Who is to Blame for Fraud? Lawyer Perspectives on Auditor Liability

This study examines how disclosures impact lawyers’ perceptions of independent auditors being sued for failure to detect fraud; specifically whether the auditor’s opinion and disclosures required by the Sarbanes-Oxley Act of 2002 may be deemed to be red flags and deter litigation. A 3x1 between-subjects experiment was conducted using 100 lawyers specializing in securities or business law. The lawyers reviewed a case in which the auditor had issued an unqualified audit opinion on financial statements of a company that ended up declaring bankruptcy. The lawyers reviewed the auditor’s opinion on internal controls which was manipulated as unqualified, unqualified with description of significant deficiencies, or adverse with description of material weakness. Results of this study indicate that the auditor’s report on controls has the potential to decrease the litigation exposure of auditors, as auditors providing an adverse opinion on internal controls were assessed most favorably by lawyers. However, voluntary disclosures of significant deficiencies in internal controls did not significantly influence auditor litigation exposure, indicating that the stronger message provided by an adverse Section 404 opinion is necessary to decrease litigation exposure. Overall, results of this study provide valuable insights on how audit disclosures influence potential litigators’ decisions and recommendations concerning auditor negligence lawsuits.