Financial Statement Fraud: Strategies for Detection and Investigation

CHAPTER TWENTY

Assessing (or Minimizing) Auditor Liability

ONCE IT HAS BEEN DETERMINED that the financial statements contain a material misstatement, two important questions must be asked:

1. Was the misstatement an intentional act of one or more individuals in management (as discussed in Chapter 19), thereby making a case for fraud?

2. Do the auditors of the financial statements have liability for failing to detect the misstatement in connection with their audit?

In this chapter, the issue of assessing auditor liability in financial statement fraud cases is addressed. The goals of this chapter are as follows:

• Provide guidance to auditors to help them minimize the risk of successful auditor liability claims by performing better audits
• Provide guidance to investigators in assessing whether auditors have failed to perform an audit that fulfills professional responsibilities

Auditors are required to exercise professional skepticism in performing an audit. This is described as having a questioning mind and a critical assessment of audit evidence. As it relates to the potential for fraud, auditors are instructed to neither assume that management is dishonest nor to assume unquestioned honesty.

LITIGATION AGAINST AUDITORS

Potential plaintiffs in litigation involving cases in which auditors failed to detect a material misstatement in the audited financial statements include the following:

• Initial and subsequent purchasers and sellers of stock (either in cases involving publicly ...