Role of External Auditor Examined
Washington, D.C. – A new research report issued today examines auditor involvement in fraudulent financial reporting cases cited in U.S. Securities and Exchange Commission (SEC) enforcement actions issued from 1998-2010. During the 13-year period, there were 87 sanctions against external auditors in SEC fraud investigations involving publicly traded companies. Approximately 9,500 entities file financial statements with the SEC on an annual basis.
An Analysis of Alleged Auditor Deficiencies in SEC Fraud Investigations: 1998 – 2010 highlights insights for the audit profession related to the 87 instances of alleged auditor deficiencies involving fraudulent financial reporting. The study notes that 11 of the 87 cases involved fraudulent reporting in periods of 2003 or later, which represents years following the passage of the Sarbanes-Oxley Act (SOX) in July 2002. There is a time lag between when an infraction occurred and when the SEC releases an enforcement action, thus the number of deficiencies is subject to change.
“The auditing profession, the CAQ and our member firms have been, and continue to be, actively engaged in efforts to mitigate the threat of fraud, which is why we commissioned this study,” said Center for Audit Quality (CAQ) Executive Director Cindy Fornelli. “I believe the fact that SEC allegations of financial reporting frauds are rare, albeit serious, events and that the large majority do not involve sanctions against public company auditors is noteworthy. Our first concern is investor confidence in the credibility of the capital markets. It is important that public company auditors and other members of the financial reporting supply chain take their responsibilities in this regard seriously and commit to seizing opportunities for improvement.”
Among the 87 instances examined, the size of the public companies involved was small, with median assets and revenues under $40 million, and the companies span a number of industries. The public company auditing profession commissioned the study in an effort to provide a critical look for auditors and others concerned with improving audit quality and the detection of financial statement misstatements due to fraud.
The study identifies the root cause issues related to audit deficiencies involving fraudulent financial reporting cases citing the auditor and contains a number of insights to enhance understanding of the audit process and strengthen the execution of procedures performed to lower the incidence of undetected fraudulent financial reporting. In recent years, the CAQ and the profession have pursued efforts that address a number of the opportunities for improvement identified in the study. The primary deficiencies cited by the SEC relate to audit evidence, due professional care, skepticism, management representations, and the audit opinion.
The CAQ’s related initiatives and projects include the funding of academic research on professional skepticism and financial reporting fraud deterrence and detection; the 2010 publication Deterring and Detecting Financial Reporting Fraud – A Platform for Action; and the Anti-Fraud Collaboration – a major, ongoing combined effort launched in 2010 by the CAQ, Financial Executives International, The Institute of Internal Auditors and the National Association of Corporate Directors. Key resources published by the Anti-Fraud Collaboration to enhance fraud deterrence efforts include the Hollate Manufacturing Case Study, which examines a potential material fraud at a fictional company to raise awareness of environments in which financial reporting fraud might flourish; and the Skepticism Webinar Series, which highlights the importance of skepticism as applied by external auditors, financial executives, internal auditors and audit committee members.
The new report’s research was compiled by professors Mark S. Beasley of North Carolina State University, Joseph V. Carcello of the University of Tennessee, Dana R. Hermanson of Kennesaw State University, and Terry L. Neal of University of Tennessee. The CAQ commissioned the research from the professors because they had previously authored the foundational research report Fraudulent Financial Reporting: 1998 – 2007, An Analysis of U.S. Public Companies, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in May 2010.
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The Center for Audit Quality (CAQ) is an autonomous public policy organization dedicated to enhancing investor confidence and public trust in the global capital markets. The CAQ fosters high quality performance by public company auditors, convenes and collaborates with other stakeholders to advance the discussion of critical issues requiring action and intervention, and advocates policies and standards that promote public company auditors’ objectivity, effectiveness and responsiveness to dynamic market conditions. Based in Washington, D.C., with an office in New York, NY, the CAQ is affiliated with the American Institute of Certified Public Accountants. For more information, visit www.thecaq.org