Interagency Advisory on the Unsafe and Unsound Use of Limitation of Liability Provisions and Certain Alternative Dispute Resolution Provisions in External Audit Engagement Letters, 24576-24581 [05-9298]
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III. Issues for EPA and stakeholders
In general, EPA is requesting
comments on the following issues: (1)
The scope and purpose of a voluntary
pilot program for nanoscale materials
that are existing chemical substances,
(2) kinds of information that are relevant
to the evaluation of potential risks from
exposure to nanoscale materials, (3)
chemical characterization and
nomenclature of nanoscale materials for
regulatory purposes, and (4)
identification of interested stakeholders.
Comments in these specific areas will be
particularly helpful:
• Feasibility and value of a voluntary
pilot program.
• Scope and design of a voluntary
pilot program, including elements such
as: purpose (e.g., R & D, use involving
environmental release, any commercial
use), administration, outcomes,
duration, and next steps.
• Information that would be useful in
the evaluation of potential effects on
human health and the environment
from exposure to nanoscale materials.
• Size, dimensions, and shapes of
chemical substances that should be
considered nanoscale materials.
• Types of information (e.g., unique
and novel properties) that would be
useful to provide for purposes of:
informing the voluntary pilot program;
and helping to name and characterize
nanoscale materials (including features
to distinguish them from otherwise
similar chemical substances that do not
involve nanoscale structures).
• Manufacturing processes for
nanoscale materials and how they relate
to identities of the products from the
nanoscale manufacturing processes.
• Identification of interested
stakeholders.
IV. References
The following references have been
placed in the official docket that was
established under docket ID number
OPPT–2004–0122 for this action as
indicated in Unit I.B.2.
1. Aitken, R.J., Creely, K.S., Tran, C.L.
2004. Nanoparticles: An Occupational
Hygiene Review. Suffolk, U.K.: Health
and Safety Executive, Research Report
274.
2. VDI Technologiezentrum GmbH.
2004. Industrial Application of
Nanomaterials - Chances and Risks.
Technology Analysis. Luther W, ed.
Dusseldorf, Germany: Future
Technologies No. 54.
3. USEPA. 2005. Considerations
Relevant to Toxic Substances Control
Act (TSCA) Application to Nanoscale
Materials. Office of Prevention,
Pesticides and Toxic Substances. Office
of Pollution Prevention and Toxics.
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4. Federal Register. June 3, 2003.
TSCA Section 8(e): Notification of
Substantial Risk; Policy Clarification
and Reporting Guidance. 68 FR 33129.
5. Federal Register. January 12, 2005.
TSCA Section 8(e) Reporting Guidance;
Correction, Clarification of
Applicability, and Announcement
Regarding the Issuance Questions and
Answers. 70 FR 2162.
C. New Business—Regulations
• Capital Adequacy Risk-Weighting
Revisions—Final Rule
Dated: May 5, 2005.
James M. Morris,
Acting Secretary, Farm Credit Administration
Board.
[FR Doc. 05–9426 Filed 5–6–05; 2:19 pm]
BILLING CODE 6705–01–P
List of Subjects
Environmental protection, Chemicals,
Hazardous substances, Nanotechnology,
Nanoscale materials.
Dated: April 25, 2005.
Susan B. Hazen,
Assistant Administrator for Prevention,
Pesticides and Toxic Substances.
[FR Doc. 05–9324 Filed 5–9–05; 8:45 am]
BILLING CODE 6560–50–S
FARM CREDIT ADMINISTRATION
Sunshine Act Notice; Farm Credit
Administration Board; Regular Meeting
AGENCY: Farm Credit Administration.
SUMMARY: Notice is hereby given,
pursuant to the Government in the
Sunshine Act (5 U.S.C. 552b(e)(3)), of
the regular meeting of the Farm Credit
Administration Board (Board).
DATE AND TIME: The regular meeting of
the Board will be held at the offices of
the Farm Credit Administration in
McLean, Virginia, on May 12, 2005,
from 9 a.m. until such time as the Board
concludes its business.
FOR FURTHER INFORMATION CONTACT:
Jeanette C. Brinkley, Secretary to the
Farm Credit Administration Board,
(703) 883–4009, TTY (703) 883–4056.
ADDRESSES: Farm Credit
Administration, 1501 Farm Credit Drive,
McLean, Virginia 22102–5090.
SUPPLEMENTARY INFORMATION: This
meeting of the Board will be open to the
public (limited space available). In order
to increase the accessibility to Board
meetings, persons requiring assistance
should make arrangements in advance.
The matters to be considered at the
meeting are:
Open Session
A. Approval of Minutes
• April 14, 2005 (Open and Closed)
B. Reports
• Corporate/Non-Corporate Report
• Risk Profile of U.S. Agriculture
• Risk Profile of the Farm Credit
System
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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
Federal Financial Institutions
Examination Council.
ACTION: Proposed interagency advisory;
request for comment.
AGENCY:
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
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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
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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.
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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.
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
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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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.
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
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.
3 Examples of auditor limitation of liability
provisions are illustrated in Appendix A.
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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 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.
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
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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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
7 See FDIC Regulation 12 CFR Part 363, Appendix
A—Guidelines and Interpretations; Guideline 14,
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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.)
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
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 § 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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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
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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.
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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 allinclusive 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
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16:17 May 09, 2005
Jkt 205001
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
PO 00000
Frm 00083
Fmt 4703
Sfmt 4703
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
E:\FR\FM\10MYN1.SGM
10MYN1
Federal Register / Vol. 70, No. 89 / Tuesday, May 10, 2005 / Notices
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, 6210–01,–P, 6714–01–P,
7535–01–P, 4810–33–P
FEDERAL MARITIME COMMISSION
Controlled Carriers Under The
Shipping Act of 1984
Federal Maritime Commission.
Notice.
AGENCY:
ACTION:
The Federal Maritime
Commission is publishing an updated
list of controlled carriers, i.e., ocean
common carriers operating in U.S.foreign trades that are owned or
controlled by foreign governments. Such
carriers are subject to special regulatory
oversight by the Commission under the
Shipping Act of 1984.
FOR FURTHER INFORMATION CONTACT:
Amy W. Larson, General Counsel,
Federal Maritime Commission, 800
North Capitol Street, NW., Washington,
DC 20573. (202) 523–5740.
SUMMARY:
VerDate jul<14>2003
16:17 May 09, 2005
Jkt 205001
The
Federal Maritime Commission is
publishing an updated list of controlled
carriers. Section 3(8) of the Shipping
Act of 1984 (‘‘Act’’), 46 U.S.C. app.
1702(3), defines a ‘‘controlled carrier’’
as:
SUPPLEMENTARY INFORMATION:
An ocean common carrier that is, or whose
operating assets are, directly or indirectly,
owned or controlled by a government;
ownership or control by a government shall
be deemed to exist with respect to any carrier
if—
(A) a majority portion of the interest in the
carrier is owned or controlled in any manner
by that government, by any agency thereof,
or by any public or private person controlled
by that government; or
(B) that government has the right to
appoint or disapprove the appointment of a
majority of the directors, the chief operating
officer, or the chief executive officer of the
carrier.
As required by the Shipping Act,
controlled carriers are subject to special
oversight by the Commission. Section
9(a) of the Act, 46 U.S.C. app. 1708(a),
states, in part:
No controlled carrier subject to this section
may maintain rates or charges in its tariffs or
service contracts, or charge or assess rates,
that are below a level that is just and
reasonable, nor may any such carrier
establish, maintain, or enforce unjust or
unreasonable classifications, rules, or
regulations in those tariffs or service
contracts. An unjust or unreasonable
classification, rule, or regulation means one
that results or is likely to result in the
carriage or handling of cargo at rates or
charges that are below a just and reasonable
level. The Commission may, at any time after
notice and hearing, prohibit the publication
or use of any rates, charges, classifications,
rules, or regulations that the controlled
carrier has failed to demonstrate to be just
and reasonable.
Congress enacted these protections to
ensure that controlled carriers, whose
marketplace decision making can be
influenced by foreign governmental
priorities or by their access to nonmarket sources of capital, do not engage
in unreasonable below-market pricing
practices which could disrupt trade or
harm privately-owned shipping
companies.
The controlled carrier list is not a
comprehensive list of foreign-owned or
-controlled ships or shipowners; rather,
it is only a list of ocean common carriers
(as defined in section 3(16) of the Act)
that are owned or controlled by
governments. Thus, tramp operators and
other non-common carriers are not
included, nor are non-vessel-operating
common carriers, regardless of their
ownership or control.
Since the last publication of this list
on June 9, 2003 (68 FR 34388), the
Commission has newly classified two
PO 00000
Frm 00084
Fmt 4703
Sfmt 4703
24581
ocean common carriers as controlled
carriers. On September 27, 2004,
American President Lines, Ltd. and APL
Co. Pte, Ltd. (one ocean common carrier
designated ‘‘APL’’) was classified as a
carrier controlled by the Government of
the Republic of Singapore (‘‘GOS’’). The
majority ownership of APL’s parent
company, Neptune Orient Lines
(‘‘NOL’’) had been purchased by a GOS
controlled holding company. On
November 29, 2004, the Commission
classified China Shipping (Hong Kong),
Ltd. (‘‘CSHK’’) as a carrier controlled by
the Government of the People’s
Republic of China. CSHK was a new
entrant in the U.S.-foreign trades.
Neither APL nor CSHK raised any
objections to these classifications.
It is requested that any other
information regarding possible
omissions or inaccuracies in this list be
provided to the Commission’s Office of
the General Counsel. See 46 CFR 501.23.
The amended list of currently classified
controlled carriers and their
corresponding Commission-issued
Registered Persons Index numbers is set
forth below:
(1) American President Lines, Ltd and
APL Co., Pte. (RPI No. 000240)—
Republic of Singapore;
(2) Ceylon Shipping Corporation (RPI
No. 016589)—Democratic Socialist
Republic of Sri Lanka;
(3) COSCO Container Lines Company,
Limited (RPI No. 015614)—People’s
Republic of China;
(4) China Shipping Container Lines Co.,
Ltd. (RPI No. 016435)—People’s
Republic of China;
(5) China Shipping Container Lines
(Hong Kong) Company, Ltd. (RPI No.
019269)—People’s Republic of China;
(6) Compagnie Nationale Algerienne de
Navigation (RPI No. 000787)—
People’s Democratic Republic of
Algeria;
(7) Sinotrans Container Lines Co., Ltd.
(d/b/a Sinolines)(RPI No. 017703)—
People’s Republic of China;
(8) Shipping Corporation of India Ltd.,
The (RPI No. 001141)—Republic of
India.
By the Commission.
Bryant L. VanBrakle,
Secretary.
[FR Doc. 05–9322 Filed 5–9–05; 8:45 am]
BILLING CODE 6730–01–P
FEDERAL RESERVE SYSTEM
Agency Information Collection
Activities: Proposed Collection;
Comment Request
Board of Governors of the
Federal Reserve System.
AGENCY:
E:\FR\FM\10MYN1.SGM
10MYN1
]]>Agencies
[Federal Register Volume 70, Number 89 (Tuesday, May 10, 2005)]
[Notices]
[Pages 24576-24581]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-9298]
=======================================================================
-----------------------------------------------------------------------
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.
-----------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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, 6210-01,-P, 6714-01-P, 7535-01-P, 4810-33-P
