Management behavior -- An auditing horizon;

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Management Behavior—An Auditing Horizon
W. Donald Georgen
Touche Ross & Co.
The independent accountant has—and always had—a responsibility to look for management fraud and illegal acts. Less clear is the auditor's responsibility to discover these activities if they have occurred. The professional literature is ambiguous, and the recent Supreme Court ruling in the Hochfelder case did little to resolve the uncertainty. Speaking practically, however, the profession must face up to the expectations of the public. The question is not whether we have any responsibility in these areas—the real questions today are, how far does that responsibility go, and how should the independent accountant go about executing that charge.
While not new, this responsibility is being given considerable attention by practitioners, academicians, and regulatory agencies, as well as the courts, because of the sensational disclosures recently regarding implied improprieties (most of which have not been proved conclusively), management fraud, and illegal pay­ments.
The public is concerned and dismayed, not only that such events could have happened, but also that they were not detected and reported on a timely basis. Ultimately, that concern focuses on the independent accountant. In the public view, the independent accountant has the best opportunity (and therefore the responsibility) to determine that proper controls are operative to prevent such events, or where those controls fail, to timely detect and report the events. The public must acknowledge that independent accountants will never be able to guarantee that all instances of management fraud and other illegal acts have been detected—but on the other hand, it is my opinion that our detection "hit rate" must be substantially improved.
Attributes of Management Fraud and Other Illegal Acts
Before we attempt any analysis of the auditor's responsibility, we have to examine the attributes of management fraud (and analogously, illegal acts). Also, we must look at the traditional audit approach to see how it might be changed.
Fraud, very simply, is a deceptive practice—one where the perpetrator hopes to avoid detection. (Armed robbery is not a fraud, because the overt act is obvious.) Frauds in the business environment fall into two broad categories— those occurring at the employee level and those occurring at the management level.
Employee frauds generally have two basic characteristics:
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