Question

Bill Young felt uneasy but good about downloading hundreds of pages of documents about Infant Products Inc., an audit client of his former CPA firm, Rogers & Autry, which involved the bribery of foreign government officials to gain favored treatment—a crime under the Foreign Corrupt Practice Act. He had stumbled upon the information while looking for other files online. Bill had already decided to quit his job and was in the process of cleaning up his office and boxing personal items. He thought about it but did not see anything wrong with the downloading. Besides, the bribery case involved selling tainted infant formula in China. Payments were made to government officials to look the other way. Bill pondered what his options were. Should he inform management of the company even though he had handed in his official resignation letter? Should he disclose the matter to an investigative reporter who had been sniffing around the company for months following up on a tip he had received about improper foreign payments by the company? Or should he report the matter to the authorities? He also considered remaining silent. Bill carefully weighed these options by reflecting on the harms and benefits of his alternative courses of action.

Questions 1. You are Bill’s best friend. Assume he asks for your advice about what he should do. What would you say and why? Support your answer with reference to relevant auditing and/or ethics requirements.

2. Bill is at home now having already spoken to you about the matter. He decides to carefully consider the consequences of his actions. What are the harms and benefits of the alternatives identified by Bill?

3. Assume Bill decides not to follow your advice but calls you again to let you know about his decision. If you sense an opportunity to provide additional input during the conversation, what would your advice be to Bill at this point and why?

Answer 1

The anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) subjects companies traded in U.S. exchange markets and individuals to criminal and civil liability for paying bribes to foreign government officials in exchange for obtaining or retaining business or securing any improper advantage. Although the FCPA primarily targets companies and their executives, independent auditors are not free from FCPA related-liability.2 Public perceptions of the role of independent auditors coupled with rigorous enforcement of the FCPA have resulted in heightened scrutiny of the independent auditors’ responsibility to detect bribes. According to the Association of Certified Fraud Examiners (ACFE), most fraud and bribery are uncovered through tips, management reviews, internal audits, account reconciliations, or merely by accident. Ultimately, given the vital role that audits of financial statements play in corporate governance, can auditors ignore the possibility of bribes to foreign government officials when auditing financial statements? The answer to this question is “No.” As this study explains, auditors have a responsibility under the Securities Exchange Act of 1934 (Exchange Act) and the standards issued by the Public Company Accounting Oversight Board (PCAOB) to design and implement audit procedures that provide reasonable assurance of detecting violations of the FCPA’s anti-bribery provisions and, in some instances, must report these violations to U.S. authorities.

Independent auditors’ responsibility with respect to bribery

Pursuant to Section 10A of the Exchange Act and AU section 317, Illegal Acts by Clients, auditors have a responsibility to design procedures that provide reasonable assurance of detecting illegal acts that have a direct and material effect on the financial statements. Bribing a foreign government official is illegal and has a direct and material effect on a company’s financial statements. Companies that pay bribes generally record the underlying transactions in their accounting books as legitimate operating expenses in an effort to avoid detection. Since bribes often involve disbursements of cash, recording a bribe as a legitimate operating expense results in false reporting of expenses on the income statement. Although such amounts paid may not be monetarily substantial, determining whether these have a material effect on the financial statements does not necessarily depend on a numerical threshold. In Staff Accounting Bulletin No. 99, Materiality, the Securities and Exchange Commission (SEC) stated that a quantitatively small misstatement will likely be considered material when “the misstatement involves concealment of an unlawful transaction.’’