The case in question in this instance is that involving Logitech. The SEC charged Logitech with accounting fraud in 2016 for some of its activities previously in the decade. In particular, the company was charged with misrepresenting many of its liabilities and some of its losses. This kept the stock artificially high for a time, and required the company to pay a fine and the CEO to pay back bonus money tied to the fraud. In addition, there were issues with the write-downs of various elements, and there were also allegations that the company failed in its controls over its accounting departments and statements.
In looking over the audit prepared by the company’s accounting firm, one can see that there is some liability to third parties potentially under both common law and federal securities law. The question at bar for the accountant in question is whether their actions were mistakes of negligence or whether there was actual fraud involved. It is apparent in this case that there was a significant amount of fraud involved, and it went beyond mere negligence. If negligence existed, then the accountant would have been, under securities law, only liable for damages to the client. However, under common law negligence doctrine, there is liability any time there is a foreseeable harm to another party. It would have been foreseeable that the statement would have been relied on by third parties in this instance for stock investment and other purposes, so those damages may have been foreseeable.
However, in this case, given that there was some fraud, there is a different standard. The courts have held that in order for an accountant to be liable to a third party for damages, several factors need to exist. Namely, the court held that in order for there to be third party liability for the accountant, that accountant would need to have a few things going on. First, he would have to have knowledge that the third party was going to rely on the accounting statement. Beyond that, he might be held liable if it can be shown that he knew or should have known that the client was going to present the accounting statement to a third party. Finally, there must be a showing that the third party was justified in relying on the statement. In this instance, those things appear to have been met. The third parties would have been justified in relying on the statement, and the accountant would have had to have known that this was going to take place. It all adds up to a situation where the implications were quite clear. Even under negligence standards, there is common law liability, and that is likely what happened here.
In this instance, two of the standards of field work would have been violated. Namely, principle two of the field work standards would have been violated. It states, “The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures” (GAAS). Importantly, it is the due diligence requirement there that was violated. The accountant on the case did not put in the background research needed to understand that the company had major problems in its controls and in its reporting for accounting statements. This led the accountant to put a stamp of approval on the shoddy work of the organization.
Management has the greater responsibility when it comes to reporting. This is true because they have more information and can, if they want, hide things from the auditor. The auditor is only able to do his or her job to the extent the management of the company allows this to be. It all depends on a good faith basis on the part of the manager. Without that, the auditor is useless in the situation and cannot provide the service that is promised. This becomes an important consideration at the end of the day that ultimately can fall a company. An auditor can only do so much when things are hidden.
One of the sanctions available is making executives give back bonuses that were earned as a result of the inflated stock prices from the bad accounting. This can and should be done in these cases. In addition to that, further sanctions should be imposed. There can also be fines of up to $5 million and imprisonment for a decade. While this may not be the kind of case that should rise to the level of prison time, it is important to impose a financial penalty. If these companies know that they are not going to be able to get away with things scot-free, then they will be more likely to put tight controls on in the future (Barra, 2010). If they know they just have to pay back the ill-gotten gains, then this creates no incentive for good behavior. They know that the worst case scenario puts them right back at the starting point.
Ultimately, this is the kind of case that shows just how easy it is for little things to get hidden. There are multiple layers there to protect against this, but none of them caught the problem. With a company of this size, these issues can cost investors millions, so having better reporting standards is key.
- Barra, R. A. (2010). The impact of internal controls and penalties on fraud. Journal of information Systems, 24(1), 1-21.
- Generally Accepted Accounting Standards. (n.d.). Retrieved from https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00150.pdf