Blogging Employee Benefits

February 15, 2006

LOL No Laughing Matter

Filed under: Accounting, Regulations — Fuguerre @ 11:10 am

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.

Here’s a major current topic that deserves a BeneBlog place in line for all the various ways I and my colleagues encounter it in our own practice and in contacts with auditors; plus worth at least a note on this particular development for a specific exclusion for particular aspects of our work; but then back to the general continuing saga that brings this issue to the table for an increasing part of our work, well beyond S-O 404 and the specific industry addressed here, and regardless of this piece’s benefits plan exemption.

A coalition of five federal agencies has finalized an Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions in External Audit Engagement Letters (“Advisory”), informing financial institutions that they should not enter into agreements with external auditors that incorporate unsafe and unsound limitation of liability provisions 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. [71 FR 6487, 2/9/06]

The Advisory does not apply to audits of a financial institution’s 401(k) plans, pension plans, or other similar audits. The Advisory also does not apply to service providers (including legal advisors) other than a financial institution’s external auditor. Which is not to say that LOL provisions are acceptable or permissible for employee plan audits or non-audit engagements; but only that those audits or engagements are outside the scope prescribed by this Advisory.

The federal agencies are concerned that LOL provisions in engagement letters may weaken an external auditor’s objectivity, impartiality, and performance, thereby reducing the reliability of the audit. The Advisory addresses agreement between a financial institution and an external auditor that includes LOL provisions to –

  • Indemnify the external auditor against third-party claims;
  • Hold harmless or release the external auditor from liability for claims or potential claims that might be asserted by the financial institution; or
  • Limit the remedies available to the financial institution.

The Advisory also expresses concern about agreements to submit disputes to mandatory and binding alternative dispute resolution, binding arbitration, and other binding non-judicial dispute resolution processes or to waive the right to full discovery, limit appellate review, and limit or waive other rights and protections available in ordinary litigation proceedings.

Engagement letter provisions that waive the right of the financial institution to seek punitive damages from the external auditor are not treated as impermissible under the Advisory. However, an agreement by an institution to indemnify its auditor against third-party damage awards, including punitive damages, are considered unsafe and unsound LOL provisions under the Advisory.

The Advisory directs financial institutions against audit engagements that incorporate impermissible LOL provisions. Financial institutions are to document the business rationale for agreeing to any other engagement provisions that limit their legal rights.

The five federal agencies jointly issuing the Advisory are: 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. The Advisory is effective for engagement letters executed on or after 2/9/06. Financial institutions are not required to nullify existing audit engagement letters, but are encouraged to seek amendment of multi-year engagements for years ending after 2006.

Additional background to the agencies’ Advisory is given in the Federal Financial Institutions Examination Council’s Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions and Certain Alternative Dispute Resolution Provisions in External Audit Engagement Letters (5/4/05). Separate but related reading on the emerging debate over engagement letter LOL provisions includes –

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