Whose Job is it Anyway? Are Auditors Expected to Detect Fraud?

A recent article in The Wall Street Journal details what could be one of the only legal cases from the great recession to actually go to trial. Taylor Bean & Whitaker Mortgage Corp. is suing PriceWaterhouseCoopers LLP (PWC) for $5.5 billion dollars claiming that PWC was negligent in auditing one of their clients. While PWC didn’t audit Taylor Bean, they did audit a bank with which Taylor Bean did frequent business--Colonial Bank (Colonial). Taylor Bean overdrew its accounts with Colonial for several years to cover cash shortfalls, then sold fake pools of mortgages to Colonial in order to cover up the fraud. Taylor Bean claims PWC was negligent in auditing Colonial, and that the collapse of Colonial led to them losing billions of dollars. The real question is how liable should auditors be for detecting fraud?

Elizabeth Tanis, an attorney for PWC, said that PWC did its job correctly and should not be held liable. Further, she added that it is not even an auditor's job to detect fraud. In contrast, in 2007 Dennis Nally, who recently retired as PWC’s global chairman, said that “the audit profession has always had a responsibility for the detection of fraud.” 

Unfortunately for Ms. Tanis and PWC, auditing standards have clearly stated that auditors are responsible for providing reasonable assurance that audited financial statements contain no material misstatements due to fraud (or error). Auditors have long wanted to be exempt from the responsibility of fraud detection. 

However, in this case, the jury will decide if auditors are responsible for detecting a fraud perpetrated by a client's customer. At some point, if auditors don't provide adequate assurance that material misstatements due to fraud do not exist, the market will likely not value audit services much. In my opinion, this age-old question of whether and to what extent auditors are responsible for detecting fraud will be debated as long as auditors keep providing independent services.