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Auditors have a duty to be alert to fraud

Friday 3rd July 2020

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There is no shortage of lessons to be drawn from the collapse of Wirecard, the German payments company and once Europe’s most valuable financial technology group. Many of the exact details of what went on have yet to be unravelled, but the sorry tale demonstrates one thing clearly: reform of the audit profession is long overdue. 

In the case of Wirecard’s auditors, EY, it appears the accounting firm failed to conduct certain basic checks, including carrying out routine procedures to verify the German company’s bank balances for at least three years. The firm has countered that “third parties, with a deliberate aim to deceive” had provided it with false documentation during its audit of Wirecard’s financial statements. That may be so, but relying on documents and screenshots provided by a third-party trustee and Wirecard itself, instead of obtaining independent confirmation, is a very thin excuse. The impression is of a culture that encouraged the ticking of boxes rather than any genuine inquiry. 

The scandal gives greater urgency to calls for a new purpose for audit, in particular whether auditors should be responsible for detecting fraud. The profession has long argued that it is a watchdog, not a bloodhound, and that directors bear responsibility for stopping fraud. 

That line, however, has often been too tightly drawn. Donald Brydon, the former chair of the London Stock Exchange, last year set out recommendations to overhaul the profession. Among these was making clear that auditors have an obligation to find fraud. Auditors, he suggested, should “endeavour to detect material fraud in all reasonable ways”.

This would be a step in the right direction, and a welcome intrusion of common sense. Auditors need to be diligent. They should put in place checks to minimise the possibility of fraud going undetected. This may not be enough to stop the most determined effort on the part of a devious management, but Sir Donald is not talking about making auditors into Sherlock Holmes. What he is advocating is sensible accountants who cannot easily have the wool pulled over their eyes. In the case of Wirecard, the questions raised over its accounting should have offered EY enough red flags to provide, at the very least, a basis for questioning. 

Sir Donald also recommends changing one of the central duties of the auditor: the requirement in company law to exercise judgment on whether a company’s accounts present a “true and fair” view of its affairs. This should be changed to assure accounts present a company’s situation “fairly in all material aspects”. 

The industry needs to address the inherent conflict of interest in its structure. Audit firms are hired and paid by the companies they are meant to audit. There is an added conflict for the Big Four firms in that their advisory and consulting arms provide lucrative work to the very same companies that are audit clients. This has led to the role of auditing being downgraded. The UK regulator has also asked these firms to voluntarily ringfence the costs and profits of their audit work but progress on this has drifted in the wake of the coronavirus pandemic. There is also a case for greater scrutiny of companies’ audit committees. 

There is no guarantee that the Wirecard scandal would not have happened had some of these reforms already been in place. Improving the quality of audit will also require cultural, not just structural change. The coronavirus pandemic has put companies’ balance sheets under intense strain. The need for trustworthy auditing is greater than ever. 

Source: Financial Times 

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