Auditors’ Liability for Failure to Detect Fraud: Lessons Learned from Recent American Case Law

Abstract

Auditors are occasionally sued for their failure to detect fraud in the client firm during an audit. These lawsuits are typically grounded in professional negligence, negligent misrepresentation, fraud, aiding and abetting fraud, or federal securities fraud. The PCAOB recently promulgated AS 2401, “Consideration of Fraud in a Financial Statement Audit,” which contains fraud-related Generally Accepted Auditing Standards (GAAS) applicable to audits of publicly-traded entities. An auditor’s failure to comply with GAAS may be evidence of professional negligence. U.S. states are divided as to whether an auditor’s averment of compliance with GAAS in an audit report is a statement of opinion or a statement of fact. An auditor’s failure to investigate evidence indicating potential fraud is one factor used to determine an auditor’s legal liability. An auditor may be able to use the doctrine of in pari delicto as a defense if the plaintiff is also a wrongdoer.