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Auditors need to guard against the scenario that led to one of auditing's darkest hours.
If you didn't detect 64,000 phony transactions with a face value of $2 billion, $25 million in counterfeit bonds, and $100 million in missing assets, what would people think of your competence as an auditor, or of the credibility of your audit organization? For three auditors who did not report evidence of large scale fraud at Equity Funding Corporation of America, it resulted in their being found guilty of fraud by a jury in California. The court sentenced them to serve two-year prison terms, spend four years on probation, and do 2,000 hours of charity work.
The notorious Equity Funding scandal, which was covered extensively by the press and in The Great Wall Street Scandal, by Raymond L. Dirks and Leonard Gross, was an embarrassment to the securities industry, the insurance regulatory agencies, and the auditing profession. In early 1973, when the world started learning of the magnitude of the fraud that had occurred, many questions were raised: Where was the Securities and Exchange Commission, the Federal agency responsible for monitoring publicly traded companies? Where were the various state insurance departments responsible for monitoring the activities of insurance companies? And where were the auditors? How could they not find a fraud of such towering magnitude?
After studying this case and the reasons the auditors didn't put a stop to the fraud that occurred under their noses, it has occurred to me that the same kind of detection failure could happen again today to many auditors and audit organizations. Working in state government, I've had an opportunity to review the activities of state insurance departments, to observe the activities of public accounting firms providing services to state agencies, and to see how auditors approach their work.
The lessons provided by the Equity Funding case, exhaustively detailed by Dirks and Gross, are just as important and relevant for internal and external auditors today as they were more than 20 years ago when the scandal broke. If we want to be worthy of public trust in our competence and credibility, we must be constantly diligent in meeting the standards of our profession. We must try to understand past mistakes, like those...