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The Securities and Exchange Commission (SEC) thinks auditors are crucial in the fight against fraud. Auditors who inform stakeholders otherwise risk incurring the wrath of the agency during subsequent enforcement actions.
In a statement released on Tuesday, Paul Munter, the SEC's acting top accountant, emphasized the role auditors play in preventing fraud and mentioned recent findings of inadequacies in the field made by his office. Munter called this practice "particularly troubling," noting that auditors often frame explanations of their duties linked to fraud by outlining what they are not obligated to do rather than what they may offer.
He stated: "We find this attitude of focusing on the limits of the auditor’s responsibilities at the outset as opposed to the affirmative requirements with respect to the responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement, whether caused by error or fraud, deeply concerning, as it could impact an auditor’s mindset or their degree of professional skepticism and may thereby reduce the likelihood of fraud detection and potentially result in dereliction of professional responsibilities to the public trust."
External auditors have a troubled history of embracing their responsibility to reveal misconduct. Regulators have given the issue greater attention recently, with the German Wirecard fraud crisis providing as an example where the auditor, EY, was criticized for not doing enough to detect the misbehavior.
According to Munter's statement, auditors must maintain appropriate professional care and skepticism throughout an audit in accordance with Public Company Accounting Oversight Board (PCAOB) standards. Defects in these areas are frequently found by the PCAOB in its examinations. Auditors frequently overlook warning signs and do not gather enough audit evidence, which the SEC charged accounting firm Friedman with in a $1.5 million enforcement action last month.
Munter suggested the following effective procedures to prevent SEC scrutiny and guarantee compliance with PCAOB rules linked to finding substantial misstatements as a result of fraud:
1. Avoid utilizing auditing standards examples of fraud risk factors as a comprehensive checklist. According to him, audit answers "should be tailored to the identified fraud risk and dynamic to changing business environments."
2. When conducting an audit, take into account information that is open to the public and examine how it affects risk assessment and the audit response.
3. Invest time and money into evaluating the entity-level controls of the issuer. Munter noted that auditors should also review a company's code of ethics. "This would include assessing whether the organization demonstrates a commitment to integrity and ethical values," Munter said.
4. Check that business whistleblower hotlines are properly established and are not merely a box to be checked.
5. Examine the issuer's methodology for determining its own fraud risk.
6. Use technology to help in fraud investigation. "[R]emember that the use of technology is most effective when combined with sound professional judgment and other audit procedures that do not lend themselves to the use of technology," advised Munter.
Additionally, Munter counseled auditors to approach their work with a "questioning mind" and to "set aside any prior beliefs about management's honesty and integrity." Biases make it more difficult for auditors to determine whether detected misbehavior was purposeful or accidental.
Invoices for sizable sums with ambiguous descriptions, invoices from related parties with descriptions outside the ordinary course of business, or materials provided by management in the closing stages of an audit to address a potentially complex or contentious issue are examples of suspect forms of evidence, according to Munter.
He advised auditors to use the necessary amount of professional skepticism, avoid making any assumptions about the truth, and be aware of any potential unconscious biases.