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FIL-41-2005 Attachment

[Federal Register: May 10, 2005 (Volume 70, Number 89)]

[Notices]

[Page 24576-24581]

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

[DOCID:fr10my05-83]


 

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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL


 

 

Interagency Advisory on the Unsafe and Unsound Use of Limitation

of Liability Provisions and Certain Alternative Dispute Resolution

Provisions in External Audit Engagement Letters


 

AGENCY: Federal Financial Institutions Examination Council.


 

ACTION: Proposed interagency advisory; request for comment.


 

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SUMMARY: The Federal Financial Institutions Examination Council

(FFIEC), on behalf of the Office of Thrift Supervision (OTS), Treasury;

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), Treasury (collectively, the Agencies), is seeking

public comment on 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. The proposal advises financial institutions' boards of

directors, audit committees, and management that they should ensure

that they do not enter any agreement that contains external auditor

limitation of liability provisions with respect to financial statement

audits.


 

DATES: Comments must be received on or before June 9, 2005.


 

ADDRESSES: Comments should be directed to: FFIEC, Program Coordinator,

3501Fairfax Drive, Room 3086, Arlington, VA 22226; by e-mail to

FFIEC-Comments@fdic.gov; or by fax to (703) 516-5487. Comments will be


 

available for public inspection during regular business hours at the

above address. Appointments to inspect comments are encouraged and can

be arranged by calling the FFIEC at (703) 516-5588.


 

FOR FURTHER INFORMATION CONTACT:

OTS: Jeffrey J. Geer, Chief Accountant, at

jeffrey.geer@ots.treas.gov or (202) 906-6363; or Patricia



 

[[Page 24577]]


 

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.


 

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.

OCC: Brent Kukla, Accounting Fellow, at brent.kukla@occ.treas.gov

or (202) 874-4978.


 

SUPPLEMENTARY INFORMATION:


 

I. Background


 

The Agencies have observed an increase in the types and frequency

of provisions in certain financial institutions' external audit

engagement letters that limit the auditors' liability. While these

provisions do not appear in a majority of financial institution

engagement letters, the provisions are becoming more prevalent. The

Agencies believe such provisions may weaken an external auditor's

objectivity, impartiality, and performance; therefore, inclusion of

these provisions in financial institution engagement letters raises

safety and soundness concerns.

While these provisions take many forms, they 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; or

Limit the remedies available to the client financial

institution.


 

Collectively, these and similar types of provisions are referred to in

the proposed advisory as limitation of liability provisions.


 

II. Comments


 

The FFIEC has approved the publication of the proposed advisory on

behalf of the Agencies to seek public comment to fully understand the

effect of the proposed advisory on the inappropriate use of limitation

of liability provisions on external auditor engagements. While public

comments are welcome on all aspects of this advisory, the Agencies are

specifically seeking comments on the following questions. Please

provide information that supports your position.

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?

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

financial institutions' ability to negotiate the terms of audit

engagements?

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?

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?

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.

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.

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).


 

III. Paperwork Reduction Act


 

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

Chapter 35), the Agencies have reviewed the proposed advisory and

determined that it does not contain a collection of information

pursuant to the Act.


 

IV. Proposed Advisory


 

The text of the proposed advisory follows:


 

Interagency Advisory on the Unsafe and Unsound Use of Limitation of

Liability Provisions and Certain Alternative Dispute Resolution

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 the external auditor's liability in a financial

statement audit. While the Agencies have observed several types of

these 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 financial statement audits.

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\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.

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Agreements by financial institutions to limit their external

auditors' liability or to submit to certain alternative dispute

resolution (ADR) provisions that also limit the external auditors'

liability may weaken the external auditors' objectivity, impartiality,

and performance and thus, reduce the Agencies' ability to rely on

external audits. Therefore, such agreements raise safety and soundness

concerns, and entering into such agreements is generally considered to

be an unsafe and unsound practice.

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).


 

Background


 

A properly conducted external 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


 

[[Page 24578]]


 

of financial statements 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. For these reasons, the Agencies encourage all financial

institutions to obtain external 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 of an institution substantially and

lessen the risk the institution poses to the insurance funds

administered by'' the FDIC.

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

FR 52319-27). The NCUA, a member of the FFIEC, has not adopted the

policy statement.

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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 external audit of the financial institution. The engagement letter

commonly describes the objective of the external audit, the reports to

be prepared, the responsibilities of management and the external

auditor, and other significant arrangements (e.g., fees and billing).

As with any important contract, the Agencies encourage boards of

directors, audit committees, and management to closely review all of

the provisions in the external audit engagement letter before agreeing

to sign. To assure that those charged with engaging the external

auditor make a fully informed decision, any agreement such as an

engagement letter that affects the financial institution's legal rights

should be carefully reviewed by the financial institution's legal

counsel.

While the Agencies have not observed provisions that limit an

external auditor's liability in the majority of external audit

engagement letters reviewed, the Agencies have observed a significant

increase in the types and frequency of these provisions. These

provisions take many forms,\3\ but they can be generally categorized as

an agreement by a financial institution that is a client of an external

auditor to:

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


 

\3\ Examples of auditor limitation of liability provisions are

illustrated in Appendix A.

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


 

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.


 

Collectively, these and similar types of provisions will be referred to

in this advisory as ``limitation of liability provisions.''

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

management should also be aware that certain financial institution

insurance policies (such as error and omission policies and director

and officer liability policies) may not cover the financial

institutions' losses arising from claims that are precluded by the

limitation of liability provisions.


 

Limitation of Liability Provisions


 

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 external audits as part of their assessment of

the safety and soundness of a financial institution's operations.

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\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.

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In order for an external audit to be effective, the external

auditors must be independent in both fact and appearance, and they must

perform all necessary procedures to comply with generally accepted

auditing standards established by the AICPA and, if applicable, the

standards of the PCAOB. When a financial institution executes an

agreement that limits the external auditor's liability, the external

auditor's objectivity, impartiality, and performance may be weakened or

compromised and the usefulness of the external audit for safety and

soundness purposes may be diminished.

Since limitation of liability provisions can impair the external

auditor's independence and may adversely affect the external auditor's

performance, they present safety and soundness concerns for all

financial institution external audits. By their very nature, these

provisions can remove or greatly weaken an external auditor's objective

and unbiased consideration of problems encountered in the external

audit engagement and induce the external auditor to depart from the

standards of objectivity and impartiality required in the performance

of a financial statement audit. The existence of such provisions in an

external audit engagement letter may lead to the use of less extensive

or less thorough procedures than would otherwise be followed, thereby

reducing the benefits otherwise expected to be derived from the

external audit. Accordingly, financial institutions should not enter

into external audit arrangements that include any limitation of

liability provisions. This applies regardless of the size of the

financial institution, whether the financial institution is public or

not, and whether the external audit is required or voluntary.


 

Auditor Independence


 

Currently, auditor independence standard-setters include the AICPA,

the SEC, and the PCAOB. Depending upon the audit client, an external

auditor is subject to the independence standards of one or more of

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

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

to have annual independent audits pursuant to Part 363 of the FDIC's

regulations or pursuant to 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 in Part 363 of the FDIC's regulations or subject to 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


 

[[Page 24579]]


 

December 13, 2004, Frequently Asked Question (FAQ) on the application

of the SEC's auditor independence rules, the SEC 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 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.)

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\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 accountant.

\8\ AICPA Ethics Ruling 94 (ET Sec. 191.188-189) currently

concludes that indemnification for ``knowing misrepresentations by

management'' does not impair independence. At this writing, the

AICPA's Professional Ethics Executive Committee has formed a task

force that is studying the use of indemnification clauses in

engagement letters and how such clauses may affect an auditor's

independence.

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

limitation of liability provisions are already inappropriate in auditor

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

at 12 CFR 562.4 require to have annual independent audits.


 

In addition, many of these limitation of liability provisions may

violate the AICPA independence standards. Because limitation of

liability provisions may impair an auditor's independence and may

adversely affect the external auditor's objectivity, impartiality, and

performance, the provisions present safety and soundness concerns for

all financial institution external audits.


 

Alternative Dispute Resolution Agreements and Jury Trial Waivers


 

The Agencies have also observed that some financial institutions

are agreeing in their external audit engagement letters to submit

disputes over external auditor services to mandatory and binding

alternative dispute resolution, binding arbitration, or some other

binding non-judicial dispute resolution process (collectively referred

to as mandatory ADR) or to waive the right to a jury trial. By agreeing

in advance to submit disputes to mandatory ADR, the financial

institution is effectively agreeing to waive the right to full

discovery, limit appellate review, and limit or waive other rights and

protections available in ordinary litigation proceedings. While ADR may

expedite case resolution and reduce costs, financial institutions

should consider the value of the rights being waived. Similarly, by

waiving a jury trial, the financial institution may effectively limit

the amount it might receive in any settlement of its case. The loss of

these legal protections can reduce the value of the financial

institution's claim in an audit dispute.

The Agencies recognize that ADR procedures and jury trial waivers

may be efficient and cost-effective tools for resolving disputes in

some cases. However, financial institutions should take care to

understand the ramifications of agreeing to submit audit disputes to

mandatory ADR or to waive a jury trial before an audit dispute arises.

In particular, pre-dispute mandatory ADR agreements in external

audit engagement letters present safety and soundness concerns when

they incorporate additional limitations of liability, or when mandatory

ADR agreements operate under rules of procedure that may limit auditor

liability. Examples of such limitations on liability include

provisions:

Capping the amount of actual damages that may be claimed;

Prohibiting claims for punitive damages or other remedies;

or

Shortening the time in which the financial institution may

file a claim.

Thus, financial institutions should not enter into pre-dispute

mandatory ADR arrangements that incorporate limitation of liability

provisions, whether the limitations on liability form part of an audit

engagement letter or are set out separately.

The Agencies encourage all financial institutions to review each

proposed external audit engagement letter presented by an audit firm

and understand the limitations on the ability to recover effectively

from an audit firm in light of any mandatory ADR agreement or jury

trial waiver. Financial institutions should also review the rules of

procedure referenced in the ADR agreement to ensure that the potential

consequences of such procedures are acceptable to the institution. In

addition, financial institutions should recognize that ADR agreements

may themselves contain limitation of liability provisions as described

in this advisory.


 

Conclusion


 

Financial institutions' boards of directors, audit committees, and

management should ensure that they do not enter any agreement that

contains external auditor limitation of liability provisions with

respect to financial statement audits. In addition, financial

institutions should document their business rationale for agreeing to

any other provisions that alter their legal rights.

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 may take appropriate supervisory action if such

provisions are included in external audit engagement letters or other

agreements related to financial statement audits that are executed

(accepted or agreed to by the financial institution) after the date of

this advisory. Furthermore, if boards of directors, audit committees,

or management have already accepted an external audit engagement letter

or related agreement for a fiscal 2005 or subsequent financial

statement audit (i.e., fiscal years ending on or after January 1,

2005), the Agencies strongly recommend that boards of directors, audit

committees, and management consult with legal counsel and the external

auditor and take appropriate action to have any limitation of liability

provision nullified.

Financial institutions' boards of directors, audit committees, and

management should also check with their insurers to determine the

effect, if any, on their ability to recover losses as a result of the

external auditors' actions that were not recovered because of the

limitation of liability provisions.

As indicated in the Interagency Policy Statement on External

Auditing Programs of Banks and Savings Associations, 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 is adequate and does not raise any safety and

soundness concerns and (2) the external auditor maintains appropriate

independence regarding relationships with the financial institution

under relevant professional standards.


 

[[Page 24580]]


 

Appendix A


 

Examples of 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 the financial statement audit of

any of the illustrative provisions (which do not represent an all-

inclusive list) or any other language that would produce similar

effects is generally 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 the 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 claimed incidental, consequential, punitive,

or exemplary damages.

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

terms of this Agreement include responsibility for any claimed

incidental, consequential, or exemplary 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

also may preclude any recovery at all. It appears that the external

audit firm would have no liability until the external audit report

is actually delivered and any liability thereafter might be limited

to the period covered by the external audit. In other words, it

might limit the external audit firm's liability to the period before

there is 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 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 audited 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


 

[[Page 24581]]


 

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 which

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: May 4, 2005.

Tamara J. Wiseman,

Executive Secretary, Federal Financial Institutions Examination

Council.


 

[FR Doc. 05-9298 Filed 5-9-05; 8:45 am]


 

BILLING CODE 6720-01-P