Fraud Type and Auditor Litigation: An Analysis of Sec Accounting and Auditing Enforcement Releases

TLDR

The study investigates whether certain types of financial reporting fraud increase the likelihood of litigation against independent auditors. Using SEC Accounting and Auditing Enforcement Releases, the authors classify each fraud as common or arising from fictitious transactions and test their association with auditor litigation while controlling for client, auditor, and case characteristics. Results indicate that auditors are more likely to be sued when the financial statement frauds are common or stem from fictitious transactions.

Abstract

This study examines whether certain types of financial reporting fraud result in a higher likelihood of litigation against independent auditors. We expect that auditors are more likely to be judged responsible for failing to detect commonly occurring frauds or those that stem from fictitious transactions. We examine companies with SEC Accounting and Auditing Enforcement Releases and designate whether each fraud present in their financial statements is common and/or arises from fictitious transactions. We then examine whether these types of fraud are related to auditor litigation in analyses that control for various client, auditor and case characteristics. Our results provide some support for our two primary hypotheses-auditors are more likely to be sued when the financial statement frauds are of a common variety or when the frauds arise from fictitious transactions.