Fraud Specialists On Independent Audits

Abstract

The recent audit failures involving Enron, WorldCom, et al., have left the accounting profession and governmental regulators scrambling to find better methods of detecting and preventing fraudulent financial reporting. Congress passed the Sarbanes-Oxley Act of 2002 (SOX) which requires companies to report on the operating effectiveness of their internal controls over financial reporting.  Additionally, the independent auditor is required to assess and report on the effectiveness of their client’s internal controls, and they must attest to management’s internal control assessment.  Notably absent from SOX is a requirement that independent auditors must employ fraud specialists in their independent audits of SEC filers.

This study examines the benefits and costs associated with requiring the use of fraud specialists on independent audits of SEC filers.  Fraud specialists have expertise better attuned to fraud detection not ordinarily possessed by regular auditors.  First, the narrow but deep perspective of the fraud specialist enables them to find fraudulent activity that would be missed by regular auditors.  Second, unlike regular auditors, fraud specialists employ methodologies that are effective in the presence of management collusion.  They are more highly skilled at interviewing potential witnesses and fraud suspects and are trained in recognizing deception.  Third, fraud specialists are better trained in the use of antifraud technology, methods, and computerized forensic accounting software.  Fourth, fraud specialists have superior investigative skills and can conduct covert examinations, access restricted databases, conduct background checks, and locate hidden assets better than regular auditors.  Finally, they understand the legalities of gathering evidence of fraud and can operate without violating the rights of potential witnesses and fraud suspects.

Qualitative analysis demonstrates that utilizing fraud specialists on independent audits has positive net benefits to financial reporting.  Recommendations are made regarding the types of fraud detection/deterrence skills and techniques that would be beneficial to independent auditors.