Interagency advisory issued on use of limitation of liability provisions in external audit engagement letters, as AICPA urged.

The Federal Financial Institutions Examination Council, on behalf of the five major banking regulatory agencies, has issued a Final Advisory informing financial institutions not to enter into external audit engagement letters that incorporate "unsafe and unsound" limitation of liability provisions with respect to audits of financial statements and internal control over financial reporting. The Advisory includes examples of limitation of liability provisions that are considered to be unsafe and unsound.

In June 2005, the AICPA submitted comments to the FFIEC's Proposed Advisory urging the FFIEC to permit provisions limiting an auditor's liability to the client for punitive damage claims, provided the auditor remained liable for actual damages. The Institute also requested that the Final Advisory make clear that the inclusion of alternative dispute resolution (ADR) and waiver of jury trial provisions would not impair independence or constitute an unsafe and unsound practice. We are pleased to report that the Final Advisory states provisions that waive the right of financial institutions to seek punitive damages from their external auditor are not considered to be unsafe and unsound and that mandatory ADR or waiver of jury trial provisions would not present safety and soundness concerns, provided the engagement letters do not also incorporate prohibited limitation of liability provisions.

The Advisory is effective for audit engagement letters executed on or after the date it is published in the Federal Register and does not apply to previously executed engagement letters. However, the FFIEC encourages any financial institution subject to a multi-year audit engagement letter containing limitation of liability provisions considered to be unsafe and unsound to amend their engagement letters to be consistent with the Advisory for periods ending in 2007 or later. The Advisory is available at www.ots.treas.gov/docs/4/480217.pdf.