The audit report for General Employment Enterprises, Inc. (GEE) for the 2009 fiscal year was performed by independent auditors, BDO Seidman, LLP, and was released in January 2010. The audit documents that the net revenues of the company had dropped by 32% compared to 2008. There was also a considerable decrease of 15% in the company’s spending on selling, general, and administrative expenses compared to the prior year.
Income from investment also fell, amounting to a total loss of $50,000. As a result of this decline in business revenue, the company’s assets decreased by $1,695,000. The biggest loss was in the form of cash and cash equivalents, where the assets decreased by $1,355,000, and the total liabilities and shareholders’ equity of the company declined by over 33%. The overall losses in revenues and current assets can be attributed to the economic crisis of 2008, which resulted in the reduction of demand for the company’s services. The audit report contains all the relevant financial information that can be provided to third parties as proof of the company’s business activities, profitability, and financial management.
Liabilities to Third Parties
The actions of BDO make the company liable to third parties under both the Common Law and the Federal Law of Securities. In the present case, under the Common Law, BDO owes a duty of care to the following categories of entities: auditors’ clients, third-party beneficiaries, and prospective third-party beneficiaries (Baker & Prentice, 2008). The main Federal Law applying to BDO, in this case, is the Security Act of 1934 (Baker & Prentice, 2008). Under Section 10A of the Security Act of 1934 (2011), the firm is subject to a civil penalty, whereas, under Section 21C, BDO would also be subject to a Cease-and-Desist Order, which may require it to freeze its activities temporarily and prohibit workers responsible for violations from further audit work (permanently or temporarily).
Auditing Standards, Ethics & the Auditor’s Liability
The GAAP (2006), effective December 15, 2001, outlines the basic auditing standards that should have been applied in BDO’s activities. The standards include reporting suspicious activities and clearly indicating the inadequacy of unjustified financial information in the report (GAAP, 2006); these requirements were clearly violated by the BDO. Regarding auditing ethics, objectivity must be at the core of any independent auditor’s work. Audits are designed to promote transparency and ensure the identification of cases providing misleading financial information and fraud. Falsified or misleading information can harm current and prospective beneficiaries, as well as the shareholders of the company who rely on audit reports.
Therefore, the auditors that do not report possible fraud cases breach official standards for work, as well as auditing ethics, and are partly liable to third parties for any damage incurred by entities who relied on their report. However, the auditors’ liability is limited under the Security Act of 1934 (2011), as they are not deemed responsible for the audited firm’s fraudulent actions, but only for not complying with the reporting and investigation standards.
Management vs. Auditor Responsibility
The company’s management is responsible for providing transparent, current, and reliable financial information, which can be used by clients and shareholders to assess the company’s performance. Auditors, on the other hand, are responsible for ensuring that the information is indeed transparent and to report any suspicious activities to the Commission. I believe that, in this case, the management of the company should be held responsible for the fraud itself; however, auditors should have a greater burden as they breached both their official standards of work and professional ethics.
The Sarbanes-Oxley Act
One of the main provisions of the Sarbanes-Oxley Act (SOA) was the establishment of a separate body to govern the activities of external auditors (EY, 2012). This improved control over auditors and increased their liability in the cases of potential non-compliance. The Act also prohibited auditing firms from providing certain services to clients, such as financial information systems design and implementation, appraisal or valuation services or fairness opinions, and internal audit outsourcing services (EY, 2012).
Overall, the provisions of the Act enhanced accountability improved oversight and governance and granted better transparency of audit services. Under the SOA (2002), the audit firm would be subject to investigation and disciplinary procedures, including sanctions, such as suspension or firing of any persons involved, temporary registration suspension, limitation of the company’s activity, and civil monetary penalties.
Conclusion: Proposed Action
In the present case, it is evident that the auditor overseeing GEE’s financial statements concealed the suspicious information intentionally, which is a severe violation of both the law and the auditing standards. I believe that the appropriate line of action should begin with an investigation to determine the involvement of individual persons in the illegal act, as well as to determine conclusively whether the misconduct was indeed intentional. Based on the results of this investigation, I believe that any subsequent action should include the consideration of the application of a full range of sanctions available, outlined under the SOA (2002).
One of the sanctions that could be applied to BDO is the suspension of individuals who were proven to be directly implicated in the violation of the accounting and auditing activities (SOA, 2012). This action would prevent further violations. The suspension, in this case, may be temporary; however, depending on the results of the investigation, the company may have to fire the auditors that participated in the audit of GEE if their fault is greater than anticipated. For instance, if the investigation found that the reversal of the investigation claim was due to the bribing of the auditor, the said employee should be banned from future work in auditing to prevent future cases of misconduct.
The second sanction under the SOA (2012) is the revocation or suspension of the company’s registration. Similarly, the severity of the sanction under the SOA (2012) depends on the degree of BDO’s involvement with the violation and knowledge of GEE’s suspicious activities. For example, if BDO was aware of the fraud in the company and withheld the information from the legal authorities and the Commission, the firm could lose its license permanently.
Another possible sanction is the limitation of the company’s activities or certain functions (SOA, 2002). Both the temporary registration suspension and the limitation of the company’s activities would give management the time needed to determine the sources of internal non-compliance and solve the issues, as well as to provide additional training to staff that would help avoid similar situations in the future.
Finally, the violation of the reporting and investigation requirements by BDO should incur a substantial monetary penalty under the SOA (2002). The size of the fine is dependent on the results of the investigation and may range from under $100,000 to $15,000, depending on the involvement and intent of the responsible auditor (SOA, 2002). A combination of these sanctions would ensure appropriate future control of individual auditors by the management, leading to fewer cases of misconduct, as well as helping the firm to re-establish its reliability and reputation within the accounting market.
References
Baker, C. R., & Prentice, D. (2008). The origins of auditor liability to third parties under United States common law. Accounting History, 13(2), 163-182.
Generally Accepted Auditing Standards (GAAP). (2006). Web.
Sarbanes-Oxley Act (SOA). (2002). Web.
Ernst & Young LLP (EY). (2012). The Sarbanes-Oxley Act at 10: Enhancing the reliability of financial reporting and audit quality. Web.