The Perils Of Pre-Inspection File Polishing

This column was originally published at Going Concern.com on July 28, 2010.  Given the latest disciplinary actions reported over there at that fine blog regarding a young lady at Ernst & Young and her apple polishing – I mean file polishing – I thought I would reprint it.

Ever wondered what it would be like to see your name in print?  Most auditors do not aspire to seeing their name in the papers.  It’s a career-limiting move to be cited in a bankruptcy examiner’s report or a disciplinary order issued by the PCAOB.  But that’s just what might happen if you follow your partner’s orders blindly and roll over. Be very wary if asked to participate in a pre-inspection file review and you’re asked to add evidence of reviews and signoffs, insert documents after the fact, change conclusions or recreate analyses.

Last week Going Concern reported the latest findings of the UK version of the PCAOB, the Audit Inspection Unit.  There were two troubling findings that you may have dismissed as uniquely British – faking facts in support of weak assertions and “premature” discharge of the audit report before true completion.   Going Concern quoted Accountancy Age and FT Alphaville:

“Auditors have also been accused of altering documents before handing them to regulators and putting cost savings ahead of quality {and} some cases where partners signed audit reports before the audit was complete.”

Have you ever been involved in “cleaning up” a file in preparation for an internal risk and quality review or a PCAOB inspection?  Do you know when to say “when”?

Recent cases may provide some guidance.  In the New Century Financial case, junior auditors and professional practice specialists saw their names in the bankruptcy examiner’s report because they raised issues and were ignored or overruled by engagement and professional practice partners. In one instance, issuance of the 2005 audit report was delayed until the last minute because of concerns expressed by a KPMG hedge accounting specialist.

He was overruled.

“The issue, however, had not yet been resolved to Klinge’s (KPMG Partner Financial Risk Management/Financial Derivatives Resource Group) satisfaction and it was still holding up KPMG’s audit opinion…In an e-mail exchange in the late evening of March 15, 2006, Kim (KPMG Senior Manager) learned that Klinge was not prepared to sign off on the FRM/FDR review…Donavan (KPMG Engagement partner) stated : “I am very disappointed we are stil discussing this. As far as I am concerned, we are done. The client thinks we are done. All we are going to do is piss everybody off.”

Ultimately…a high ranking member of the KPMG Department of Professional Practice, Terri Iannaconi authorized Donovan to issue KPMG’s audit report…also instructed Klinge to prepare and forward a sign off memorandum and instructed Kim to prepare a “disagreement memorandum” to document the dispute.”

Sources tell me they’ve been asked by audit teams, long after report issuance, to provide “backdated” reports and documents that were needed to “complete” the file. Auditing Standard 3 covers the requirements for audit documentation and lays out, in vague terms, the basic requirements for crossing t’s and dotting i’s.  But it’s your firm’s internal quality procedures that should mirror AS3 and provide sufficient and clear detail on exactly what is and isn’t allowed when it comes to “cleaning up the file.”

There’s a less well-known PCAOB disciplinary case that refers to changing documents after the fact.

(Mr. Nardi has since been reinstated by the PCAOB to practice.)

Ex-BDO Seidman Auditors Disciplined by PCAOB

The Public Company Accounting Oversight Board has disciplined two former auditors at BDO Seidman for failing to review the audit work of a junior member of the firm and then trying to cover up by backdating documents…The subordinate noted the absence of initials and signatures indicating that a detailed review had been performed.

(fm Note: There was probably time billed to the client for the partner and manager review but an absence of any time charged in the firm’s internal time reporting system. Regulators: you should be looking for this common discrepancy.) .

When Fitzpatrick returned from vacation the following week, Nardi directed her to initial and sign the workpapers and backdate them to dates preceding the issuance of the March audit report, even though she had not done a detailed review…”

Rule of thumb for junior auditors:  If a partner uses the word “backdate” it’s pretty certain he or she wants you to do something you may be famous for later – and not in the good way.  If you hear the word “backdate”, run as fast as you can in the other direction to your firm’s Ethics Hotline.

If you get no satisfaction there, try the PCAOB tip line or, maybe, the SEC’s new whistleblower tip line. If your client is a SEC registrant, there may be big bucks for you that will compensate for the fact you will almost surely lose your job, be blackballed from working for any other PCAOB registered firm and never hear from any of your former colleagues ever again.

Small price to pay for being on the side of right…