Credit

Union Administration (NCUA), and the Office of the Comptroller of the

Currency (OCC) (collectively, the ``Agencies''), alerts financial

institutions' \1\ boards of directors, audit committees, management,

and external auditors to the safety and soundness implications of

provisions that limit external auditors' liability in audit

engagements.

---------------------------------------------------------------------------

\1\ As used in this document, the term financial institutions

includes banks, bank holding companies, savings associations,

savings and loan holding companies, and credit unions.

---------------------------------------------------------------------------

Limits on external auditors' liability may weaken the external

auditors' objectivity, impartiality, and performance and, thus, reduce

the Agencies' ability to rely on Audits. Therefore, certain limitation

of liability provisions (described in this Advisory and Appendix A) are

unsafe and unsound. In addition, such provisions may not be consistent

with the auditor independence standards of the U.S. Securities and

Exchange Commission (SEC), the Public Company Accounting Oversight

Board (PCAOB), and the American Institute of Certified Public

Accountants (AICPA).

Scope

This Advisory applies to engagement letters between financial

institutions and external auditors with respect to financial statement

audits, audits of internal control over financial reporting, and

attestations on management's assessment of internal control over

financial reporting (collectively, ``Audit'' or ``Audits'').

This Advisory does not apply to:

Non-Audit services that may be performed by financial

institutions' external auditors;

Audits of financial institutions' 401K plans, pension

plans, and other similar audits;

Services performed by accountants who are not engaged to

perform financial institutions' Audits (e.g., outsourced internal

audits, loan reviews); and

Other service providers (e.g., software consultants, legal

advisors).

While the Agencies have observed several types of limitation of

liability provisions in external Audit engagement letters, this

Advisory applies to any agreement that a financial institution enters

into with its external auditor that limits the external auditor's

liability with respect to Audits in an unsafe and unsound manner.

Background

A properly conducted audit provides an independent and objective

view of the reliability of a financial institution's financial

statements. The external auditor's objective in an audit is to form an

opinion on the financial statements taken as a whole. When planning and

performing the audit, the external auditor considers the financial

institution's internal control over financial reporting. Generally, the

external auditor communicates any identified deficiencies in internal

control to management, which enables management to take appropriate

corrective action. In addition, certain financial institutions are

required to file audited financial statements and internal control

audit/attestation reports with one or more of the Agencies. The

Agencies encourage financial institutions not subject to mandatory

audit requirements to voluntarily obtain audits of their financial

statements. The Federal Financial Institutions Examination Council's

(FFIEC) Interagency Policy Statement on External Auditing Programs of

Banks and Savings Associations \2\ notes, ``[a]n institution's internal

and external audit programs are critical to its safety and soundness.''

The Policy also states that an effective external auditing program

``can improve the safety and soundness

[[Page 6853]]

of an institution substantially and lessen the risk the institution

poses to the insurance funds administered by the Federal Deposit

Insurance Corporation (FDIC).''

---------------------------------------------------------------------------

\2\ Published in the Federal Register on September 28, 1999 (64

FR 52319). The NCUA, a member of the FFIEC, has not adopted the

policy statement.

---------------------------------------------------------------------------

Typically, a written engagement letter is used to establish an

understanding between the external auditor and the financial

institution regarding the services to be performed in connection with

the financial institution's audit. The engagement letter commonly

describes the objective of the audit, the reports to be prepared, the

responsibilities of management and the external auditor, and other

significant arrangements (e.g., fees and billing). The Agencies

encourage boards of directors, audit committees, and management to

closely review all of the provisions in the audit engagement letter

before agreeing to sign. As with all agreements that affect a financial

institution's legal rights, legal counsel should carefully review audit

engagement letters to help ensure that those charged with engaging the

external auditor make a fully informed decision.

While the Agencies have not observed provisions that limit an

external auditor's liability in the majority of external audit

engagement letters reviewed, they have observed a significant increase

in the types and frequency of these provisions. These provisions take

many forms, making it impractical to provide an all-inclusive list.

This Advisory describes the types of objectionable limitation of

liability provisions and provides examples.\3\

---------------------------------------------------------------------------

\3\ Examples of auditor limitation of liability provisions are

illustrated in Appendix A.

---------------------------------------------------------------------------

Financial institutions' boards of directors, audit committees, and

management should also be aware that certain insurance policies (such

as error and omission policies and director and officer liability

policies) might not cover losses arising from claims that are precluded

by limitation of liability provisions.

Limitation of Liability Provisions

The provisions the Agencies deem unsafe and unsound can be

generally categorized as an agreement by a financial institution that

is a client of an external auditor to:

Indemnify the external auditor against claims made by

third parties;

Hold harmless or release the external auditor from

liability for claims or potential claims that might be asserted by the

client financial institution, other than claims for punitive damages;

or

Limit the remedies available to the client financial

institution, other than punitive damages.

Collectively, these categories of provisions are referred to in

this Advisory as ``limitation of liability provisions.''

Provisions that waive the right of financial institutions to seek

punitive damages from their external auditor are not treated as unsafe

and unsound under this Advisory. Nevertheless, agreements by clients to

indemnify their auditors against any third party damage awards,

including punitive damages, are deemed unsafe and unsound under this

Advisory. To enhance transparency and market discipline, public

financial institutions that agree to waive claims for punitive damages

against their external auditors may want to disclose annually the

nature of these arrangements in their proxy statements or other public

reports.

Many financial institutions are required to have their financial

statements audited while others voluntarily choose to undergo such

audits. For example, banks, savings associations, and credit unions

with $500 million or more in total assets are required to have annual

independent audits.\4\ Certain savings associations (for example, those

with a CAMELS rating of 3, 4, or 5) and savings and loan holding

companies are also required by OTS regulations to have annual

independent audits.\5\ Furthermore, financial institutions that are

public companies \6\ must have annual independent audits. The Agencies

rely on the results of Audits as part of their assessment of the safety

and soundness of a financial institution.

---------------------------------------------------------------------------

\4\ For banks and savings associations, see Section 36 of the

Federal Deposit Insurance Act (FDI Act) (12 U.S.C. 1831m) and Part

363 of the FDIC's regulations (12 CFR Part 363). For credit unions,

see Section 202(a)(6) of the Federal Credit Union Act (12 U.S.C.

1782(a)(6)) and Part 715 of the NCUA's regulations (12 CFR Part

715).

\5\ See OTS regulation at 12 CFR 562.4.

\6\ Public companies are companies subject to the reporting

requirements of the Securities Exchange Act of 1934.

---------------------------------------------------------------------------

In order for Audits to be effective, the external auditors must be

independent in both fact and appearance, and must perform all necessary

procedures to comply with auditing and attestation standards

established by either the AICPA or, if applicable, the PCAOB. When

financial institutions execute agreements that limit the external

auditors' liability, the external auditors' objectivity, impartiality,

and performance may be weakened or compromised, and the usefulness of

the Audits for safety and soundness purposes may be diminished.

By their very nature, limitation of liability provisions can remove

or greatly weaken external auditors' objective and unbiased

consideration of problems encountered in audit engagements and may

diminish auditors' adherence to the standards of objectivity and

impartiality required in the performance of Audits. The existence of

such provisions in external audit engagement letters may lead to the

use of less extensive or less thorough procedures than would otherwise

be followed, thereby reducing the reliability of Audits. Accordingly,

financial institutions should not enter into external audit

arrangements that include unsafe and unsound limitation of liability

provisions identified in this Advisory, regardless of (1) The size of

the financial institution, (2) whether the financial institution is

public or not, or (3) whether the external audit is required or

voluntary.

Auditor Independence

Currently, auditor independence standard-setters include the SEC,

PCAOB, and AICPA. Depending upon the audit client, an external auditor

is subject to the independence standards issued by one or more of these

standard-setters. For all credit unions under the NCUA's regulations,

and for other non-public financial institutions that are not required

to have annual independent audits pursuant to either Part 363 of the

FDIC's regulations or Sec. 562.4 of the OTS's regulations, the

Agencies' rules require only that an external auditor meet the AICPA

independence standards; they do not require the financial institution's

external auditor to comply with the independence standards of the SEC

and the PCAOB.

In contrast, for financial institutions subject to the audit

requirements either in Part 363 of the FDIC's regulations or in Sec.

562.4 of the OTS's regulations, the external auditor should be in

compliance with the AICPA's Code of Professional Conduct and meet the

independence requirements and interpretations of the SEC and its

staff.\7\ In this regard, in a December 13, 2004, Frequently Asked

Question (FAQ) on the application of the SEC's auditor independence

rules, the SEC staff reiterated its long-standing position that when an

accountant and his or her client enter into an agreement which seeks to

provide the accountant immunity from liability for his or her

[[Page 6854]]

own negligent acts, the accountant is not independent. The FAQ also

states that including in engagement letters a clause that would

release, indemnify, or hold the auditor harmless from any liability and

costs resulting from knowing misrepresentations by management would

impair the auditor's independence.\8\ The SEC's FAQ is consistent with

Section 602.02.f.i. (Indemnification by Client) of the SEC's

Codification of Financial Reporting Policies. (Section 602.02.f.i. and

the FAQ are included in Appendix B.)

---------------------------------------------------------------------------

\7\ See FDIC Regulation 12 CFR Part 363, Appendix A--Guidelines

and Interpretations; Guideline 14, Role of the Independent Public

Accountant--Independence; and OTS Regulation 12 CFR 562.4(d)(3)(i),

Qualifications for independent public accountants.

\8\ In contrast to the SEC's position, AICPA Ethics Ruling 94

(ET Sec. 191.188-189) currently concludes that indemnification for

``knowing misrepresentations by management'' does not impair

independence. On September 15, 2005, the AICPA published for comment

its proposed interpretation of its auditor independence standards.

In that proposal the AICPA specifically identified limitation of

liability provisions that impair auditor independence under the

AICPA's standards. Most of the provisions cited in this Advisory

were deemed to impair independence in the AICPA's proposed

interpretation. At this writing, the AICPA has not issued a final

interpretation.

---------------------------------------------------------------------------

Based on this SEC guidance and the Agencies' existing regulations,

certain limits on auditors' liability are already inappropriate in

audit engagement letters entered into by:

Public financial institutions that file reports with the

SEC or with the Agencies;

Financial institutions subject to Part 363; and

Certain other financial institutions that OTS regulations

(12 CFR 562.4) require to have annual independent audits.

In addition, certain of these limits on auditors' liability may

violate the AICPA independence standards. Notwithstanding the potential

applicability of auditor independence standards, the limitation of

liability provisions discussed in this Advisory present safety and

soundness concerns for all financial institution Audits.

Alternative Dispute Resolution Agreements and Jury Trial Waivers

The Agencies have observed that some financial institutions have

agreed in engagement letters to submit disputes over external audit

services to mandatory and binding alternative dispute resolution,

binding arbitration, other binding non-judicial dispute resolution

processes (collectively, ``mandatory ADR'') or to waive the right to a

jury trial. By agreeing in advance to submit disputes to mandatory ADR,

financial institutions may waive the right to full discovery, limit

appellate review, or limit or waive other rights and protections

available in ordinary litigation proceedings.

The Agencies recognize that mandatory ADR procedures and jury trial

waivers may be efficient and cost-effective tools for resolving

disputes in some cases. Accordingly, the Agencies believe that

mandatory ADR or waiver of jury trial provisions in external Audit

engagement letters do not present safety and soundness concerns,

provided that the engagement letters do not also incorporate limitation

of liability provisions. The Agencies encourage institutions to

carefully review mandatory ADR and jury trial provisions in engagement

letters, as well as any agreements regarding rules of procedure, and to

fully comprehend the ramifications of any agreement to waive any

available remedies. Financial institutions should ensure that any

mandatory ADR provisions in Audit engagement letters are commercially

reasonable and:

Apply equally to all parties;

Provide a fair process (e.g., neutral decision-makers and

appropriate hearing procedures); and

Are not imposed in a coercive manner.

Conclusion

Financial institutions' boards of directors, audit committees, and

management should not enter into any agreement that incorporates

limitation of liability provisions with respect to Audits. In addition,

financial institutions should document their business rationale for

agreeing to any other provisions that limit their legal rights.

This Advisory applies to engagement letters executed on or after

February 9, 2006. The inclusion of limitation of liability provisions

in external Audit engagement letters and other agreements that are

inconsistent with this Advisory will generally be considered an unsafe

and unsound practice. The Agencies' examiners will consider the

policies, processes, and personnel surrounding a financial

institution's external auditing program in determining whether (1) the

engagement letter covering external auditing activities raises any

safety and soundness concerns, and (2) the external auditor maintains

appropriate independence regarding relationships with the financial

institution under relevant professional standards. The Agencies may

take appropriate supervisory action if unsafe and unsound limitation of

liability provisions are included in external Audit engagement letters

or other agreements related to Audits that are executed (accepted or

agreed to by the financial institution) on or after February 9, 2006.

Appendix A

Examples of Unsafe and Unsound Limitation of Liability Provisions

Presented below are some of the types of limitation of liability

provisions (with an illustrative example of each type) that the

Agencies observed in financial institutions' external audit

engagement letters. The inclusion in external Audit engagement

letters or agreements related to Audits of any of the illustrative

provisions (which do not represent an all-inclusive list) or any

other language that would produce similar effects is considered an

unsafe and unsound practice.

1. ``Release From Liability for Auditor Negligence'' Provision

In this type of provision, the financial institution agrees not

to hold the audit firm liable for any damages, except to the extent

determined to have resulted from willful misconduct or fraudulent

behavior by the audit firm.

Example: In no event shall [the audit firm] be liable to the

Financial Institution, whether a claim be in tort, contract or

otherwise, for any consequential, indirect, lost profit, or similar

damages relating to [the audit firm's] services provided under this

engagement letter, except to the extent finally determined to have

resulted from the willful misconduct or fraudulent behavior of [the

audit firm] relating to such services.

2. ``No Damages'' Provision

In this type of provision, the financial institution agrees that

in no event will the external audit firm's liability include

responsibility for any compensatory (incidental or consequential)

damages claimed by the financial institution.

Example: In no event will [the audit firm's] liability under the

terms of this Agreement include responsibility for any claimed

incidental or consequential damages.

3. ``Limitation of Period To File Claim'' Provision

In this type of provision, the financial institution agrees that

no claim will be asserted after a fixed period of time that is

shorter than the applicable statute of limitations, effectively

agreeing to limit the financial institution's rights in filing a

claim.

Example: It is agreed by the Financial Institution and [the

audit firm] or any successors in interest that no claim arising out

of services rendered pursuant to this agreement by, or on behalf of,

the Financial Institution shall be asserted more than two years

after the date of the last audit report issued by [the audit firm].

4. ``Losses Occurring During Periods Audited'' Provision

In this type of provision, the financial institution agrees that

the external audit firm's liability will be limited to any losses

occurring during periods covered by the external audit, and will not

include any losses occurring in later periods for which the external

audit firm is not engaged. This provision may not only preclude the

collection of consequential damages for harm in later years, but

could preclude any recovery at all. It appears that no claim of

[[Page 6855]]

liability could be brought against the external audit firm until the

external audit report is actually delivered. Under such a clause,

any claim for liability thereafter might be precluded because the

losses did not occur during the period covered by the external

audit. In other words, it might limit the external audit firm's

liability to a period before there could be any liability. Read more

broadly, the external audit firm might be liable for losses that

arise in subsequent years only if the firm continues to be engaged

to audit the client's financial statements in those years.

Example: In the event the Financial Institution is dissatisfied

with [the audit firm's] services, it is understood that [the audit

firm's] liability, if any, arising from this engagement will be

limited to any losses occurring during the periods covered by [the

audit firm's] audit, and shall not include any losses occurring in

later periods for which [the audit firm] is not engaged as auditors.

5. ``No Assignment or Transfer'' Provision

In this type of provision, the financial institution agrees that

it will not assign or transfer any claim against the external audit

firm to another party. This provision could limit the ability of

another party to pursue a claim against the external auditor in a

sale or merger of the financial institution, in a sale of certain

assets or a line of business of the financial institution, or in a

supervisory merger or receivership of the financial institution.

This provision may also prevent the financial institution from

subrogating a claim against its external auditor to the financial

institution's insurer under its directors' and officers' liability

or other insurance coverage.

Example: The Financial Institution agrees that it will not,

directly or indirectly, agree to assign or transfer any claim

against [the audit firm] arising out of this engagement to anyone.

6. ``Knowing Misrepresentations by Management'' Provision

In this type of provision, the financial institution releases

and indemnifies the external audit firm from any claims,

liabilities, and costs attributable to any knowing misrepresentation

by management.

Example: Because of the importance of oral and written

management representations to an effective audit, the Financial

Institution releases and indemnifies [the audit firm] and its

personnel from any and all claims, liabilities, costs, and expenses

attributable to any knowing misrepresentation by management.

7. ``Indemnification for Management Negligence'' Provision

In this type of provision, the financial institution agrees to

protect the external auditor from third party claims arising from

the external audit firm's failure to discover negligent conduct by

management. It would also reinforce the defense of contributory

negligence in cases in which the financial institution brings an

action against its external auditor. In either case, the contractual

defense would insulate the external audit firm from claims for

damages even if the reason the external auditor failed to discover

the negligent conduct was a failure to conduct the external audit in

accordance with generally accepted auditing standards or other

applicable professional standards.

Example: The Financial Institution shall indemnify, hold

harmless and defend [the audit firm] and its authorized agents,

partners and employees from and against any and all claims, damages,

demands, actions, costs and charges arising out of, or by reason of,

the Financial Institution's negligent acts or failure to act

hereunder.

8. ``Damages Not to Exceed Fees Paid'' Provision

In this type of provision, the financial institution agrees to

limit the external auditor's liability to the amount of audit fees

the financial institution paid the external auditor, regardless of

the extent of damages. This may result in a substantial

unrecoverable loss or cost to the financial institution.

Example: [The audit firm] shall not be liable for any claim for

damages arising out of or in connection with any services provided

herein to the Financial Institution in an amount greater than the

amount of fees actually paid to [the audit firm] with respect to the

services directly relating to and forming the basis of such claim.

Note: The Agencies also observed a similar provision that

limited damages to a predetermined amount not related to fees paid.

Appendix B

SEC's Codification of Financial Reporting Policies, Section

602.02.f.i and the SEC's December 13, 2004, FAQ on Auditor

Independence

Section 602.02.f.i--Indemnification by Client, 3 Fed. Sec. L. (CCH) ]

38,335, at 38,603-17 (2003)

Inquiry was made as to whether an accountant who certifies

financial statements included in a registration statement or annual

report filed with the Commission under the Securities Act or the

Exchange Act would be considered independent if he had entered into

an indemnity agreement with the registrant. In the particular

illustration cited, the board of directors of the registrant

formally approved the filing of a registration statement with the

Commission and agreed to indemnify and save harmless each and every

accountant who certified any part of such statement, ``from any and

all losses, claims, damages or liabilities arising out of such act

or acts to which they or any of them may become subject under the

Securities Act, as amended, or at `common law,' other than for their

willful misstatements or omissions.''

When an accountant and his client, directly or through an

affiliate, have entered into an agreement of indemnity which seeks

to assure to the accountant immunity from liability for his own

negligent acts, whether of omission or commission, one of the major

stimuli to objective and unbiased consideration of the problems

encountered in a particular engagement is removed or greatly

weakened. Such condition must frequently induce a departure from the

standards of objectivity and impartiality which the concept of

independence implies. In such difficult matters, for example, as the

determination of the scope of audit necessary, existence of such an

agreement may easily lead to the use of less extensive or thorough

procedures than would otherwise be followed. In other cases it may

result in a failure to appraise with professional acumen the

information disclosed by the examination. Consequently, the

accountant cannot be recognized as independent for the purpose of

certifying the financial statements of the corporation. (Emphasis

added.)

U.S. Securities and Exchange Commission; Office of the Chief

Accountant: Application of the Commission's Rules on Auditor

Independence Frequently Asked Questions; Other Matters--Question 4

(issued December 13, 2004)

Q: Has there been any change in the Commission's long standing

view (Financial Reporting Policies--Section 600--602.02.f.i.

``Indemnification by Client'') that when an accountant enters into

an indemnity agreement with the registrant, his or her independence

would come into question?

A: No. When an accountant and his or her client, directly or

through an affiliate, enter into an agreement of indemnity that

seeks to provide the accountant immunity from liability for his or

her own negligent acts, whether of omission or commission, the

accountant is not independent. Further, including in engagement

letters a clause that a registrant would release, indemnify or hold

harmless from any liability and costs resulting from knowing

misrepresentations by management would also impair the firm's

independence. (Emphasis added.)

Dated: February 1, 2006.

By the Office of Thrift Supervision,

John M. Reich,

Director.

By order of the Board of Governors of the Federal Reserve

System, February 1, 2006.

Jennifer J. Johnson,

Secretary of the Board.

Dated at Washington, DC, the 2nd day of February, 2006.

By order of the Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

By the National Credit Union Administration Board on January 31,

2006.

Mary F. Rupp,

Secretary of the Board.

Dated: February 1, 2006.

John C. Dugan,

Comptroller of the Currency.

[FR Doc. 06-1189 Filed 2-8-06; 8:45 am]