The auditing profession has been lusting for caps on their legal responsibility for failed audits for some time now. The failure of Arthur Andersen has played nicely into their hands in this regard, allowing them to invoke the doomsday scenario of "what would life be like if there were only three major auditing firms?" Therefore, they need protection from lawsuits that could make this a reality. 

The funny thing is - the audit is under the control of the auditor. They could "audit better," if they chose to do so. And they could walk away from audits that they cannot audit better. Better that they have limits to their legal responsbility? Hmm... seems like they'd have even less incentive to do an audit better. I smell a moral hazard in the offing.

 There's an idea floated by Professor Lawrence Cunningham of the George Washington Law School that's worth considering, and he blogs about it in his post at the Concurring Opinions blog. Skip the caps: instead, have the auditing firms issue catastrophe bonds as a backstop for liability above the limits of their insurance policies.

 "The firms would issue bonds in debt markets to provide a backstop against the big judgment. Paying a high interest rate to reflect risk, the bonds would be repaid at maturity if no big claims arose but principal would be released to cover massive judgments if they did. This would protect share owners against losses from incorrect accounting without bankrupting an audit firm."

 It's a fascinating notion, one that might be worth some effort on the part of the auditing firms to consider. One puzzle: if a market could be found/created for these bonds, why wouldn't insurance firms just underwrite the risks in that particular market?

 Will auditing firms give it serious consideration? They should, but they're probably far too wedded to their lobbying efforts to minimize liability to pay much attention to it.