Interesting article in this morning's Wall Street Journal, a maybe-phenomenon that I hadn't come across before.
The article describes an unusual disclosure in Sun Microsystems' proxy describing the "liability cap" arrangement between Sun and its auditor, Ernst & Young. The cap limits the ability of Sun to sue Ernst & Young in the event of an audit failure; as the article puts it, the audit arrangment is "subject to alternative dispute resolution procedures and an exclusion of punitive damages." It also mentions that Silicon Graphics is another liability capper.
(Know of any others? Send 'em in.)
Nothing focuses the mind more clearly than the prospect of hanging, to paraphrase Samuel Johnson. And he was right. Obviously, such an arrangement gives the auditor comfort that a single audit won't drive them into oblivion a la Arthur Andersen - and removes the prospect of hanging. The article mentions that, anecdotally at least, all of the Big Four firms have demanded them, making it impossible for some firms to find an auditor keeping all of their skin in the game.
At first blush, these are not investor-friendly arrangements; it's hard to see where taking the heat off the auditors is going to produce higher-quality audits for investors. (The only investor-friendly rationale I can manufacture is that this preserves the financial health of the auditing profession. But if they aren't concerned with the intensity of audits - how is the investor better off with a financially healthy audit profession?)
There's only one silver lining to this: for every action there's a reaction. If firms lose an avenue of reparation due to shoddy reporting, maybe they'll take more seriously their own first-line responsibility for producing high-quality financial reporting. Take the heat off the auditors, it's going to go somewhere else; this should raise the stakes for the reporting companies. That's not a bad thing. A slim straw to grasp, but a straw nevertheless.