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For decades, investors have complained about how rarely external auditors uncover corporate fraud. From Enron to Wirecard, the question after every scandal is: Where were the auditors? The Association of Certified Fraud Examiners’ biennial report on how fraud is detected in the workplace showed that auditors are typically the ones who detect wrongdoing only 4 percent of the time.
Bad news. The most recent report a few weeks ago said the number had fallen to 3 percent. Whistleblower hotlines and other internal controls may have helped some companies detect wrongdoing earlier on their own, but what if management is the perpetrator or the company culture is poor? An investor survey by the Center for Audit Quality, a professional group for major accounting firms, found that 57 percent said the current system “often” fails to detect illegal actions.
Regulators fear auditors are failing in their role as investors’ last line of defense against corporate fraud. Accounting firms argue that companies’ managers are responsible for the accuracy of financial statements and that an auditor’s role is only to provide reasonable assurance – not a guarantee – that financial statements are free from material misstatement.
It’s an argument that has led the Securities and Exchange Commission’s chief accountant, Paul Munter, to exclaim to me more than once that he is tired of hearing what auditors say not Do.
However, there are now a number of proposals to clarify and expand auditors’ responsibilities. In the United States, the Public Company Accounting Oversight Board is revising rules on how auditors must search for and deal with evidence of a client’s noncompliance with laws and regulations (known as “Noclar”). The intent is to force auditors to cast a wider net on matters that could have a material impact on a company’s finances, even indirectly, by resulting in large fines or regulatory action that jeopardizes the business.
Accounting firms have responded that they cannot be expected to make legal judgments and that the enormous additional burden imposed by the Noclar proposal in its current form is unlikely to uncover anything material that the current procedures do not already do .
A narrower proposal in the UK – which would mean auditors would not have to review every minor law or regulation and could use management’s own compliance programs as a starting point – has drawn an almost equally vocal range of opposition statements.
The latest move comes from the International Auditing and Assurance Standards Board, which sets rules that are used as a template by numerous countries around the world. She has proposed tightening fraud detection standards to emphasize that auditors must look for financial misstatements that may not be “quantitatively material” but are “qualitatively material,” depending on who instigated the fraud and why it was committed became.
The emergence of all these proposals is not a coincidence, and it is not that the accounting firms themselves do not see room for improvement. PwC promised last year that it would overhaul its fraud detection procedures and take a closer look at its clients’ whistleblower programs, among other reforms to improve audit quality. PwC boss Tim Ryan tried to get all Big Four companies to agree on these issues, but failed.
Other executives still talk about an “expectations gap” between what investors expect of an audit and what it really is, as if it were the investors who needed to be trained, not the profession that needed to change.
An alternative response to some of the current proposals would be to introduce them to strengthen the position of auditors. They provide a new justification for tracking down client trades, fighting back against hostile CFOs and CEOs, and highlighting more matters of concern to directors, investors or the authorities – delivering on the very professional skepticism at the heart of the CFO’s creed Auditors. There is also room for agreement on the controversial Noclar proposal.
Even better for accountants, there is evidence that investors are willing to pay for a more comprehensive service. The CAQ survey found that a majority would favor auditors charging an additional surcharge of 20 percent or more to cover the additional work in remediating violations.
A high-quality audit is sometimes referred to as a “credibility asset” because its value is difficult to calculate. But as the shareholders of Enron, Wirecard, and countless others will tell you, the costs of a bad audit can be much higher.