Charlie Welch

Dr. Cornell
Managerial Accounting
1/14/13
Memo #1
Thieves are running rampant in corporate America. We wouldnt think of our co-workers,
or even our boss, of being would-be criminals, but the number of fraud cases over the last decade
has risen dramatically. For example, 2004 and 2005 saw the number of financial misstatements
nearly double from 616 to 1,195, making up about 8.5% of all publically traded companies
(Apostolou). In another development, these publically traded companies are required by the SEC
to undergo a financial review every year by third-party entities known as auditors. A debate rages
on whether these auditing firms have legal responsibility on detecting and reporting the fraud or
not. One thing is certain, these auditors have a responsibility to plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement, whether caused by error or fraud, according to the Public Company Accounting
Oversight Board, or PCAOB, AU section 110.02 (Apostolou).
So should auditors be legally responsible for detecting fraud in client companies?
According to observers of the PCAOBs appointed advisory groupa group commissioned to
clarify the duties and limitations of auditorslike Andrew Bailey, University of Illinois
accountancy professor emeritus, think they should be held responsible. If the discovery of
material errors and fraud is not a major part of what the audit is about, it is not clear what valueadded service the auditor offers the investor and capital markets, Bailey stated (Johnson).
Investors want to know that their investments are smart and safe. If the companies are able to get
away with questionable accounting, how are public investors going to make safe investments
without the potential of getting screwed? Investors want to know where the high risks are,

said Mary Hartman Morris, an investment officer of the California Public Employees' Retirement
System (Johnson). If auditors arent going to be the authority reviewing the authenticity of
companies financial statements, who is going to detect the fraud present in many companies?
So again, should auditors be legally responsible for detecting fraud in client companies?
New York says no. In 2010, the appeals courts of New York ruled that auditors of New York can
not be held liable for companies who knowingly commit acts of fraud and other forms of
financial misstatements, regardless of the auditors role in the fraud or their irresponsibility in
detecting it (Gaetano). In one of two New York cases, an employee retirement system of school
districts and the city of New Orleans filed with AIG, leading to the officers misstating funds, and
making investors think that the company was performing better than reality (Gaetano). While the
auditing firm, PricewaterhouseCoopers, was not apart of the fraud, they failed to detect the fraud
and should have been held liable, according the plaintiffs (Gaetano). On one hand, it seems a
little odd that Auditors, government-ordained firms that provide services required by the federal
law, are not responsible for detecting or reporting the very problem of financial misstatements
they work to solve. On the other hand, the judges majority opinion in Cenco, Inc. vs. Seidman &
Seidman brought about an interesting point on the whole debate; if the owners of the corrupt
enterprise are allowed to shift the costs of its wrongdoing entirely to the auditor, their incentives
to hire honest managers and monitor their behavior will be reduced (Gaetano).
Looking at the evidence, why cant both entities be responsible? Of course the
corporations should be setting internal controls that disallow the misstatements and illegal
corrections to occur in the first place. But the auditors need to report the fraud and be liable if
that they fail to do so. As Professor Bailey stated above, what real service are auditors
performing if they have no repercussions for failing to report fraud, especially if the fraud is

hurting investors? The Latin term in pari delicto, meaning in equal fault, perfectly describes
the situation (Gaeteno). While auditors should not be liable for the entire amount of the value
forged, there should be some system of consequences for firms failing to detect and report the
fraud, maybe a percentage of the amount. While the AU 110.02 clearly states that it is the
responsibility of the auditors to obtain reasonable assurance that the finances are free of
misstatement, many auditors use this same statement to claim ignorance. If fraud were so well
hidden in a companys records that the auditor is unable to find it, wouldnt he have reasonable
assurance that there was no fraud present? After all, we are just human, and it is in our nature to
make mistakes.
In conclusion, fraud is a very prevalent problem in corporate America, today. Criminals
within organizations are able to get around internal controls and hide the adjustments from the
companies and auditors. They can steal millions if not billions of dollars in stolen loot. In
instances where the company itself is unable to detect that it is being stolen from or looks the
other way when the theft is occurring, auditors are the next line of defense. But should auditors
be legally responsible for detecting fraud in client companies? Some, like Andrew Bailey say
yes, while the state of New York says no. In a professional opinion, this author feels that both
entities are in pari delicto. Both should be held responsible; the company for false financial
documentations and the auditor for failing to help protect the public investors. All in all, this
debate shows just how the ethics of business are constantly being tested.

Works Cited
Apostolou, Nicholas, and D. Larry Crumbley. "Auditor's Responsibilities with Respect to Fraud:
A Possible Shift?" Nysscpa.org. N.p., Feb. 2008. Web. 14 Jan. 2013.

Gaetano, Chris. "New York Courts Exclude Auditors from Being Held Liable for Corporate
Client Actions." New York Courts Exclude Auditors from Being Held Liable for
Corporate Client Actions. N.p., 18 Nov. 2010. Web. 14 Jan. 2013.

Johnson, Sarah. "What Is the Auditor's Role in Finding Fraud?" CFO.com. N.p., 13 Apr. 2010.
Web. 14 Jan. 2013.