How To Avoid Accounting Malpractice Suits

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Mark Cheffers, CEO of has created a primer for auditors based on lessons learned from Enron. In this multi-part series, Mr. Cheffers examines a number of issues in easy-to-read white papers (available for download at the end of this story). The parts include:

Part I - Old Line Partners Wanted
Part II - Why Andersen is so Exposed
Part III - An Independence Dilemma
Part IV - Could It Get Any Worse?

The lessons in part IV relate to six specific areas:

  1. Document Shredding.Auditors are advised to keep all documents for at least six years to avoid a legal doctrine called “Spoliation.” This doctrine allows a judge to instruct a jury to draw an adverse inference from destruction of documents. “In short,” Mr. Cheffers explains, “that means they can be instructed to assume the worst.” For a practitioner's own protection, Mr. Cheffers suggests a document retention policy of at least ten years may be preferable.
  2. Financial Fraud or Collusion.Auditors are also advised to look more to substance than form when addressing aggressive accounting treatments. “Any auditor who becomes aware of any activities that relate to manipulation of earnings should act immediately,” says Mr. Cheffers. “They should not try to help the company work out a strategy to escape the problem.”
  3. Involvement by Other Audit Firms.The press has reported that KPMG audited the unconsolidated partnerships and PricewaterhouseCoopers acted as a valuation advisor in one or more of the transactions. Auditors should keep in mind that the Sargeant Shultz defense, “I know nothing,” does not work well in these circumstances. The decision to turn the other way and not question what another Big Five firm is doing, can be a source of exposure.
  4. Providing Internal Audit Services.Performing internal audit functions can be another source of exposure because it makes a practitioner part of management. It removes one layer of control and one layer of “second opinion” from the arsenal used by the board of directors to get key information.
  5. Consulting Firms.Traditionally, consulting firms, such as McKinsey and Company, have had little direct exposure to lawsuits. But in the Enron case, Mr. Cheffers observes, “McKinsey may have become akin to an arm of management instead of a consulting firm.” He cautions that consultants run the risk of increasing their liability exposure when they engage in activities that go beyond consulting.
  6. Tax Havens.The press has reported that Enron used more than 900 offshore tax haven entities to avoid paying taxes. The lesson here, says Mr. Cheffers, is one moderation and reasonableness. While many corporations establish subsidiaries in tax havens for legitimate business purposes, Enron seems to have “pushed the envelope beyond recognition.” To the extent Andersen was involved in establishing, auditing, accounting for or advising about these entities, Mr. Cheffers cautions, the accounting firm may become the target of related claims.

Part I - Old Line Partners Wanted (12/6/2001)
Part II - Why Andersen is so Exposed (12/11/2001)
Part III - An Independence Dilemma (12/21/2001)

In the most recent installment of the series, Part IV - Could It Get Any Worse? (1/18/2002), Mr. Cheffers provides lessons learned from evidence uncovered in the Enron case over the past week.

-Rosemary Schlank

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