Limited manoeuvres by KPMG herald new era: Protection against liability is behind the firm's plans to create a new arm. Roger Trapp reports

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THE announcement by KPMG Peat Marwick, Britain's second biggest accountancy firm, that it intends to increase its protection against audit liability claims by creating a limited company to audit its publicly-quoted clients heralds the end of an era.

The other leading firms are all looking at incorporation and some look set to follow KPMG's lead.

In the US, where figures suggest total claims over accounting advice are running at dollars 40bn and costing 10 per cent of accounting revenues to handle, all six of the biggest practices have become limited liability partnerships.

In this country, Ian Brindle, senior partner of Price Waterhouse, is on record as saying that incorporating is a question of 'when, not if'. A spokeswoman for the firm, which with Ernst & Young is facing a possible writ claiming up to dollars 8bn in damages over the collapse of Bank of Credit and Commerce International, said an announcement of some sort was likely to be made next year. Likewise, Coopers & Lybrand, which is the largest firm and is facing potential claims over the failure of the Maxwell empire, said it was looking at various options. However, it did not expect to make a decision soon.

Colin Sharman, KPMG's senior partner, said that since the firm audited about a fifth of Britain's public companies, limiting liability in this way was perhaps more important for it than for others. With audit and accounting taking up 200 of the firm's 600 partners and about pounds 200m of total fee income of pounds 498m, it was a 'bigger chunk of our business than for anybody else', he added.

Incorporation has been available to accountants for several years. But what is changing minds now is the upsurge in lawsuits. A crisis that started in the US has spread across the Atlantic and led to the launch earlier this year of parallel campaigns by the leading firms and the Institute of Chartered Accountants in England and Wales for reform of the law. Minet, the leading insurance broker in the professional liability field, says there is a real risk of one of the leading firms collapsing, while some insiders are predicting that the big six will be replaced by the big three before long.

With estimates suggesting that last year the eight largest firms in Britain spent 8 per cent of their combined audit fee income of pounds 932m on costs associated with legal claims, it is not surprising that insurance premiums have soared to the point where many firms cannot obtain cover at any price and are thus in effect self-insuring.

The accountants are pressing for a change to the law that allows them to be sued because they are perceived to have 'deep pockets' as a result of the heavy insurance cover they are reputed to carry.

In particular, they want ministers to tackle the legal principle of joint and several liability, under which they can be forced to meet a total loss resulting from a company failure even if they bear only a tiny proportion of the blame.

However, since both campaigns recognise that such a change would take a long time to reach the statute book, they are also arguing for the more limited measure of amendment to section 310 of the 1985 Companies Act, which makes auditors the only providers of professional services unable to limit their liability through agreement with their clients.

KPMG's move is being seen as an acknowledgement that even this would be a long time coming. Even within the profession, there is a view that limiting liability flies in the face of current thinking on corporate governance, which holds that auditors are in fact accountable to shareholders and therefore should not make deals with directors. It has also been pointed out that it is difficult for the firms to claim they are at serious risk if they do not open up their books to demonstrate it.

Perhaps mindful of the need to offer a quid pro quo, KPMG is planning to publish full financial information for the whole of its operations if the clients, investors and regulators whose views it is seeking back the proposal to make the audit division a company. It feels that this will answer a persistent media criticism and give it a substantial lead on its rivals.

But it could lead to many more problems. At a time when Arthur Andersen, for one, is publicly stating that it wanted to merge with Binder Hamlyn because it fancied its chances of selling other services to that firm's audit clients, it is difficult to see how the earnings of one part can be separated from the others completely.

One caveat made by Chris Pearce, finance director of Rentokil and chairman of the influential Hundred Group's technical committee, goes to the heart of the issue. Though not an audit client of KPMG in the UK, he would make his approval subject to auditors regaining their willingness to express judgements on companies, 'which is what the public expectations of auditors are'.

It is a view that is perhaps surprisingly close to that of Prem Sikka, an accountancy academic at East London University who has long been a critic of the profession. 'If they really want to improve their liability position, they've really got to to improve the quality of their work,' he said. And that involved making them subject to pressures which - because of self- regulation - did not exist yet.

Inside the profession, the real fear is that KPMG's move - which could come into effect next year - could convince the public that the liability issue has been solved when it has not.

Even Mr Sharman is anxious to point out that the proposal offers only partial protection. Partners would no longer risk losing their homes. But they could still be sued personally, and the firm could still be wiped out, leaving so much mayhem that not even the rest of the big six could pick it up.

(Photograph and graph omitted)