Clarifying the Imputation Doctrine: Charging Audit Clients with Responsibility for Unauthorized Audit Interference

Monday, January 1st, 2001 at 12:00 am by Andrew J. Morris
Andrew J. Morris, Clarifying the Imputation Doctrine: Charging Audit Clients with Responsibility for Unauthorized Audit Interference, 2001 Colum. Bus. L. Rev. 339

Corporations frequently are victims of unauthorized fraud perpetrated by their own officers or other employees. These frauds usually involve manipulation of accounting records or rules for such obvious motives as boosting earnings or glossing over unwise acquisitions. Fraud can inflict enormous costs on the wrongdoers’ corporation, especially if the fraud escapes detection by the directors and officers — and the auditors. The auditing firm that fails to detect such a fraud is likely, of course, to find itself a defendant in a lawsuit brought by its client. In its defense, that auditor typically asserts contributory negligence, contending that the client is responsible for the fraudulent acts of the client’s own employees.

This paper addresses which party — client or auditor — should bear a loss caused by the unauthorized acts of the client’s employees when those acts include interference with the audit. Surprisingly, no court has been squarely presented with this question. A few decisions have touched on the question, however, and they assume that the auditor always bears responsibility for employee fraud against an audit client, whether or not the wrongdoer also interferes with the audit. They make this assumption by taking a rule conceived for frauds that do not involve audit interference and applying it, unaltered, to cases that do involve such interference. This paper contends that this assumption is wrong. It argues that existing imputation rules dictate that, when a client sues its auditor for failing to detect unauthorized fraud by the client’s employees, unauthorized audit interference by those employees is imputed to the client. Thus, this paper concludes, accountants have a powerful defense in many or most cases of unauthorized employee fraud.

Because the few relevant authorities and, in my experience, most knowledgeable attorneys, assume that the law is the opposite, this paper defends its conclusion at length. In addition to explaining the plain words of the relevant rules, this paper explains how imputation of unauthorized audit interference to audit clients advances the purpose of these imputation rules and achieves strong coherence with neighboring legal doctrines. These bases for this paper’s conclusion — the words of the governing rules, the rules’ purpose, and the conclusion’s coherence with numerous neighboring principles — give considerable assurance that the conclusion is a correct reading of existing law. The small number of reported cases indicates that this defense has been overlooked despite its demonstrable power.

Author Information

Mayer, Brown & Platt, Washington, D.C.