Investors can and must fight back against auditor fraud.
While it is not particularly common to sue outside auditing firms, the institutional investor community has had significant success over the past two decades holding auditors accountable, obtaining billions of dollars in recoveries through securities class actions. Recently, this has even become a global phenomenon. In Australia, PwC recently paid $67 million to resolve a securities class action. In Canada, Ernst & Young was required to pay $118 million in 2012 in what emerged as the country's largest ever class action settlement relating to audit fraud.
However, litigation is a last resort to resolve the results of systemic misconduct.
Investor advocacy is a key tool in combating auditor misconduct before it can take root and visit losses on investor portfolios. Shareholder advocacy and action has resulted in meaningful corporate governance changes that pre-empt opportunities for wrongdoing, including obtaining investor input on selection of an auditor and developing mechanisms to enhance transparency. For example, after KMPG failed to spot crucial accounting errors leading to SEC and Consumer Financial Protection Bureau investigations, shareholders pressured General Electric and Wells Fargo to switch auditors for the first time in nearly a century. Similarly, after a major data breach in 2017, Equifax shareholders called for restructuring of the board and greater audit quality control policies.
Despite these efforts, and significant regulatory steps taken after the wave of scandal in the early 2000s, auditor fraud shows no signs of stopping. The government might make good rules, but greed is forever busy. The institutional investor community — i.e., the "owners" of our most cherished corporations and institutions — are uniquely positioned and empowered to address and halt this worrying trend.
There are numerous ways public pension funds and other institutional investors can leverage their power to encourage and facilitate better conduct by the auditing profession upon which our markets rely so critically:
- Become aware of the role that auditors play in securities fraud.
- Advocate for financial independence between auditors and companies being audited.
- Petition for greater transparency and oversight within a company, such as demanding creation of a multitiered independent review body within organizations to check audits.
- Lobby for key auditor performance indicators based upon audit quality, not the client company's performance. These auditor performance indicators could be mediated by a third party or outside certifying organization, which would review and certify the audits.
- Demand regulations requiring Big Four auditors to work with outside audit firms to create joint audits for certain significant transactions. These outside audit firms could also provide a second review of primary audits, thereby serving as a "check" on Big Four audits.
- Propose a requirement that companies rotate auditors at selected intervals, such as every three to five years. Under such a requirement, auditors could be capped on the number of times they audit a particular company within a given time period, such as being limited to auditing the same company once every 10 years.
- Demand auditors impose requirements that eliminate or reduce bias, such as blind reviews of a certain financial statements.
It is clear that the near-monopoly of the accounting field by the Big Four, if unchecked, will continue to perpetuate auditor fraud. Public pension funds and other institutional investors play a key role in fighting back.