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Abstract

Eighty-seven percent of managers recently surveyed were willing to commit financial statement fraud. More than half were willing to overstate assets, forty-eight percent were willing to understate loss reserves and thirty-eight percent would "pad" a government contract. These disturbing results are underscored by the financial miseries still brewing in the savings and loan industry, as well as by other corporate and banking financial debacles of the past decade, including Lincoln Savings & Loan, Wedtech, and the Delorean sports car venture scandal. Amidst these financial ruins we find the chronic element of management fraud. Unfortunately for investors and depositors a troublesome number of these financial disasters have followed a "clean bill of health" from the company auditors, thus leaving investors, depositors, and creditors looking on in despair. As the investing public labors over its lost investment and nervously contemplates its next move, one question inevitably comes to mind: Who is watching over the financial statements of corporate America? More precisely, where are the auditors? The investing public has long expected and relied upon the independent audit to uncover and disclose employee embezzlement and fraudulent reporting by management. Certified public accountants (CPAs) who perform these audits, however, have traditionally refused to accept primary responsibility for providing this needed service. Indeed, the auditing profession has consistently sought to limit its responsibility and liability in this area by establishing auditing standards that place substantial restrictions on the auditor's duty to detect fraud. CPAs maintain that these self-imposed auditing standards define the contours of their responsibilities, and thus the degree to which the public can rely upon the audit to reveal fraud. According to CPAs, as long as a CPA has performed the audit in compliance with generally accepted auditing standards (GAAS) and the financial statements were presented in accordance with generally accepted accounting principles (GAAP), the CPA's responsibilities have been fulfilled. Thus, many in the auditing profession maintain that the professional standards provide a safe harbor for auditors, permitting CPAs who faithfully comply with the professional standards to effectively immunize themselves from liability. The extent to which CPAs can actually insulate themselves from liability has been the subject of much heated debate, a debate that is likely to resurface with the 1989 promulgation by the American Institute of Certified Public Accountants (AICPA) of Statements On Auditing Standards (SAS) No. 53, The Auditor's Responsibility to Detect and Report Errors and Irregularities. SAS No. 53 is the latest in a series of auditing standards that attempt to define the CPA's responsibility for detecting fraud, and represents the culmination of an intense effort by the AICPA to stem a growing tide of public criticism and suits against auditors. SAS No. 53 differs from prior auditing standards on management fraud by acknowledging for the first time that an auditor has an affirmative obligation to detect fraud. Under SAS No. 53 the CPA must now design the audit to provide reasonable assurances of fraud detection.
The AICPA undoubtedly hopes that courts will, in time, apply SAS No. 53 as the measure of liability for CPAs when they are sued for failing to detect or disclose management fraud, thereby providing auditors with a safe harbor and some certainty in this volatile area of auditor liability. Lawyers who represent CPAs will soon be asked to advise their clients on whether CPAs can fortify themselves against liability by complying with this new standard. This Comment endeavors to provide guidance by ascertaining the evidentiary role SAS No. 53 is likely to play in future malpractice suits.

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