Should you offer a job to your external auditor?

Mark S. Beasley, Joseph V. Carcello, and Dana R. Hermanson

Companies search-ing for financialand accounting

talent to join their sen-ior executive teamsoften lure partners andother professional staffaway from accountingfirms that perform their annualaudits. Although there are manyadvantages when hiring peopleaway from your external auditfirm, there are also risks thatneed to be managed. Amongthese risks are potential threatsto the audit firmÕs independ-enceÑboth before and after aformer employee of the auditfirm is hired. Any reduction ofaudit firm independence is likelyto reduce the quality of a com-panyÕs financial reporting, andreduced independence also mayincrease the potential that finan-cial reporting irregularities willremain undetected by the auditfirm.

Livent, the Toronto-basedproducer of Broadway shows,recently faced this exact problemwhen a former professional of itsexternal audit firm joined Liventas a member of the financialexecutive teamÑand allegedlybecame enmeshed in a financialreporting fraud. Between 1995

and 1998, LiventÕs managementallegedly perpetrated a massiveaccounting fraud in order tomask losses associated with anumber of its theatrical releases.In the middle of the fraud, Liventhired the partner who wasresponsible for the audit ofLiventÕs prior yearsÕ financialstatements to serve as its newchief financial officer (CFO).Did LiventÕs hiring of the auditengagement partner as CFO helpperpetuate the fraud by prevent-ing discovery by the audit firm?Although there is no definitiveanswer to this question, manyargue in the financial press thatthe answer may be Òyes.Ó Forexample, the National Post(January 19, 1999) argues:

Having a top officerwho knew how Deloitte[the external audit firm]worked, and what itsauditors were lookingfor, no doubt made it

easier for the com-pany to keep audi-tors from findingevidence of anyfraud. She [thenew CFO] alsohad credibilitywith former col-

leagues when questionsarose, which may havebeen used to reassurethem if something suspi-cious was noticed.

POTENTIAL BENEFITS WHENHIRING A FORMER AUDITOR

Although there are risksassociated with hiring an indi-vidual from the external auditfirmÕs staff, companies routinelyhire ex-auditors to fill numeroustypes of company positions.Most of these employment rela-tionships benefit both the com-pany and the ex-auditor, with nodecline in the quality of finan-cial reporting. For example, onerecent forthcoming study (byBehn, Carcello, and Hermansonin Contemporary AccountingResearch) found that 33 percentof Fortune 1000 controllers hadprior experience with the currentaudit firm.

Companies searching for senior executive talentoften lure partners from the firms that performtheir annual audits. But this can be risky, warn theauthors. Is it worth it? How can you manage thoserisks? © 2000 John Wiley & Sons, Inc.

Should You Offer a Job to Your ExternalAuditor?

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35© 2000 John Wiley & Sons, Inc.

Clients often prefer to hireformer employees of their auditfirm because former auditorstypically possess numerousattractive attributes. The level oftraining in an audit firm, andexposure to both numerous typesof businesses and to complexaccounting and financial transac-tions provide valuable experi-ence. And accounting firmsÑparticularly the five largest inter-national accounting firms (oftenreferred to as the ÒBig FiveÓ)Ñtry to hire the best performingstudents at top business schoolsaround the country.

Most importantly,when a company hiresdirectly from the audit staffexamining the companyÕsfinancial statements, theformer auditor is intimatelyfamiliar with the clientÕsbusiness strategy, financialreporting processes, andindustry peculiarities. Thisknowledge helps jump-startthat individual when he orshe becomes a part of theclient management team.The company that is consideringextending employment to amember of the external auditfirmÕs staff has been able toobserve the auditor over a periodof years, which provides thecompany first-hand knowledgeof the auditorÕs personality, workethic, and other individual pro-fessional traits. This allows thecompany to assess whether theauditor is likely to represent aÒgood fitÓ within its corporateculture and environment. Thisbenefit often outweighs hiringindividuals outside the audit firmbecause the latter requires thecompany to resort to other typesof evaluations of a candidateÕspersonal traits, such as writtentests and personal interviews,which are often less reliablemeasures relative to first-hand

observations of the candidateÕsperformance. Therefore, a com-pany often finds it difficult tomatch the talent, training, expe-rience, and overall fit that a for-mer auditor can bring to theorganization.

POTENTIAL PROBLEMS WITHHIRING A FORMER AUDITOR

There are at least threepotential threats to the integrityof the financial reporting processthat may result when hiring aformer auditor to become part ofthe companyÕs executive team.

These threats often increasewhen the former auditor is hiredinto a senior financial positionwithin the company. One threatarises prior to the audit firmemployeeÕs decision to leave theaudit firm to join the client exec-utive team. The two additionalthreats arise when financialreports are issued after the ex-auditor has joined the client.

The first threat starts whenan employee of the audit firmbegins to contemplate leavingthe firm and joining a particularclient and can continue until aformal job offer is received.Concern about integrity arises,given that an auditor who is con-sidering an employment oppor-tunity at a client may exhibit alack of due diligence in auditinghis or her future employerÕs

financial statements during thetime between when the companyand the candidate begin dis-cussing employment opportuni-ties and the time the candidatedecides to resign from the auditfirm. (In fact, the AmericanInstitute of Certified PublicAccountants [AICPA] guidelinesrequire the firm to remove anaudit firm professional from theengagement if that professionalis considering an employmentoffer from the audit client.) Thislack of due diligence may mani-fest itself in a number of ways,including the following: (1) fail-

ing to gather sufficient auditevidence; (2) overlookingproblems indicated by theaudit evidence that is gath-ered; and (3) improperlyacquiescing to client pref-erences towards certainaccounting principles, esti-mates, and other judgmen-tal decisions. The auditorÕsmotivation to sidestepappropriate levels of duediligence might be due to adesire to ingratiate oneself

with current client managementfor the purpose of increasing thelikelihood of securing a positionwith the client. While in manyinstances the auditor exercisesappropriate levels of due dili-gence throughout the engage-ment, there is some risk that theappearance of financial reportingintegrity may be affected whenaudit firm personnel are asked tojoin the companyÕs financialmanagement team when the cur-rent yearÕs financial statementaudit is in process.

Threats to the integrity ofthe companyÕs financial report-ing process may continue evenafter the ex-auditor joins thecompanyÕs management team.There is some concern that theaudit firm will be less likely todetect financial reporting prob-

36 The Journal of Corporate Accounting & Finance

© 2000 John Wiley & Sons, Inc.

Most importantly, when a companyhires directly from the audit staffexamining the company’s financialstatements, the former auditor isintimately familiar with the client’sbusiness strategy, financial reportingprocesses, and industry peculiarities.

lems in subsequent audits afteran ex-auditor joins a client. Twofactors contribute to this con-cern. First, the remaining mem-bers of the audit team may bereluctant to question formeraudit firm colleagues who arenow part of the client manage-ment team, particularly when theformer auditor previously super-vised the current audit team nowresponsible for the audit engage-ment. In this situation, the cur-rent audit team overrelies ontheir trust and confidence in thereliability of the former auditfirm colleague and fails to exer-cise the typical level of profes-sional skepticism towards thejudgments and decisions nowbeing made by that individualÑwho is now a member of theclient management team.Second, the ex-auditor hasa detailed understanding ofthe audit firmÕs plan andstrategy, providing usefulknowledge of what his orher former firm does anddoes not look for duringthe conduct of an audit.Such knowledge mayenable the ex-auditor todesign a misstatement thatis unlikely to be detectedby his or her former firm.

REGULATORY INITIATIVESADDRESSING THE RISKS

Because of these issues, theSecurities and ExchangeCommission (SEC) has expressedconcern with ex-auditors accept-ing employment with auditclients. They have identified situ-ations where ex-auditors wereemployed in audit sensitive posi-tions in several high-profile casesof fraudulent financial reporting.

Partially as a result of theSECÕs concerns regarding auditindependence (including situa-tions where auditors join

clients), the accounting profes-sion created the IndependenceStandards Board (ISB) to over-see independence issues associ-ated with audits of public com-panies in the United States. TheISB, which was created in 1997,is responsible for developingstandards of audit independencethat are binding on all SEC reg-istrants and their auditors. Oneof the issues currently on theISBÕs agenda is a project thataddresses the issue of accountingfirm personnel acceptingemployment with an audit client.

The ISB has a task force thatis currently studying this issue ingreater depth. As a result of thework of this task force and theISBÕs own staff, the ISB issuedin early 1999 a discussion mem-orandum, titled ÒEmployment

with Audit Clients,Ó thatdescribes the issue, potentialrisks associated with acceptingemployment with an audit client,and potential remedies to theperceived problem. The tworemedies suggested in that dis-cussion memorandum include(1) a mandatory Òcooling-offÓperiod and (2) additional auditfirm safeguards.

Under the mandatory cool-ing-off period remedy, an auditfirm individual would be pre-cluded from leaving an account-

ing firm to join an audit clientfor some period of time (oneyear being the most likely timeperiod). Because such anapproach might face substantiallegal challenges from individualssought by the client, some haveargued that the burden for imple-menting the cooling-off periodwould likely be shifted from theindividual to the audit firm. Inthat case, the penalty would beincurred by the firm, whichwould be deemed as not beingindependent of a client if thatclient successfully hired certainemployees of the accountingfirm during the past year.

As an alternative to themandatory cooling-off period,additional firm safeguards havebeen suggested as remedies.These firm safeguards include

actions that the audit firmwould take in the year thatthe ex-auditor resignedfrom the firm as well asactions that the audit firmwould take in the subse-quent year. One remedywould require that the workperformed on the auditengagement by the ex-audi-tor prior to his or her resig-nation be reviewed by anindividual in the firm atleast one level higher thanthe departing employee.This review would assess

the objectivity and impartiality ofthe work performed by thedeparting professional. In the cir-cumstance when the departingemployee formerly served as theengagement partner, the safe-guard would require a review ofthe departing partnerÕs work byanother partner, who is not amember of the companyÕs auditengagement team. To protect theintegrity of future audits, the newaudit partner should be viewed asat least a peer (in terms of staturewithin the firm) of the departing

May/June 2000 37


As a result of the work of this taskforce and the ISB’s own staff, theISB issued in early 1999 a discussionmemorandum, titled “Employmentwith Audit Clients,” that describesthe issue, potential risks associatedwith accepting employment with anaudit client, and potential remediesto the perceived problem.

partner. In addition, the nextyearÕs audit would be subject to adetailed internal firm review toassess compliance with the firmÕspolicies in the areas of independ-ence, integrity, objectivity, andengagement performance. Also,audits where a former audit pro-fessional has joined a clientwould be among the engage-ments examined during the firmÕsnext regularly scheduled peerreview. Finally, relationshipsbetween the remaining membersof the audit team and the depart-ing professional would bereviewed to determine if there isthe need to replace one or moreof the remaining engagementmembers with new personnel.

The ISB received 28written comments on thisdiscussion memorandum.The overwhelming majorityof the respondents favoredthe alternative safeguardsremedy rather than themandatory cooling-off peri-od remedy. The ISB recent-ly released an ExposureDraft (ED 99-2),ÒEmployment with AuditClients,Ó of a proposedindependence standard onaccepting employment withan audit client. The ED rec-ommends adoption of thesafeguards remedy.

WHAT DOES THE EVIDENCESAY?

While the perceived damagesto financial reporting integrityassociated with hiring audit firmpersonnel encouraged the ISB, atthe SECÕs insistence, to addressthe issue of an audit firm employ-ee joining a clientÕs managementteam, there is little empirical evi-dence on actual damages to thefinancial reporting process thathave occurred preceding or fol-lowing such a move. In a recent

(1999) study commissioned bythe Committee of SponsoringOrganizations of the TreadwayCommission (COSO), we exam-ined instances of fraudulentfinancial reporting between 1987and 1997 and found some evi-dence of financial statementfrauds surrounding the movementof personnel from an accountingfirm to an audit client.

In that study we examinedSEC enforcement actions issuedbetween January 1987 andDecember 1997 that involved analleged violation of a financialstatement fraud-related SECstatute. After reading more than800 enforcement releases, weidentified nearly 300 unique

instances of financial statementfraud in that 11-year period.From this group of 300 compa-nies, we selected a random sam-ple of approximately 200 fraud-related companies to examine indetail. As a part of that study, wegathered the last proxy statementissued to shareholders during thefraud period. There were 99proxies available. These proxystatements often provided usdetailed information about thebackground and experience ofthe company executives.

A detailed description of theCFOÕs background was available

for 44 of these 99 companies. Infive of these 44 cases involvingfinancial fraud (11 percent), thecurrent CFO had previous expe-rience with the companyÕs auditfirm immediately prior to joiningthe company. A description ofthese five alleged fraud casesfollows to provide real-worldexamples of the pitfalls that canoccur when audit team membersare hired to join the companyÕsexecutive team in a key financialreporting role. While fewinstances of hiring former auditfirm personnel lead to financialstatement fraud, these examplesshow that the perceived concernscan be realizedÑand that theyoften lead to serious damages for

the companies, audit firms,and individuals involved.

Chambers DevelopmentCompany, Inc.

Chambers Develop-ment, Inc. was in the busi-ness of collecting, hauling,and disposing of solidwaste; building and oper-ating solid waste sanitarylandfills; and performingrelated operations. Thecompany and certain of itsofficers were charged withincluding fraudulently

misstated financial statements inForm 10-Ks and 10-Qs filedwith the SEC between 1989 and1991. The alleged violationsinvolved understating expensesand overstating earnings andassets by improperly capitalizingand deferring certain costs.

As it turns out, in August1990, Chambers hired the man-aging partner of GrantThorntonÕs (GT) Pittsburghoffice as its new CFO. This indi-vidual was the partner in chargeof GTÕs audit of ChambersÕfinancial statements between1983 and 1989. GT issued



In a recent (1999) study commis-sioned by the Committee ofSponsoring Organizations of theTreadway Commission (COSO), weexamined instances of fraudulentfinancial reporting between 1987 and1997 and found some evidence offinancial statement frauds surroundingthe movement of personnel from anaccounting firm to an audit client.

unqualified audit reports onChambersÕ financial statementsin each of these years and issuedan unqualified audit report onChambersÕ financial statementsin 1990, the year after the formerpartner joined Chambers as CFO.

The SEC alleged thatChambersÕ new CFO knew of theimproper expense capitalizationmethod employed by Chambersby early 1989 (when this individ-ual was still the GT partner incharge of the Chambers audit),and indicated that this methodwas acceptable under generallyaccepted accounting principles(GAAP). In 1990, when the for-mer audit partner was ChambersÕnew CFO, GT continued to auditChambersÕ capitalization figuresusing procedures developed andapplied in prior years under thedirection of the former auditpartner. In addition, the SEC alsoalleged that the new CFO/formeraudit partner actively participatedin the fraud by instructingChambersÕ controller to cap-italize whatever expenseswere necessary in order tomeet earnings targets forthree of the fiscal year 1991quarters. ChambersÕ CFOwas charged with multipleviolations of SEC statutes,including fraud-relatedstatutes under both the 1933and 1934 Securities Acts.This individual was perma-nently denied the privilege ofappearing or practicing beforethe SEC as an accountant.

Another interesting aspect ofthe fraud at Chambers was thattwo other individuals (both ofwhom served as corporate con-troller at different times duringthe fraud period) had prior expe-rience on the audit staff of GTÕsPittsburgh office. The SECcharged both of these individualswith violations of the securitieslaws as well.

Monarch Capital Corporation,Inc.

Monarch Capital Corporationoperated in the financial servicesindustry by offering a variety offinancial products and services,including variable life insurance,disability income insurance, andannuities, to its clients. The com-pany and certain of its officerswere charged by the SEC forallegedly including false finan-cial statements in a Form 10-Kfiled for fiscal year 1989, and inForm 10-Qs filed during the firsttwo quarters of 1990. Duringthose years, Monarch had bor-rowed large sums of money fromMonarch Life, MonarchÕs princi-pal subsidiary. Monarch LifeÕsreceivable from Monarch CapitalCorporation represented 91 per-cent of Monarch LifeÕs statutorycapital. Monarch CapitalCorporation used the amountsborrowed from Monarch Life to

fund its real estate investments ata time when there were signifi-cant declines in real estate mar-kets nationwide, with suchdeclines hitting the northeasternpart of the United States particu-larly hard. Unfortunately,Monarch was located in thenortheast. Monarch CapitalCorporation failed to disclosethat Monarch Life was the majorinternal source of its liquidity,which violated SEC disclosurerules for the management discus-

sion and analysis section of theForm 10-K. Monarch also over-stated net income for the secondquarter of 1990 due to its failureto recognize impaired real estatevalues.

Prior to the issuance of thosemisstated financial statements,Monarch hired as its new CFO aformer Ernst & Whinney (E&W)partner who worked on theMonarch audit engagement. Thisindividual worked for E&W forover 20 years and was the firmÕsnational director of services tothe insurance industry at the timehe left the firm. The SECenforcement action indicated thatthe CFO/former audit partnerworked on the Monarch engage-ment prior to his departure fromE&W. The SEC charged thisindividual with multiple viola-tions of SEC regulations, includ-ing the fraud-related statute underthe 1934 Securities Act. The SECimposed a Òcease and desistÓ

order on the Monarch CFO.

Platinum SoftwareCorporation

Platinum SoftwareCorporation developedand marketed financialsoftware. The companyand certain of its officerswere charged by the SECwith engaging in anaccounting scheme to

fraudulently overstate PlatinumÕsrevenue and earnings betweenMarch 1993 and January 1994.The SEC alleged that membersof the companyÕs managementteam backdated and withhelddocuments from its auditors,manipulated the companyÕsaccounting records, andemployed side letters giving cus-tomers the right to return pur-chased software, even thoughthese sales were recognized inPlatinumÕs financial statements.

May/June 2000 39


Another interesting aspect of thefraud at Chambers was that twoother individuals (both of whomserved as corporate controller at dif-ferent times during the fraud period)had prior experience on the auditstaff of GT’s Pittsburgh office.

The existence of these side let-ters was hidden from the audi-tors, and Platinum improperlyrecognized revenue on thesesales in its financial statements.

Prior to the issuance of thesefinancial statements, Platinumhired a new CFO in July 1992. Atthe time of hiring, that individualworked for PlatinumÕs externalaudit firm, Arthur Andersen,where he had been employed forat least five years. The formerauditorÕs last position withinArthur Andersen (AA) involvedhis serving as the partner-in-charge of Arthur AndersenÕsEnterprise Group andBusiness SystemsConsulting Practice inIrvine, California. TheSECÕs enforcement releasewas silent as to whetherPlatinumÕs CFO everworked on the Platinumengagement whenemployed at AA. However, itis worth noting that Platinum washeadquartered in Irvine,California. PlatinumÕs CFO wascharged with multiple violationsof SEC statutes, including fraud-related statutes under both the1933 and 1934 Securities Acts,and was permanently denied theprivilege of appearing or practic-ing before the SEC as anaccountant. Additionally, he was:

¥ Permanently enjoined fromviolating the antifraud provi-sions of the securities laws;

¥ Required to disgorge tradinglosses avoided and bonusesreceived, and was requiredto pay prejudgment interest;

¥ Barred from serving as anofficer or director of a publiccompany for ten years.

Silk Greenhouse Inc.

Silk Greenhouse sold,through warehouse-style stores,

artificial flowers, plants, andother related items. The compa-ny and certain of its officerswere charged by the SEC forincluding fraudulent financialstatements in the Form 10-Qfiled for the third quarter of1990. The SEC charged SilkÕsmanagement with creating ficti-tious documents and for back-dating legitimate documents tojustify fraudulently recordedtransactions. The financial state-ments included in SilkÕs 1990third quarter 10-Q included thefollowing GAAP violations:

¥ Improper deferral ofChristmas ÒsetupÓ expenses;

¥ Improper deferral of adver-tising expenses; and

¥ Understatement of liabilitiesand expenses.

In December 1986, just afew years before this allegedfraud occurred, Silk hired a for-mer audit manager at PeatMarwick & Mitchell (PMM) asits new CFO. This individualworked at PMM for at least theprevious five years and servedon the Silk audit engagementteam before joining Silk as CFO.This individual was latercharged with multiple violationsof SEC regulations, includingthe fraud-related statute underthe 1934 Securities Act for inap-propriate actions as SilkÕs CFO.He was denied the privilege ofappearing or practicing beforethe SEC as an accountant in thefuture.

SilkÕs vice president offinance, who previously workedfor PMM prior to joining SilkÕsmanagement team, also wascharged by the SEC for multipleviolations of SEC statutes,including the fraud-relatedstatute under the 1934 SecuritiesAct. He was denied the privilegeof appearing or practicing beforethe SEC as an accountant.

Westwood One

Westwood One owned andoperated one of the nationÕslargest radio networks at the

time an alleged fraudulentfinancial reporting prob-lem occurred. The compa-ny and certain of its offi-cers were charged withincluding fraudulent finan-cial statements in reportsfiled with the SECbetween March 1987 andDecember 1988.

According to the SEC, the viola-tions of GAAP included fraudu-lent revenue recognition,improper capitalization ofexpenses, and inadequate disclo-sure. In the area of revenuerecognition, Westwood front-endloaded the recognition of rev-enue on barter transactions andrecognized revenue beforeadvertisements were broadcast.In addition, Westwood issuedside letters to customers thatcalled into question the validityof immediately recognizing rev-enues for those transactions.WestwoodÕs CFO convinced anonfinancial employee of one ofits customers to deny the exis-tence of any side agreementswhen that employee wasresponding to an audit confirma-tion of accounts receivablerecorded on WestwoodÕs books.Westwood also failed to recordother material accounting journalentries proposed by its auditor.



In the area of revenue recognition,Westwood front-end loaded therecognition of revenue on bartertransactions and recognized revenuebefore advertisements were broadcast.

Westwood hired a formerauditor (a Price Waterhouse[PW] employee) to serve as itscontroller in May 1985. Whilethe SECÕs enforcement releasedid not disclose the title of thisformer PW employee, he waslikely at least a manager at thetime he left PW, given that hehad eight years of experiencewith PW. By April 1986,Westwood had promoted thisindividual to vice president offinancial operations and chiefaccounting officer (CAO). SinceWestwoodÕs president also heldthe CFO title, WestwoodÕs VP offinancial operations and CAOappeared to be the senior finan-cial officer with nonoperatingresponsibilities.

The SECÕs enforcementrelease was silent as to whetherWestwoodÕs VP of financial oper-ations and CAO was involvedwith the Westwood engagementwhen he worked for PW.Regardless of whether this indi-vidual worked on the Westwoodengagement while at PW, he wasallegedly involved with the fraud.The SEC charged WestwoodÕsVP of financial operations andCAO with multiple violations ofSEC statutes, including fraud-related statutes under both the1933 and 1934 Securities Acts.The sanction imposed on thisindividual involved a cease anddesist order.

WHAT ISSUES SHOULD YOUCONSIDER BEFORE HIRING?

While these five exampleshopefully highlight worst-casescenarios when hiring formeraudit firm personnel to join acompanyÕs financial reportingteam, they emphasize the impor-tance of cautiously handling suchtransitions. Several actions can betaken before offering a senior-level financial position (e.g.,

CFO, controller, director of inter-nal audit) to an employee of youraudit firm. In these situations, thefollowing should be considered:

¥ Financial reporting reputa-tion of the hiring company;

¥ Characteristics of the indi-vidual under consideration;

¥ Background and likelyfuture actions of your auditfirm; and

¥ Circumstances surroundingthe hiring decision.

Exhibit 1 contains examplesof questions related to each ofthese categories that can be

posed. We present an overviewof the nature of these questionsin the sections that follow.

Financial ReportingReputation of the HiringCompany

Your companyÕs track recordfor issuing top-quality financialstatements will likely have apositive effect on the impact ofhiring a former auditor as a partof the management team. If yourcompany has a reputation fortransparent financial reporting,hiring an employee from youroutside accounting firm may be

May/June 2000 41


Factors to Consider Before Offering Employment to YourExternal AuditorI. Financial Reporting Reputation of the Hiring Company

• Does your company have a reputation for transparent financialreporting?

• Is the integrity of your top management beyond reproach?• Is the financial position of your company strong?

II. Characteristics of the Individual Under Consideration• Does the individual you are trying to hire possess a unique set of

skills that other potential candidates are unlikely to possess?• Does the individual you are trying to hire exhibit appropriate per-

sonality characteristics (e.g., objectivity, integrity, ethics)?• Does the candidate provide sufficient responses to inquiries about

his or her ability to ensure the external auditor remains objectiveand independent during future audits?

III. Background and Likely Future Actions of Your Audit Firm• Is your audit firm likely to implement effective safeguards to

reduce to an acceptably low level any risk of loss of independencedue to an individual from its firm joining a client?

• What specific steps does the audit firm plan to take in response toan individual from its firm joining your company?

IV. Circumstances Surrounding the Hiring Decision• Have you hired others from the audit firm in the recent past and/or

are you likely to do so in the near future?• Have you recently issued securities on the capital markets and/or

are you likely to do so in the near future?

Exhibit 1

viewed as a positive steptowards strengthening youraccounting and finance functionbecause of the benefits of hiringformer auditors previouslydescribed. Likewise, if manage-ment integrity is beyondreproach, hiring a former auditormay be less likely to raise ques-tions in the minds of capitalmarket participants as to theintegrity of past or future finan-cial reports. Finally, capital mar-ket participants are more likelyto assign positive motives toyour hiring a former auditor ifyour companyÕs financial condi-tion and perceived financialreporting reputation is strong.However, as the financial condi-tion of the company declines andas the companyÕs reputation forfinancial reporting quality weak-ens, subsequent employment offormer members of the externalaudit team may be greeted withincreased skepticism.

Characteristics of theIndividual Under Consideration

Given the potential for capi-tal market participants to assigna negative signal to the hiring ofan external auditor, the individ-ual under consideration shouldpossess a unique set of skills thatother candidates are unlikely tohave. In addition, if you dochoose to hire an employee of

your external auditor, you shouldseriously assess whether thatindividual possesses the charac-ter to withstand any pressures(internal or external) to compro-mise the integrity of your com-panyÕs financial reports. Explicitdiscussions with the candidateabout these concerns shouldoccur before any offer foremployment is extended to thecandidate.

Background and Likely FutureActions of Your Audit Firm

The likely actions of theaudit firm may be a moot point ifthe ISB issues an independencestandard that requires audit firmsto adopt additional safeguardswhen a former employee is hiredby a client. Until that time, how-ever, you should ascertainwhether your auditor is likely toimplement effective safeguardsto reduce to an acceptably lowlevel any risk of loss of inde-pendence due to your hiring aformer employee of its firm. Youshould also ask your audit firmto describe the steps and safe-guards they plan to implement.In addition, the companyÕs auditcommittee should consider dis-cussing the impact of this hiringdecision on the external auditorÕsability to conduct the engage-ment with the appropriate levelof objectivity and independence.

Circumstances Surroundingthe Hiring Decision

Before hiring an employeefrom the staff of your externalaudit firm, consider whether youhave hired other professionalsfrom that firm in the recent pastor plan to hire such individualsin the near future. A pattern ofoverpopulating the accountingand finance function with ex-employees of your accountingfirm might be troublesome tosome capital market participants.For example, in the ChambersDevelopment Company and SilkGreenhouse frauds, multiplefinancial employees allegedlyinvolved in the fraud all previ-ously worked on the externalaudit firmsÕ staffs before accept-ing the employment offers.Finally, hiring employees ofyour accounting firm around thetime that your company issuessecurities to the capital marketmight particularly concern somecapital market participants.

Hiring employees from youraccounting firm can offer yourorganization many benefits.However, as we have seen, thereare risks involved in hiring suchindividuals, including risks tothe integrity of the financialreporting process. But theserisks can be managed, and thesuggestions in this article willhelp you do so.



Mark S. Beasley, Ph.D., CPA, is an assistant professor in the Department of Accounting at North CarolinaState University. He is currently serving on the Fraud Steering Task Force of the AICPA’s Auditing StandardsBoard. Joseph V. Carcello, Ph.D., CPA, CIA, CMA, is an associate professor in the Department ofAccounting and Business Law at the University of Tennessee. He is serving as a member of the AcceptingEmployment with an Audit Client Task Force of the Independence Standards Board. Dana R. Hermanson,Ph.D., CPA, is cofounder and director of Research of the Corporate Governance Center at Kennesaw StateUniversity, where he is an associate professor of accounting. He was a member of the National Associationof Corporate Directors’ Blue Ribbon Commission on Audit Committees. All three coauthored the COSO-sponsored study, Fraudulent Financial Reporting: 1987–1997, An Analysis of U.S. Public Companies (1999).

Documents

Should you offer a job to your external auditor?