Britain’s big four auditing firms have been left exposed to a surge in negligence claims after the Government refused to limit further the damages they could face.

Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers (PwC) lobbied hard for a cap on payouts. Senior figures involved in the discussions said that Lord Mandelson, the Business Secretary, appeared receptive to their concerns but stopped short of changing the law.

The decision is a huge blow to the firms — some face lawsuits relating to Bernard Madoff’s $65 billion fraud — which believe there may not be another chance for a change in the law for at least two years. They fear that they will be targeted by investors and liquidators seeking to recover losses from Madoff-style frauds and big company failures.

At present, auditors can be held liable for the full amount of losses in the event of a collapse, even if they are found to be only partly to blame.

In April, representatives of the companies met Lord Mandelson to plead for new measures to cap their liability. They warned that British business could be plunged into chaos if one of them were bankrupted by a blockbuster lawsuit.

However, an official of the Department for Business, Innovation and Skills said: “The 2006 Companies Act already allows auditor liability limitation where companies and their auditors want to take this course.”

Under present company law, directors can agree to restrict their auditors’ liability if shareholders approve; however, to date, no blue-chip company has done so. Directors have seen little advantage in limiting their auditors’ liability, and objections by the US Securities and Exchange Commission (SEC) have also been a significant obstacle.

The SEC opposes caps on the ground that their introduction could lead to secret deals whereby directors agree to restrict liability in return for auditors compromising on their oversight of a company’s accounts. The SEC could attempt to block caps put in place by British companies that have operations in the United States.

The big four auditors had hoped to persuade Lord Mandelson to amend the legislation to address the SEC’s concerns and to encourage companies to limit their auditors’ liability.

Peter Wyman, a senior PwC partner, who was involved in the discussions, said that the Government’s lack of action was disappointing. He said: “The Government, having legislated to allow proportionate liability for auditors, is apparently content to have its policy frustrated by a foreign regulator.”

Auditors are often hit with negligence claims in the aftermath of a company failure because they are perceived as having deep pockets and remain standing while other parties may have disappeared or been declared insolvent.

In 2005 Ernst & Young was sued for £700 million by Equitable Life, its former audit client, after the insurance company almost collapsed. The claim was dropped but could have bankrupted the firm’s UK arm if it had succeeded.

This year KPMG was sued for $1 billion by creditors of New Century, a failed sub-prime lender, and PwC has faced questions over its audit of Satyam, the Indian outsourcing company that was hit by a long- running accounting fraud.

Three of the big four are also facing numerous lawsuits relating to their auditing of the feeder funds that channelled investors into Madoff’s Ponzi scheme.

Investors and accounting regulators worry that the big four’s dominance of the audit market is so great that British business would be thrown into disarray if one of the four were put out of business by a huge court action. All but two FTSE 100 companies are audited by the four.

Mr Wyman said: “The failure of a large audit firm would be very damaging to the capital markets at a time when they are already fragile.”

Arthur Andersen, formerly one of the world’s five biggest accounting firms, collapsed in 2002 as a result of its role in the Enron scandal.

Suits you

KPMG A defendant in a class-action lawsuit in the Southern District of New York against Tremont, a Bernard Madoff feeder fund

Ernst & Young Sued by investors in a Luxembourg court with UBS for oversight of a European Madoff feeder fund

PwC Included in several lawsuits in Canada claiming damages of up to $2 billion against Fairfield Sentry, a big Madoff feeder fund

KPMG Sued in the US for at least $1 billion by creditors of New Century Financial, a failed sub-prime mortgage lender, which claimed that KPMG’s auditing was “recklessly and grossly negligent”

Deloitte Sued by the liquidators of two Bear Stearns-related hedge funds that collapsed at the start of the credit crunch

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