Fraud lessons

Everyone loves a scandal. But once the hue and cry is over, there is much for auditors and accountants to learn, says John Knox

The last decade has not been short of fraud cases. Some have dominated the headlines for weeks. But there has been little reflection of these events in the guidance given to their members by the accountancy bodies.

However, both the Audit Faculty of the Institute of Chartered Accountants in England and Wales and the Auditing Practices Board have begun to address the matter. The former has suggested that the accountancy profession "should develop guidance on the application of the fraud auditing standards based on case experience of recent years". The latter proposed in February to "consider the implications of major cases of fraud that have arisen in recent years".

This seems an obvious step. Why then has it not been a continuous process?

Part of the explanation lies in the change in the mechanism for investigation of fraud. In the two decades before the establishment of the Serious Fraud Office, major City scandals were usually met with the appointment of inspectors by the Department of Trade and Industry under sections 431 or 432 of the Companies Act or preceding legislation. Now this is more of a rarity. The scope of such DTI inquiries is broad. Although the terms of reference have been drawn more tightly in recent years, the inspectors can range over the whole subject matter of the scandal.

Moreover, the reports of the inspectors are usually published, unless criminal proceedings are pending. In the past they have been highly influential in bringing about improvements in regulation and professional practice.

The Vehicle and General and the Grays Building Society inquiries of the early 70s led to changes in the regulation of insurance companies and building societies respectively.

Other reports from the 1970s included comments directed at the role of the auditors, with firms or individuals coming in for sharp criticism.

Such comments led to counter-criticism of the inspection system for allowing the inspectors too much freedom to make injurious comments on a privileged basis without proper right of reply. There were other drawbacks. The work of inspectors might need to be halted while any suspected criminal offences they have uncovered were investigated by the police. Now the DTI tends to use fewer public powers and the SFO takes the lead where it appears at the outset of a new scandal that possible criminal conduct lies at its heart. These changes go a long way towards remedying the defects identified.

But the criminal investigation is not intended to cover the whole range of problems which are part of City scandal. Even the totality of alleged criminal conduct is not generally revealed, since those offences that are brought to court are necessarily a segment of the whole.

To be fair, the SFO drew some lessons from case histories in its annual report for 1996. "Accountants should be aware that there are many fraudsters around who want to persuade reputable auditors to sign off what are in fact totally bogus accounts." "Proper audit and other controls need to be put in place to detect any unusual patterns of conduct at an early stage." These comments, banal though they are, illustrate that the lessons are often obvious but need to be repeated. However the SFO has not the expertise to tell auditors how to do their jobs.

Similarly other investigations such as the Bingham inquiry into the role of the Bank of England in the BCCI affair, or the parliamentary committee inquiry into pensions, are not focused on the lessons for auditors.

Disciplinary inquiries, which have also had more prominence since the establishment of the Joint Disciplinary scheme, are of greater relevance, but even they have no direct educational role.

It will not be easy for the profession to draw these strands together. Civil litigation continues to grow and with it concern about auditors' liability. Those facing such litigation will not be happy to see guidance given to auditors that can be related to a case in which they are involved, even if the guidance is an evolution from previously accepted best auditing practice. This, rather than the need to gather information from different sources, may be the real challenge facing the professional bodies

The author is the former deputy director of the Serious Fraud Office and a consultant to accountants Pannell Kerr Forster

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