Bargaining for Salvation: How Alternative Auditor Liability Regimes Can Save the Capital Markets

Auditor litigation risk is growing increasingly out of control. This risk not only poses problems for the auditing industry, but it may also create systemic problems throughout entire financial markets. Auditor litigation risks arise from criminal and civil causes of action at both the federal and state level. This Note specifically addresses civil litigation. Scholars suggest a number of solutions for mitigating auditor civil litigation risk, including bargained liability caps, liability caps with strict liability, and decoupled liability. This Note argues that federal law should allow auditors to bargain for alternative liability regimes with the audit committees of boards of directors. This approach allows the market to determine the most efficient means for limiting auditor liability while minimizing agency and transaction costs. It also incentivizes boards to create good bargains because of shareholder takeover and proxy threats. The Note also calls for further study on requiring proxy votes to enforce these auditor-board bargains. Lastly, it calls for a provision allowing auditors to opt out of federal and state securities remedies. These proposals comply with current disclosure-based securities laws. Moreover, current regulatory and judicial players could be used to review extreme bargains to ensure fairness. The Note begins with a discussion of the major players in financial markets: management, the board of directors, shareholders, and auditors. It then follows with background of the multitude of federal and state legal regimes that govern these major corporate players, especially auditors, and the effects these regimes have on auditors. The Note then looks at the justifications of each of the proposed solutions. Continuing with a discussion of the criticisms of each approach, it specifically looks at the effects each approach has on company agency and transaction costs. It then considers the limitations each approach faces from current legal and political structures.

The full text of this Note is available to download as a PDF.