October 24, 2020

This ‘Fighting Fraud’ Video from the CAQ Isn’t Going to Help That Expectations Gap Problem Auditors Love to Complain About

Most people like to learn in some sort of visual fashion. Reading? BORING. Lectures? AWFUL. There needs to be action, bright colors, and a damsel in distress — bonus points if there's a scene of frontal nudity — to get people to pay attention for longer than five minutes. 

Investors in public companies are no different. That's why the Center of Audit Quality, steward of investor protection that it is, put together a series of comic noir videos to explain the whole "System of Investor Protection" to investors who might be confused about financial reporting, auditors, and all that stuff. I mean, you can't expect investors to read and understand Sarbanes Oxley and PCAOB auditing standards can you? Of course not! When gazillions of dollars of our investing dollars are at stake, the best thing to do is to explain what the watchdogs do by making them look like the Watchmen.1 Apparently.

Anyway, the latest chapter is "Fighting Fraud" and it has all those familiar things you hear when fraud is being discussed — triangles and red flags and communication and such. Here, watch it if you like:  

What's really interesting about this video is that it makes the whole process appear really simple and — AND! — it implies that external auditors are vigilant investigative sleuths that are always on the lookout for folders with red flags that may indicate fraud and tackle them to the ground as soon as they are visible. Funny thing — neither of these are true! 

Now, most investors don't care to get into the weeds of auditing, which is fine, but representing the process in a one-size-fits-all package like this is kinda misleading, you might even say, fraudulent!

The reason it's misleading is because the biggest problem (read: excuse) that auditors talk about in the process is this — what a lot of investors think auditors do and what auditors actually do is not the same thing. You know, the expectations gap. This video doesn't do that. AT ALL. It's like if you took the Ewoks out of the Return of the Jedi. No, wait. Maybe it's more like if you took the briefcase out of Pulp Fiction. Yeah, that's it! The whole story turns on that one thing and they took it out of the plot completely!  

And yet the CAQ is perfectly aware of this problem. In fact, they talk about it all the time. Meanwhile, audit firms have been citing the expectations gap as a HUGE problem for years; that their responsibilities to detect fraud are wildly misunderstood by people who — God forbid — want a financial audit to have some value yet don't really know what that value is when a fraud occurs but wasn't detected by auditors. And just what is their responsibility anyway? That's a whole other question that we've had on a number of occasions.

But nowhere in Auditor's Babes and Bullets does Ledger Lines sit down the pretty little investor and say2, "Look, sweetheart. I'm here to look out for you. I don't want anything bad to happen to you. But I don't think you understand what it is I do. You can't expect me to catch the bad guys when there's collusion by management or if they're lying to me. Plus, I do things on a test basis, babe, and I plan the audit to consider the risk of fraud. I really don't tackle file folders with red flags and the client really doesn't go out of their way to help me that much."

Of course, people don't like being told they're stupid, so that particular narrative got cut from the script. On the other hand, explaining fraud detection using cartoon noir might not exactly scream "you're a bunch of intelligent people." Maybe that's just me.

1 The Watchmen is far more complicated.
2 Use your low, throaty voice.

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