Financial reporting frauds have historically occurred in waves and sometimes in tidal waves as in the period of Enron, Worldcom, Tyco, Adelphia, Quest, etc.  When economic times turn challenging or become uncertain, fraud frequently increases.

Given the time since a major wave of financial reporting frauds and the current economic environment, it may not be a coincidence that Paul Munter, the SEC’s Chief Accountant, released a Statement titled “The Auditor’s Responsibility for Fraud Detection” on October 11, 2022.  (At that time Mr. Munter was Acting Chief Accountant.)

In the Statement, Mr. Munter focuses on the auditor’s gatekeeper responsibilities as they relate to financial statement fraud.  The Statement discusses detailed considerations in a number of areas, including the auditor’s role and responsibilities; the importance of a strong system of quality controls, risk assessment and responses; and good practices.

Mr. Munter’s Statement begins with an important reminder about the nature of the auditor’s role:

“Auditors must plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.”

In addition, the Statement highlights that:

“The PCAOB auditing standards further require auditors to exercise due professional care, which requires the auditor to exercise appropriate levels of professional skepticism [emphasis added] throughout the audit.”

With respect to the auditor’s responsibility, after noting several auditing standards that include fraud considerations, Mr. Munter goes on to say:

“We emphasize that the auditor’s risk assessment and use of the fraud lens is a continual and iterative process that continues until the issuance of the audit report.”

The Statement includes an important point concerning an auditor’s quality control system, which is that budget, time, and other kinds of pressure could distract an auditor from appropriately identifying fraud risk.

In his discussion of risk assessment and responses, Mr. Munter emphasizes the importance of professional skepticism, noting:

“For instance, the mindset of ‘trust but verify’ may represent potential bias if it is anchored in the belief that management is honest and has integrity. Such a mindset may interfere with an auditor’s ability to effectively evaluate signs of fraud when evaluating misstatements or to objectively challenge evidence provided by management.”

With respect to appropriate “good practices,” the Statement notes that examples of fraud risk factors in the auditing literature should not be considered a checklist.  Rather, they should inform the process of building a tailored list of fraud risk factors for each engagement.

This “early warning” Statement, which addresses many other important fraud related issues, is likely based on a desire to get out in front of any incentives that could result in increases in fraud in coming periods.  It may also inform parts of the PCAOB inspection process.  Auditors and companies should begin incorporating its points in their year-end planning now.

As always, your thoughts and comments are welcome!