Jack Ciesielski's Analyst's Accounting Observer (AAO) blog draws our attention to a piece in the Wall Street Journal about a "liability cap" agreement between Sun Microsystems and its auditor Ernst & Young.

The WSJ piece is available only to subscribers so here's a basic run-down: the liability cap contained in Sun's proxy statement says that the agreement is "subject to alternative dispute resolution procedures and an exclusion of punitive damages." Translated that means if Sun runs into accounting problems and believes that Ernst & Young botched the audit, it can't sue the firm. Instead, it has to take it through mediation and arbitration. Also, it can't seek damages beyond the actual, compensatory damages related to Ernst's conduct.

These sorts of sweetheart arrangements have been in place for some time but some are now coming to light in proxies. According to the WSJ, they are now becoming more popular. It cites reports that KPMG and Deloitte & Touche have included similar caps in their agreements.

But here's the problem: audit agreements between companies and auditors are not public documents. As a result, they get under the radar of investors. The question is whether all this is in shareholders' interests. Exactly whose interests is the company looking after?

Post Andersen, it's not difficult to see why accounting firms want these caps. Adelphia Corp has sued Deloitte & Touche and Ernst & Young has had a legal battle with HealthSouth Corp.

But it's not necessarily in the interests of their clients or shareholders. And don't ask the audit committee. As Lynn Turner, the departing chair of Sun's audit committee and a former Securities & Exchange Commission chief accountant told the WSJ: "Since all four accounting firms are demanding the companies include these liability cap clauses in their contracts audit-committee chairs, including myself, are faced with a fait accompli when asked to sign them." Or as Ted White, deputy director of the Council of Institutional Investors put it: "How do we find out how widespread this is? We're not even convinced that audit committees necessarily know about this."

Ciesielski says that while these are not at first blush great for investors, they might put pressure on companies to produce high quality financial reports. But he concedes, it's a slim straw to grasp. Thoughts?