Stanford Auditing Case
Allen Stanford was, at one point, a successful entrepreneur whose investment company’s accounts totaled in the billions. The aforementioned keyword is ‘was. ’ As CEO of Stanford Financial Group, Stanford essentially ran a massive Ponzi scheme; he issued certificates of deposit at an offshore bank that he controlled and illegally used the investors’ funds. These CD’s were appealing to investors due to their high returns of nearly twice the average rate of return of investments in U. S. banks.
Investors were led to believe that these CD’s had such high returns because they were being invested in corporate stocks, real estate, hedge funds, and precious metals (BusinessWeek). The SEC eventually uncovered Stanford’s fraud in 2008. Stanford was recently convicted and sentenced to 110 years (NYTimes). In an attempt to recover some of the money from the corrupt management of the investments, the investors’ next step was to sue the auditors of Stanford Financial Group. BDO, the accounting firm that was responsible for auditing Stanford’s financial statements, is currently the target of a major lawsuit.
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BDO did not act in accordance with the responsibilities of an auditor and thus led to audit risk, lack of independence, and various violations of the PCAOB’s auditing standards regarding investment securities. BDO consistently issued unqualified reports when there were material misstatements. This was an instance of audit risk. Audit risk is the risk that an auditor will conclude that financial statements are fairly presented and issue an unqualified opinion when, in fact, there are material misstatements.
The class-action lawsuit filed against BDO accused the auditors of audit failure, which is slightly different than audit risk. Audit failure is when the auditors do not comply with audit standards and issue an incorrect opinion. BDO consistently issued unqualified reports when there was fraud (AccountingToday). Although BDO did not directly audit Stanford Financial Group’s financial statements, they were responsible for auditing those of Stanford Group Company.
The users of the audit reports were the SEC and state regulators; these users required these unqualified opinions in order to satisfy regulation standards so that Stanford could continue his brokering deals and sale of CD’s (Madoff). BDO failed in its responsibilities to act independently and in the best interests of investors. According to Rule 101 of the AICPA’s Code of Professional Conduct, auditor independence is impaired if during the time of the engagement, the auditor “had or was committed to acquire any direct or material indirect financial interest in the client. During BDO’s audit engagements, BDO also took part in Stanford’s Task Force. The complaint filed against BDO alleged that, “A key initiative for the Stanford Task Force — fully known to BDO USA — was to amend Antigua’s Money Laundering (Prevention) Act to ensure that “fraud” and “false accounting” did not fall under the Act’s prescribed list of violations. ” By participating in the Stanford-funded Task Force and assisting in weakening Antiguan-banking laws, BDO had an indirect financial interest in Stanford Financial Group, thus violating the independence guideline.
By disregarding guidelines addressing audit evidence for investments in securities, BDO violated PCAOB’s Section 332. This section outlines audit evidence and audit risk regarding investments in securities. An auditor is responsible for addressing existence, completeness, rights and obligation, valuation, and presentation (PCAOB). Auditors for financial institutions or individuals that invested in Stanford’s company should have addressed all of the aforementioned in order to verify balances. In 2007, Stanford’s various companies were running net operating losses of over $30 million (Madoff).
Stanford had to personally keep the company afloat. The complaint against Stanford alleged that, “70% of its 2007 operating revenues through referral fees earned from SGC’s sales of SIBL CDs. ” BDO did not verify the existence of these CD’s or Stanford’s assets or income. The success of the company was riding solely on the sale of certificates. If BDO fulfilled its obligations of verifying existence, completeness, and correct valuation of these CD’s, an unqualified opinion would have been impossible.
Investors’ auditors would have been able to see these red flags and BDO would have been able to detect that the securities were not able to bring in a profit by performing analytical procedures. BDO also did not correctly assess risk. Inherent risk was present because of management’s objections and increasingly ineffective investing. Independent controls testing was also necessary but not implemented. Part of BDO’s responsibility was to test the internal controls and confirm that the funds intended to purchase the CD’s were used for that purpose.
Instead, BDO concealed such information and contributed to the fraud (PonziBook). If I were to advise clients regarding investing in off-shore banks like Stanford’s, I would refer to the statement, “If it seems too good to be true, it probably is. ” Stanford’s rates were double the average 2% rate of U. S. banks (BusinessWeek). The part that was more alarming is that there was no evidence as to where the money was exactly coming from. Similar to Madoff’s fraud, investors went into their investments blind.
My suggestion would be to thoroughly investigate any company a client would plan on investing in and ask questions regarding how the money would be invested and ask for evidence. Auditors on behalf of the investors should have verified the existence, completeness, and valuation of the investments. This would prevent another Stanford Financial Group scandal from reoccurring. The lack of questioning, especially by the auditors, BDO, led to the loss of billions of dollars from investors. Professional skepticism and acting in accordance with the PCAOB guidelines prove to be essential for success in auditing.