Contents

Chapter 8
Liability of professional service providers and advisers

The Commission’s view

8.45The Law Commission considers that there is a sound case for capped liability for auditors conducting large audits. We see large audits as comprising audits of issuers or FMC reporting entities, or a subset of the largest, most publicly accountable FMC reporting entities that will be captured by section 461K of the Financial Markets Conduct Act.

8.46The principal reasoning for capped liability for this part of the audit sector is to allow New Zealand firms to remain competitive, and reduce the risk or consequences of a catastrophic loss event. Where a trans-Tasman market exists and the conditions are more favourable in one jurisdiction, the other jurisdiction will be penalised in the market place. A similar capped regime to those operating in Australia will ensure a fair market for New Zealand auditors who want to tender for large audits. Taking prudent steps to reduce the risk or consequences of a catastrophic loss event through capping is also desirable for auditors who conduct large audits, because the risk of a catastrophic loss increases with the size of the audit. We are not convinced that there is a similar case to extend capping either to medium or smaller audits, or to other accounting services. There has been no suggestion that trans-Tasman competition extends or indeed is likely to extend to these services in the near future. Furthermore, for reasons of scale, these services do not contribute significantly to the risk of catastrophic loss. It is also possible that the lesser scale of activities and potential liabilities would make the likely caps less relevant at this level. If the relevant caps were at either $2.5 million or $10 million, depending on the firm or activity, we expect that this is a level at which suitable professional indemnity cover ought to be sufficient to manage risks.

8.47A capped liability scheme for large audits will only be realistic if it can be set up and supervised efficiently. We expect that, similar to Australia, the professional accounting body, NZICA, should develop and submit a suitable scheme that complies with appropriate legislative specifications and restrictions, to a statutory supervisor. In respect of supervision, we do not recommend the establishment of a new entity like the Australian Professional Standards Councils, for obvious reasons of economy and scale. Given the Financial Markets Authority (FMA) already has the central regulatory role under the Audit Regulation Act we recommend that the FMA be given authority to approve and supervise a scheme.

8.48Like Australia, approval of a scheme should be for a maximum of five years, with the professional body able to make a new application for a new or renewed scheme. The requirement for periodic renewal is important. Given the novelty of such a scheme, it is desirable that the need for it, as well as its features, be reviewed regularly. It may turn out that the scheme is of little use, with all or substantially all applicable liabilities falling below the capped levels. Or the opposite could be the case, with capped levels so low that they reduce liability for many claims.

8.49The capping level should be similar to the levels set in Australia and should apply to all claims from contracting parties or third party investors. The cap for each audit firm should be set based on audit firm revenue, with a cap at $2.5 million where income from audits of large companies is under $10 million per annum; $25 million where income from audits of large companies is between $10 and $20 million per annum; and $80 million where income from audits of large companies is over $20 million per annum.

8.50Practitioners and firms who wish to be subject to the capping scheme will be required to comply with ongoing professional obligations.160 Similar to Australian schemes, the scheme should require the professional body to report on the working of the scheme.161 The legislative provisions to give effect to a scheme need not be extensive. We suggest that the power to approve schemes, and the consequences and key requirements, be included in amendments to the Auditor Regulation Act, with provision to make legislative instruments, if required.

Recommendations

R12 Professional service providers and advisers should remain subject to the normal application of joint and several liability.

R13 Auditors and audit firms conducting large or complex audits in New Zealand, including audits of listed companies, other issuers or Financial Market Conduct reporting entities, should be able to participate in a capped liability scheme covering their audit work, provided the scheme is approved by the Financial Markets Authority (FMA) and individuals and firms qualify for and comply with the scheme.

R14 The New Zealand Institute of Chartered Accountants (NZICA), its successor and/or other accredited professional bodies should be invited to develop an initial scheme to be submitted to the FMA or other suitable statutory supervisor, which may approve the scheme.

R15 The cap for each audit firm should be based on revenue, with a $2.5 million cap where income from large or complex audits is under $10 million per annum, a $25 million cap where income from large or complex audits is between $10 and $20 million per annum and an $80 million cap where income from large or complex audits is over $20 million per annum.

R16 The cap will apply to all claims from contracting parties or third party investors, whether founded in contract, equity, tort, or otherwise but will not apply to liability arising from fraud, dishonesty or other intentional wrongdoing.

R17 Approval of a scheme will be for a maximum of five years, with the professional bodyable to make an application for a new or renewed scheme at that time.

160These should include: maintain adequate professional indemnity cover, to the level of the highest cap affecting them (this provision should be harmonised with the existing provisions under the Auditor Regulation Act, for compulsory professional indemnity insurance); satisfy CPD obligations; comply with other professional supervision and disciplinary requirements; and provide all necessary information required under the scheme to the professional body, which will have reporting obligations to the supervisor.
161For example, on claims patterns, availability and cost of suitable indemnity cover; plans for risk management, risk reduction and review of outcomes; and compliance with CPD requirements.