More Prosecutors Set Their Sights on Auditors

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To date, most high-profile prosecutions related to the recent rash of accounting scandals have involved corporate executives. But there is a growing consensus among prosecutors that crimes would be easier to prevent by going after gatekeepers of capital markets, especially auditors.

The major open issue seems to be when to go after the firm rather than individual auditors. Examples of recent quotes from prosecutors:

  • Manhattan District Attorney Robert M. Morgenthau, whose office has brought charges against Tyco executives, said prosecutors can not ignore accounting firms, especially in cases where it looks like "everybody is in on the act, the lawyers, the accountants, the board and the chief executive" and "there are no checks and balances." But, he added, any criminal investigations would "be directed to the people who did the misdeed and not the whole firm except in extraordinary circumstances."
  • James B. Comey, the U.S. attorney for Manhattan, whose office is handling numerous corporate fraud cases, agreed. He said, "We don't want to swing at a bad auditing team and knock down 20,000 employees." But he added that federal prosecutors can not absolutely rule out going after entire accounting firms. "It simply wouldn't do if people running an entity were able to hold their employees hostage whenever prosecutors came near. . . Sometimes we have to say, 'this corporate culture is sick.'"
  • In a speech last week, Justice Department criminal division chief Michael Chertoff said if firms do not cooperate with prosecutors and accept responsibility for failed audits, they still could face criminal charges.

The notion of prosecuting auditors aggressively is rooted in a theory first popularized by retired federal judge Stanley Sporkin. When Judge Sporkin headed the enforcement division of the Securities and Exchange Commission in the late 1970s and early 1980s, his theory of enforcement became known as the "access theory."

The theory got its name from the underlying notion that large-scale securities fraud cannot happen without access to financial markets, which is controlled by gatekeepers including accountants. One of Judge Sporkin's favorite remedies was to bar firms from taking on new clients for a month or more until they had brought in outside consultants to help clean up the business.

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