Plaintiff's fault as a defense in accountant's malpractice suits Wilson, Elser, Moskowitz, Edelman & Dicker LLP.

• Author: Larkin, Peter J.
• Position: The Risk Management RESOURCE

Consider this frequent and unfortunate situation--a bookkeeper for a multimillion dollar company has sole access to client checks and a stamp bearing the signature of the client's president. One day, she finds herself in need of money, and decides to write a fraudulent check payable to cash, signing it with the signature stamp. A few months later, she needs more money and writes additional checks to herself. She alters bank statements on her computer and attempts to erase any trace of the diverted checks.

During the subsequent year-end fieldwork, the independent auditor notices irregularities in the books and records of the client and alerts the president, who hires a forensic accountant and orders bank statements from the bank. The auditor and the forensic accountant confirmed that the bookkeeper embezzled over $500,000, and informs the president. The president is shocked by the bookkeeper's actions (despite previous notice of internal control deficiencies by the auditor), and blames the auditor for failing to detect the embezzlement earlier, filing suit.

Suits against auditors for failure to detect a theft or embezzlement are quite common, and are seldom susceptible to a summary judgment motion. (1) Faced with frequently sympathetic plaintiffs--they were robbed after all--and a societal misunderstanding of the true role of the auditor and the limitations inherent in an audit, the defendant auditors frequently fight an uphill battle. Added to this is the fact that the embezzler frequently is judgment-proof, if not actually incarcerated, and the plaintiffs have a fine recipe for a lawsuit against the auditor, who likely has malpractice insurance.

In defending these claims, a significant legal issue is whether the negligent conduct of the plaintiff can be used as a defense by the auditor, and whether the evidence of proof is available to establish the defense. The objectives of this article are to help auditors understand the legal concepts of contributory or comparative negligence defenses, and to provide practical advice to auditors on managing professional liability risk in situations wherein the client is lax in instituting and monitoring internal controls to prevent fraud and theft.

Roles and Responsibility of the Auditor and the Plaintiff

The respective roles of the accountant and plaintiff in the typical audit serve as an important starting point. Although the auditor is required by the auditing standards to assess the sufficiency of the plaintiff's accounting system, system of internal controls and fraud risks to plan the audit, the auditor is not responsible for establishing these systems, nor is the auditor charged with detecting and reporting all weaknesses in internal controls, fraud, improprieties or immaterial errors in the financial statements.

In most instances, the auditor's engagement letter, management representation letters, and the audit report clearly delineate the limitations of the audit and the primary responsibility of the plaintiff to protect its own interests. Nevertheless, disputes often arise concerning the plaintiff's understanding of these limitations and the scope of the auditor's engagement, with most plaintiffs simply claiming that everything pertaining to the financial statements is by definition the accountant's responsibility, regardless of the language contained in the engagement letters and audit reports. The rhetorical refrain heard...