Reforming the Structure of the US audit Industry
Limit the maximum damages in lawsuits against auditors -- for example, cap them at 3 times the audit fees received.
The limitation of auditors’ maximum damages in lawsuits can have bad effects on overall auditing quality or even foster fraud. Investors usually perceive a serious risk to quality and confidence in the audit where there is a limit to liability. For example, an auditing firm may have more incentive to collude with its client’s management to manage income because even if they are caught, the liability isn’t high enough to make the auditing firm out of business. The following case of the Enron scandal gives a good example of how worse a management and auditor’s collusion can be.
Enron thrived when the Congress of the United States of America passed legislation of deregulating the sale of electricity in the early 1990s and soon became one of the most successful companies in the United States. From 1996 to 2001, six consecutive years, it was named "America's Most Innovative Company" by Fortune magazine. However, Enron's plunge occurred after the company was revealed that much of its profits and revenue were actually resulted from dealing with special purpose entities. The special purpose entities provided management with full freedom of anonymous currency movement that would keep losses of the company out of the balance sheets. The management of Enron conducted financial deception to create the illusion of profits while the company was actually losing money.
The fallout from Enron’s bankruptcy resulted in many changes to the industry to make standards tougher, penalties harder, and the accounting industry more reliable. Responding to numbers of major corporate and accounting scandals, such as Enron and WorldCom, the Sarbanes-Oxley Act was enacted on July 30, 2002 in order to reinforce investment confidence and protect...