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Audit role in finding fraud needs revamp

The halls of regulators and law enforcement agencies around the world appear to be full of government officials investigating cases of bribery and corruption.

In China, there are allegations involving pharmaceutical companies and information brokers, and in the UK, we are still seeing the fall-out from the Libor scandal involving some of the world’s most respected financial institutions.

In Australia, even our central bank, the Reserve Bank of Australia, is embroiled in a corruption scandal involving the payment of bribes to secure currency production contracts with overseas governments by agents of Securency, a company in which it had a 50% interest at one point.

What do many of these cases appear to have in common, apart from failures in the organizations’ culture and corporate governance? They were uncovered as a result of whistleblowers coming forward and identifying corruption internally to management or externally to the media or regulators. The majority of fraud is reported by tip-offs, which begs the question: Why weren’t these instances of corruption identified during the audit process?

If auditors don’t appear to be detecting the instances of fraud and corruption that are making the papers, what is their role in preventing this type of behavior?

Wikipedia will tell you that the purpose of the audit is “to provide reasonable assurance, but not absolute assurance, that the financial statements are presented fairly.” It is the notion of “reasonable assurance” and the concept of “materiality” that provides auditors a level of protection should their audit process fail to find fraud or corruption.

An increasing number of commentators are asking whether the concept of an independent auditor has been compromised by the lure of further fee-generating work from other activities at their audit clients. Some argue that relying on the client to pay their fees poses an inherent challenge for the auditor to provide a truly independent review without “fear or favor.”

A recent study by MIT and Harvard researchers showed demonstrable benefits from auditors being randomly appointed to companies with their fees being paid by the State.

There is no suggestion that the auditors of the companies involved in the latest corruption scandals have engaged in unlawful conduct, but the question remains as to how such conduct could have gone undetected for years.

Perhaps the audit process needs to be reviewed to ensure that corruption “red flags” are identified and investigated as early as possible. And the next generation of auditors might require further education in how to detect fraud and corruption when examining the books and records of their clients.

Guy Underwood is the Executive chairman and founder of the RISQ Group, one of APAC’s leading providers of risk management and employment screening services. He can be reached here.

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