29 Sep

Internal Investigations and the Use of Auditors and Accountants

When whistleblowers report potential ethics violations within companies, the first step the company must take is an internal investigation. The best internal investigations are independent and led by outside counsel, for a variety of reasons.

But what about the part of the investigation that involves analyzing accounting records, financial statements, and SEC filings? Management often wants to use internal finance professionals or their outside auditors for this task. It seems to make sense to utilize the expertise of people who are already familiar with the company’s finances.

However, this is not the right approach in most situations. It is important to use outside experts – – usually forensic accountants with significant experience in fraud investigations – – to maintain independence, avoid conflicts of interest, and retain privilege in the investigation.

Foley & Lardner explains in detail why it is important to use outside forensic accounting experts in independent investigations:

CONFLICTS WITH THE COMPANY’S AUDITOR
The company may want to retain specialized accounting experts for matters relating to complicated financial matters. Retention of an independent accounting firm for a specific “deepdive” audit often is necessary to truly understand a matter and to keep it cloaked in legal privilege. In these complicated financial investigations, it is not wise to use the company’s regular auditor — for at least two reasons.

First, very often these investigations will raise questions regarding what the auditors knew and when they knew it. Therefore, the regular auditor’s conflict of interest would seem to preclude that auditor from assisting in the investigation.

Second, there typically is no legal privilege between a company and its regular auditor, so the company should hire outside experts to maintain privilege. Both of these issues are complicated because the auditor often will want to know what the company has found in course of the investigation and whether it can continue to rely on management and/or the previously issued financial statements.

Again, communication is key. Counsel and/or the consulting experts may need to regularly update the auditor regarding the progress of the investigation. To maintain privilege to the extent possible, these conversations should be oral. This is particularly true because the company may have to disclose potentially damaging facts in these communications.

3 thoughts on “Internal Investigations and the Use of Auditors and Accountants

  1. The 3rd reason to not use your auditors is non-audit engagements are perceived to impair auditor independence. Restrictions on this might leave a company in a position where it has to shop for new a new auditor.

    Privilege can be maintained using employees, but it is inadvisable to use someone who works in the area being investigated. Conflicts of interest abound. Furthermore, it is hard to strike a line between normal duties and the investigation, so privilege can be jeopardized. If you must use employees, take them from other divisions.

  2. Pingback: Risks and Rewards of Independent Internal Investigations (ACC Docket) : Sequence Inc. Fraud Files Blog

Leave a Reply