If the media and courts paid as much attention to the police force to solve crimes, as much attention given to auditors and corporate frauds, the world may be a better place with less crimes!. This may have also reduced frauds in companies due to good enforcement of the law, when something wrong is detected?
When management and Boards perpetrate frauds, the question arises as to why the auditor did not detect it. However, the auditor was not appointed to detect frauds but to give his opinion based on a set of Standards. He has to be skeptical about ‘what could go wrong’ in the company.
The dilemma is; On the one hand you are not letting him investigate and on the other you are asking him to be skeptical to detect it? How do you expect from him to unearth if he cannot investigate or he is not supposed to be investigative. Where does skepticism end and from where investigation starts?
In the famous case Re: Kingston Cotton Mills Co. (1896), Lord Justice Lopes defined an auditor’s duty of care as follows:
“It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution which a reasonably careful, cautious auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective, or, as was said to approach his work with suspicion, or with a forgone conclusion that there is something wrong. He is a watchdog, not a bloodhound. He is justified in believing tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest and rely upon their representations, provided he takes reasonable care.”
However, in the later case Fomento (Sterling Area) Ltd. v Selsdon Fountain Pen Co. Ltd. (1958), Lord Denning put it this way:
“To perform his task properly he must come to it with an enquiring mind – not suspicious of dishonesty – but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none.”
There has been a gradual metamorphosis in an auditor’s duty of care, since then. It is no longer sufficient for an auditor to rest upon the honesty and accuracy of others. Therefore, skepticism was included in the Standards with some definitive actions required during an audit. However, the Central Banks around the world, have been effectively transforming the role of the modern auditor of banks and financial institutions from that of “watchdog” to “bloodhound”. This is more thru self interest where they are unable to regulate properly, it’s easier to pass the buck to the auditor. Whereas, if the banks were well regulated, could they have noted any non compliance and taken action, to prevent a collapse?
The heart of the matters is, while investors want to know if a company is well run or not, in practice it is not feasible for the auditors to be responsible for saying that a company is poorly run. You need to employ someone else for this purpose!
However, in companies, where good boardroom governance practices are implemented with good internal audit and risk management systems, there is great appreciation for the feedback given by auditors. They want auditors to play the role of a watchdog and when issues are highlighted, they act immediately and don’t look for excuses.