The Federal Financial Institutions Examination Council (FFIEC), on behalf of numerous government agencies, seeks comments on proposed guidance restricting limitation of liability provisions in external audit engagement letters.

The AICPA Code of Professional Conduct currently permits members to include an indemnification clause in engagement letters for knowing misrepresentations by client management. Under the FFIEC proposal, this would be prohibited. The AICPA Professional Ethics Executive Committee has been evaluating the appropriateness of the use of certain indemnification and limitation of liability clauses in light of the recent focus by the FFIEC and SEC.

The FFIEC’s proposal advises financial institutions' boards of directors, audit committees and management not to enter into any agreement that contains external auditor limitation of liability provisions with respect to financial statement audits. This would apply 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.

The agencies believe such provisions may weaken an external auditor's objectivity, impartiality, and performance and therefore conclude that inclusion of these provisions in financial institution engagement letters raises safety and soundness concerns.

The agencies state that the limitation of liability provisions can be generally categorized as an agreement by a financial institution client 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.

Under the proposal, 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 after the date of the advisory (May 10, 2005).

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 they consult with legal counsel and the external auditor and take appropriate action to have any limitation of liability provision nullified.

Members are encouraged to review this important proposal and submit their comments to the following address on or before June 9, 2005.

FFIEC, Program Coordinator, 3501 Fairfax Drive, Room 3086, Arlington, VA 22226; by e-mail; or by fax to 703-516-5487.

The full proposal as printed in the Federal Registry.

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