1 See below question n In Civil law legal systems the issue relates to the qualification of the performance owed by auditors as an

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1 General remarks An approach to the issue of auditor s liability hinged on the basis criteria of a liability cap and of proportionate liability exposes itself to a variety of legal remarks. Firstly, it should be noted that both the liability cap and proportionate liability operate «in the same direction»: i.e. their possible introduction as concurrent measures would result in a significant limitation of auditor s liability. Auditors would benefit from a twofold advantage: the overall amount of recoverable loss would be limited as a consequence of its «capping» and, provided the damage does not significantly exceed the threshold corresponding to the cap, they would furthermore take advantage from the proportionate liability in case of contributory negligence by the audited company. Secondly, on a practical level, the proposals to introduce a limitation of auditors liability, both as a consequence of its «capping» and/or due to the introduction of proportionate liability, should also address the issue of the standard of conduct of auditors, particularly with reference to gross negligence 1. Thirdly, the amount of recoverable damage suffered as a consequence of unlawful behaviour of auditors depends to a large extent on i.) the allocation of the burden of proof and ii.) limitation periods, especially in case of the widely accepted opinion of the admissibility of concurrent contractual and tortious claims. Even though the report did not address the issues maybe because of the foreseeable difficulties in their harmonization within the EU, they are of utmost importance for damage compensation. As far as the allocation of the burden of proof is concerned, the relevant issue clearly relates to the party carrying the burden of proof 2. With reference to limitation periods the extent of the terms provided for by legal systems (for contractual and tortious claims, where their concurrence is admissible) and the determining of the dies a quo of the limitation play a primary role 3. Lastly, and more importantly, the report fails to address the issue of auditors liability in favour of third parties. Their in-depth study appears absolutely necessary given the de facto difficulty to conceive a more stringent liability of auditors in favour of third parties than in favour of shareholders of the audited company (especially in case of the introduction of a liability cap 4 ) and the substantial identity in the positions of actual and potential shareholders 5. 1 See below question n In Civil law legal systems the issue relates to the qualification of the performance owed by auditors as an obligation de moyens as opposed to its consideration as an obligation de résultat. For the Italian debate among legal scholars, see IUDICA/SCARSO, Abschlussprüferhaftung in Italien, in Koziol/W. Doralt, Anschlussprüfer Haftung und Versicherung, Vienna, 2004, Rz It might be interesting to note that among the arguments raised in the debate among Italian legal scholars in order to limit auditors exposition to liability claims - in the absence of a cap a «tightening» of the burden of proof allocated on damaged parties was repeatedly proposed. The author suggests that damaged parties should bear the burden of proof of the the causal link between the damage suffered and the auditor s negligent behaviour. This would allow a selection claims in order to grant compensation only to those which appear to be meritorious. See BUTA, Articolo 164, in Campobasso (ed.), Testo unico della finanza, (2002), 1360, 1369; SANTARONI, La responsabilità del revisore, (1984), 215; BRUNO, La responsabilità dei revisori nei confronti del pubblico per negligente certificazione del bilancio: diritto giurisprudenziale inglese ed italiano a confronto, in Working Papers. Diritto dell impresa, (1995), For instance, whether the dies a quo dates back to the accrual of the cause of action (which will, again depend, on whether) a contractual or a tortious claim is brought in, on the actual or imputed knowledge of the damage by the victim and of their right to bring an action. 4 See below question n. 3. A similar line of reasoning was followed by Bundesgerichtshof (BGH), in NJW, 1998, pp and 1950, with reference to the Vertag mit Schutzwirkung zugunsten Dritter, i.e. with reference to contractual claims. According to the BGH «the legislative intention to adequately cap auditor s liability, as

2 1. Do you agree with the analysis of fixing a single monetary cap at EU level? Supporters of the introduction of a liability cap argue that a limitation of auditors liability responds to reasons of «political opportunity», a.o. the promoting of stability in the international audit market, especially in case of so-called «catastrophic claims». Furthermore, the introduction of a liability cap is considered as beneficial to the boosting of competition among auditing firms, as it would facilitate the offer of audit services to listed companies by mid-tier audit firms. Additional arguments suggesting the introduction of a liability cap for auditors are: Inhibition argument: auditors may need a certain degree of protection in order to carry out their functions in a reasonable and proper manner; Floodgates argument: auditors may need protection in order to avoid the possibility to become «defendants of last resort» and to prevent that liability opens the floodgates of litigation; Moral hazard: this argument suggests that the possibility for consumers to obtain compensation from auditors may generate moral hazard since they may be less careful in deciding the investment they are going to undertake. Opponents of a liability cap point out that it might weaken the incentive on auditing firms to detect and expose corporate fraud 6. They argue that public interests involved in the mandatory auditing require the carrying out of the auditing with the highest possible diligence, which - in order to be effective - requires an unlimited liability 7. Further policies which suggest imposing unlimited liability on auditors include the following: Transparency: an efficient financial market needs to maintain the supremacy of law, which requires that «abusive» exercise of power by auditors is limited, controlled and fully sanctioned by the rule of law; Promotion of «awareness of responsibility» of auditors: this argument rests on the assumption that the accountability and discipline of auditors ant thus their credibility - is enhanced by the risk of unlimited liability; Consumer protection: the ordinary members of the public are not able to assess meaningfully the credit strength of audited firms; Information asymmetry: it must be taken into account that, because of the existence of a different access to information, investors are compelled to rely on the information and supervision provided by auditors. Finally, supporters of an unlimited liability of auditors highlight that the solution envisaged corresponds to the general principle of contractual/tortious liability, according to which debtors/tortfeasors are liable with all their present and future assets for imputable damage. expressed in 323 German Code of Commerce (GermHGB) plays a role also within contractual liability of auditors towards third parties. Its extension to an unidentified plurality of creditors, shareholders or stock buyers within the scope of protection [Schutzbereich] of the auditing would conflict with this legislative trend. It cannot be assumed that the auditor is generally - willing to carry such an extensive liability risk». 5 See below question n For England, see the Feasibility Investigation of Joint and Several Liability, HMSO, 1996, 3.20 & f. 7 For Italy, see CASADEI, La responsabilità della società di revisione, (1999), 123 f.

3 Even though arguments against the introduction of a liability cap seem convincing, a few remarks - in case a liability cap should be introduced - concerning the standard of conduct of auditors and the amount of recoverable damage appear appropriate. Auditors liability presupposes either a breach of contract or, as far as tortious liability is concerned, an unlawful behaviour. Both in the case of contractual claims as well as in the case of tortious claims liability of auditors requires at least mere negligence of the auditing firm in carrying out its supervising duties. In case of contractual claims the breach of contract flows from the qualification of the performance owed by auditors, whilst in case of tortious claims the breach of the duty of care follows from the general principles of Tort law 8. Despite its apparent obviousness, the statement is of great importance under two different aspects: firstly, it implies that as long as the unlawful behaviour by directors/officers of the audited company could not have been detected using professional diligence liability of the auditing firm has to be excluded; secondly, it suggests an approach to the issue hinged on the standard of conduct required to attach liability to auditors. Every legal system renders void any provision purporting to exempt the contractual party in breach/the tortfeasor from liability caused intentionally 9. The same result applies to auditor s liability in legal system which introduced a liability cap, where the cap does not operate in case of intentionally inflicted damages 10. It follows that the issue of the application of the liability cap in case of damage due to gross negligence of auditors plays a key role. The issue has been addressed by legal systems which introduced a liability cap. In Austria the amount of the liability cap is five times higher in case of gross negligence than in case of mere negligence 11. In England Clause 520, Subsection 1, Company Law Reform Bill [HL], whilst allowing for a liability limitation agreement between the auditor and the audited company, explicitly states that the conventional cap is not «effective to limit the auditor s liability to less than such amount as is fair and reasonable in all the circumstances of the case», having regard among others to «the professional standards expected of him». On the contrary, in Germany 323 S 2 GermHGB does not distinguish between mere negligence and gross negligence 12. A systematic approach to the issue suggests to treat gross negligence and/or intent the same way Apart from the numerous and significant cases of strict liability, as is well known the general Tort law rule requires at least mere negligence in order to attach liability to a tortfeasor. 9 For the nullity of a liability limitation in case of deliberately inflicted damage, see, in Italy Art 1229 Italian Civil Code (ItalCC); in France, Art 1150 Code civil. 10 Liability of auditors in case of intentionally inflicted damage follows from: liability for deceit in England; (See Standard Chartered Bank v Pakistan National Shipping Corporation (No 4) [2002] UKHL, 43; 323 S 2 GermHGB and/or from 826 German Civil Code (BGB); 275 S 2 Austrian Code of Commerce (AustHGB) in Austria. 11 See 275 S 2 AustHGB. 12 See 323 S 2 GermHGB, which literally refers «to persons acting negligently» (fahrlässig). According to legal scholars, the cap also applies in case of grossly negligent behaviour by auditors, see MAGNUS, Abschlussprüferhaftung in Deutschland, both in Koziol/W. Doralt, (Fn 2), p. 19 ff.; ZIMMER, Großkommentar Handelsgesetzbuch, III/2, (2002), 323, Rz As WIDMER, Liability based on Fault, in Principles of European Tort Law Text and Commentary, Vienna, 2005, Rn 10, observes, «It is widely accepted that fault, especially intent and gross negligence should be a factor which has an important weight for the decision and evaluation as to whether a certain conduct should entail liability and to what extent». See also Art 10:401 PETL on «Reduction of Damages», according to which the basis of liability (mere negligence, gross negligence, intent) is certainly one of the most important factors to

4 A further indication in favour of the non-application of the liability cap in case of a damage due to gross negligence can be drawn from statutory law 14 and from jurisprudence related to liability of Regulatory Authorities for defective supervision 15 : whilst domestic courts hesitate in granting compensation in case of mere negligence of Regulatory Authorities, judges state their liability in case of damage to investors in case of defective supervision due to gross negligence. The comparison is of great interest, since «catastrophic claims», usually involve - besides a faulty conduct by auditors - a negligent behaviour of Regulatory Authorities. It therefore is difficult to understand why in case of grossly negligent conduct auditors should be granted a de facto immunity (for the loss exceeding the cap), not granted to Regulatory Authorities, whose conduct in case of «catastrophic claims» is usually less blameworthy than the behaviour of auditing firms. Besides, as experience teaches 16, to partially exonerate auditors in case of damage due to gross negligence in carrying out their duties de facto implies a partial immunity for their acting as a «sort of accomplice» to directors/officers of the audited company for their wrongdoings. Finally, an additional argument for the non-application of a liability cap in case of gross negligence lies in the exceptional nature of (partial) immunity for breach of contract or for tortious breach of the duty of care, which suggest a restrictive handling. A second key issue is related to the amount of the cap. It should be fixed in a manner consistent with the primary legislative goal of promoting competition in the international be taken into account for the decision whether and to which extent a reduction of the damages should take place. Widmer concludes that «A reduction will probably not be conceded to a person who has acted with intent or with gross negligence». In conceptually similar terms, see MONATERI, La responsabilità civile, in Trattato Sacco, Milano, 1998, See Art 1229 S 1 ItalCC, which states that «Any agreement which, in advance, excludes or limits liability of the debtor for intent or gross negligence is void». In France, see Art 1150 Code civil, ruling that, in case of breach of contract, liability is limited to the damage which the debtor could foresee at the time of the entering into the contract, unless non-performance is due to their intent (dol). As far as clauses limiting or exempting from liability are concerned, French jurisprudence has a long tradition (dating back to 1938) in assimilating gross negligence (faute lourde) to intent (faute dolosive ou intentionnelle). 15 As far as Italian jurisprudence is concerned, see Corte di Cassazione (Italian Supreme Court for civil matters) , n 3132, in Foro it., 2001, I, 1139 = Diritto ed economica dell assicurazione, 2001, 1093 = Corriere giur., 2001, 880 = Cons. Stato, 2001, 2, 1829 = Giur. it., 2001, I, 2269 = Le società, 2001, 576 = Danno e resp., 2001, 509 = Resp. civ. prev., 2001, 571 = Giust. civ., 2001, 913 = NGCC, 2001, I, 161 = Giorn. dir. amm., 2001, 1135 = Contratto e impr., 2001, 953 = Banca, borsa e titoli di credito, 2002, II, 19 = Giur. comm., 2002, II, 12, concerning the publishing of a prospectus containing false information with reference to the real value of the assets of the issuing company - in order to promote the placement with the public of certain securities, and the subsequent Court of Appeal of Milan , in Foro it., 2004, I, 584, which applied the principles laid down by the Corte di Cassazione. In the case submitted to the Corte di Cassazione and to the Milanese judges the easily detectable falsity of the information provided to CONSOB (the Italian financial market supervisor) indicates that, in the specific case, CONSOB s conduct was grossly negligent. With reference to France, see Conseil d Etat , Ministre de l economie, des finances e des l industrie v. Kechichian, n ( which ruled that in order for the Commission bancaire to be held liable a «faute lourde» is required. In Germany a single investor does not have a right to sue the Regulatory Authority BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht) in case of defective supervision, unless there is a so called abuse of power (Amtsmissbrauch). An abuse of power requires the civil servant to commit an infringement satisfying the requisites of 826 BGB (i.e. damage intentionally caused in a way infringing upon morals - «gute Sitten») and may also occur, depending on the circumstances, in selected cases of grossly negligent behaviour: see, for instance, BGH , in BGHZ, 99, 243, 252 = in NJW, 1984, 2216; BGH , in NJW, 1973, Recent scandals (Enron, Parmalat) appear to indicate that auditors ended up tolerating many forms of malpractice. See, as far as Parmalat is concerned, SCARSO, Parmalat: Corporate governance und die Rolle des Abschlussprüfers nach italienischem Recht, in GesRZ, 2004, 291 ff.

5 audit market, whilst granting stability of capital markets and a «fair» compensation to damaged parties 17. The caps set down by the Austrian and German legal systems 18 appear absolutely insufficient, especially in case of «catastrophic claims». The amount of the cap should be set at a level that allows for the maximum protection of actual and potential shareholders, in order to promote investors confidence in capital markets stability, whilst allowing mid-tier audit firms to potentially offer their services to listed companies (thereby promoting competition in the international audit market). 2. Would a cap based on the size of the listed company, as measured by its market capitalisation be appropriate? Would a cap based on the audit fees charged to the company be appropriate? See question n. 1. Even though the introduction of a monetary cap to auditor s liability does not appear to be desirable, it might turn out to be appropriate, if at all, to refer to an objective index, i.e. an index which cannot be «influenced» by the auditor. The adoption of an index (directly) determined by the auditor bears the risk of «elusive measures», in order to reduce prospective liability claims. This is particularly true for the fees charged to the audited company: it is common knowledge that their amount often does not reflect the «real» value of auditing services provided, since auditors tend to consider the auditing of a company as a «bridgehead» in order to gain access to lucrative consulting services, which might be offered more easily and at lower costs than competitors, due to the knowledge of the company gained through its auditing. The concern that auditing fees might not provide an appropriate index as to the extent of the economic interests involved is confirmed by the composition of the turnover of auditing companies, which generally indicates that a significant share is related to the consulting business. 3. Do you agree with the analysis of the option of the introduction of the principle of proportionate liability? In most Member States auditors liability in favour of the audited company is governed both by the principles of the law of contract and tort. Arguments usually brought forward in order to introduce a proportionate liability are: the law of joint and several liability might be «unfair» for auditors, since it implies that auditing companies might be left to pay the full amount of damages, in cases where other tortfeasors (the audited company s directors/officers) are uninsured and do not have the resources to pay, even though the «proportion of culpability» of the auditor is insignificant as compared to the legal person (i.e. the audited company) deemed to be «primarily» responsible for the loss; 17 See the Commission Staff Working Paper: Consultation on auditors liability and its impact on the Euripean capital markets, 2007, 8 f. 18 In Germany the liability cap is for non-listed companies and for listed companies. These caps are applied in case of any form of negligent conduct by auditors, therefore also in case of gross negligence: ZIMMER, (Fn 12), 323 Rz 45; MAGNUS, (Fn 12), p. 26. In Austria the liability cap is for non-listed and for listed companies, unless the damage is due to a gross negligence (grobe Fahrlässigkeit), in which case the caps are raised to and respectively. See W. DORALT, Haftung der Abschlussprüfer, Vienna, 2005, 98 ff.

6 given the potentially very high amount of damage shareholders and third parties could suffer, it is practically impossible for auditors to insure their possible losses (see question n. 1); a de facto reduction of auditors liability (by applying the principle of proportionate liability as compared to joint and several liability) would increase stability in the international audit market, especially in case of «catastrophic claims». Even though the arguments mentioned might sound convincing, they do not seem to consider that it is the precise and primary duty of auditors to discover misfeasance and, more generally, unlawful behaviour of directors/officers of the audited company 19. It therefore seems contradictory to allow for a de facto limitation of liability (implicit in proportionate liability) in case of contributory negligence 20, as it would conflict with the specific trust implicit in the relationship between auditing firm and audited company, and with the public interest in the «responsible» carrying out of the audit 21. Nor seem the reasons on which contributory negligence - and thus proportionate liability rests applicable in relation to legal entities. The principle of proportionate liability is based on the assumption that the concurrent unlawful behaviour of the party seeking compensation calls for an apportionment of the damage as a whole according to their relative responsibility. A legal entity obviously acts through its directors/officers. The principle of self-responsibility implies that directors/officers are exposed to a proportionate reduction in case of damage imputable to both their negligent conduct and the faulty behaviour of the auditing firm. For the same reason it is not pertinent to apply proportionate liability to (minority) shareholders of the audited company 22. Its application would penalize (minority) shareholders, who deserve protection, both because they did not commit any wrongdoing and inasmuch as they - given the structure of listed companies - have no choice than to rely on auditors (and Regulatory Authorities) for the detection of corporate fraud. The same necessity to place «reliance» on auditors applies to third parties. This is the reason why a debate over the introduction of a cap to auditors liability (and/or, given the de facto difficulty in granting a higher compensation to third parties, proportionate liability) should tackle the problem of damage suffered by third parties. The failure to address the issue in the Commission Staff Working Paper is unfortunate. A variety of reasons should have suggested to consider damage suffered by third parties: the experience of legal systems which introduced a liability cap for auditors whilst allowing for damage compensation in favour of third parties indicates that, on a practical level, it is difficult to grant third parties the same (or a higher) compensation awarded to shareholders 23 ; 19 See, as far as Austrian jurisprudence is concerned, Oberster Gerichtshof (OGH), in ÖBA, 2001, 560 ff. 20 Extensively KOZIOL/W. DORALT, Der Mitverschuldenseinwand des Abschlussprüfers gegen Ersatzansprüche der Gesellschaft, in Festschrift Peter Doralt, Vienna, 2004, 345; CASADEI, (Fn 7), For that reason Italian legal scholars exclude the admissibility of a exoneration from liability for mere negligence also in case of a voluntary audit, as it would conflict with Art 1229 S 2 ItalCC (according to which «Any agreement which, in advance, exonerates from or limits liability in cases in which the act of the debtor or his auxiliaries constitutes a violation of a duty arising from rules of public policy is also void»). 22 KOZIOL/W. DORALT, (Fn 20), For the Austrian situation see, W. DORALT, (Fn 18), 140 ff.

7 on a substantial level, there is no difference between the position of actual (minority) shareholders and third parties: due to their informational asymmetry both necessarily have prima facie to rely on supervision by the auditing firm (which also explains why the audit is mandatory for listed companies); as far as general interests involved are concerned, stability of financial markets relies to a great extent on potential investors confidence in their transparency which, in turn, is promoted by auditors unlimited liability for their wrongdoings. 4. What are your views on the two ways in which proportionate liability might be introduced? None seems really convincing. To allow Courts to award damages only for the portion of loss corresponding to auditors degree of fault exposes shareholders to the risk of receiving an «unfair» compensation. To allow auditing firms to negotiate the liability cap with the audited company represents an incentive for directors/officers to agree on particularly low liability caps, since auditing fees will obviously depend on the amount of the cap. To provide for a possible overriding of the conventional cap by national courts in case the cap should be deemed not to be «fair» and «reasonable» shifts the problem to the judges: whilst it could work in Member countries having a solid tradition of judicial independence and impartiality, it could potentially expose jurisprudence to undue pressures in Member countries with a weaker and, due to their recent history, shorter tradition of political non-interference in judicial decisions. The vast range of judicial evaluation as to the «fairness» and «reasonableness» of the conventional liability cap seems to confirm those fears. Prof. Alessandro P. Scarso Professor of Civil Law Faculty of Law University of Parma Strada Università, Parma - Italy