We are going to explore the relevant facts from the case study, find the ethical issues, find choices for Jenifer, constraints, and then finally we will recommend what Jenifer should do.
Relevant Facts – ‘Fantastic Developments’ a private company is a potential client of Coshocton National Bank (CNB). Jennifer Grace, who is working on current year audit for CNB came to know that ‘Fantastic Development’, which had a bad financials, had applied for a loan to CNB with and excellent unaudited financial statement. Jenifer did an audit on Fantastic Development in the last financial year and found out about the companies struggling financial condition.
When Jenifer tried calling CFO of ‘Fantastic Developments’ she got to know that the company is doing well, as a result, the unaudited financial statement and more interestingly, she got to know that Fantastic Developments has engaged a new CPA firm for its accounting and auditing needs. That made Jenifer wonder, if ‘Fantastic Developments’ had anything to hide, in other words – if the unaudited financial statement she found during auditing CNB, might not be correct.
The fact of the matter is, Jenifer did not have a way to confirm her suspicion since her firm was not going to audit ‘Fantastic’ anymore, and there was no direct way to validate it. And Fantastic Development is a private company, so they are not going to make their finances public either, so there is no way to go to SEC and validate their financials.
Ethical Issues – In this situation, the ethical problem or dilemma, Jenifer knew about bad financials of the ‘Fantastic Development’ company (her former client) and wanted to share her suspicion with CNB (her current client), to warn them, but she did not have any proof to back her suspicion. Just based on suspicion going to CNB would not have been professional either. But then, there is another point we have to consider, ‘Fantastic Development’ was a former client, which is a private company, so probably it was not ethical for Jenifer to disclose their information to CNB ( her current client) without Fantastic’ s consent.
Jenifer, as an auditor of CNB, had the responsibility to find out problems and alert her client about them. And she found one potential problem. So here is another ethical dilemma. To fulfill her current responsibility ethically, she had to break the confidentiality of former client, and that too, based on a knowledge which is not current, and from last financial year, and there was no way she could substantiate her suspicions.
In case Fantastic Development is really trying cheat CNB with a fake financial statement, then informing CNB about that, and saving CNB from a potential loss making a deal is Jenifer’s obligations towards, CNB’s management, customer, shareholders.
On the other hand, if Fantastic Development’s financials are still bad like Jenifer suspects, and if they do not get the loan from CNB, then they can go bankrupt ( at worst case) and employees can lose jobs, management can lose their business and money.
Identifying Stakeholders – In this particular case, there are 3 parties involved, CNB, ‘Fantastic Development’ and Jenifer’s Audit firm. Stakeholders are shareholders, customers, employees, managers of all 3 companies. If anything bad or good happens these stakeholders feel the direct impact. So what Jenifer does right or wrong or what Tom Ward the CFO of Fantastic Development does right or wrong, impacts all stakeholders mentioned above.
Possible Alternatives – In the given situation Jenifer had few alternatives –
- Do nothing, complete audit with provided information, do not inform CNB
- Or she could inform the whole incident to CNB management and take it forward
- The last option was quitting CNB, in that way should have escaped the whole situation.
If Jenifer decides to let it go and not to inform CNB, that might result in a loss for CNB. Assuming Jenifer would still be the auditor, she won’t be able to do anything, even if she decides to tell the CNB management about her prior knowledge. So, letting it go is not ethical as it might result in a loss for CNB and ‘Fantastic Development’ would get away with the financial crime.
2nd option is to inform CNB about what Jenifer knows with the disclaimer that she was the auditor and she knew that the company had bad financials, and she suspects that the financial statements ‘Fantastic Development; has provided is fake. As long as doing this does not violet Jenifer’s company policy, there is no problem doing this, in case it does violet a policy she should seek her management’s consent first. Trying to help current client seems to be ethical, fulfilling her professional responsibilities and obligations. But this is not legal, AICPA Code of Professional Conduct includes a new Confidential Client Information Rule under Section 1.700.001, which expands the guidance on maintaining the confidentiality of client information (Blatch, 2015).Per this law she cannot divulge one client’s information to anyone else. Although, it might appear that since she is not going to work form ‘Fantastic Developer’ anymore, she does not have a professional obligation to serve their interest. Moreover, as a client, CNB has a right to know about any potential fraudulent financial statement. As long as Jenifer does not violet ay code of conduct, it is only justified that she tries to fulfill her professional obligation by providing the information she has to CNB and make them aware of the situation.
Trying to leave the situation is not going to professional, although she might avoid any obligation, this option is neither ethical nor responsible.
Practical Constraints – Jenifer might face few practical constraints, even if she wants to let NBC know about what she knew about “Fantastic Developer’s” financials. The first constraint might be her own company policy that might stop her from disclosing client’s financial information to another client. And Jenifer needs to talk to her management and compliance team to get an exception. If Jenifer violets, some laws or company policy, that might end up badly for her.
Next constraint is, Jenifer does not have any proof that Tom Ward did not tell her the truth. The company might have really turned around. Since the company is private, they won’t disclose their finances to the public or to SEC. And the financial they have provided to CNB are unaudited, so they can claim later that there were some mistakes.
With so many changing parts, it will be hard for Jenifer to go to CNB management and make a compelling point. Since she is auditing them for the first time, she does not have a great relationship either ( I am making an assumption here). So, in case Jenifer’s suspicion turns out not to be true, she will lose credibility. And the CNB might think, Jenifer is not an Auditor they can trust their information with, because in future she can go to another client of CNB and disclose their information to them. So, Jenifer might get fired.
Specific Action – Jenifer should talk to her leadership team and compliance team first, to find out what she should do in this situation. Most probably, she cannot legally disclose one client (previous or current) information to another client. But, if her superiors or compliance team or the organization policy stops her from disclosing information to CNB, she can always do her professional duty in another way. She can highlight to CNB that “Fantastic Developer’ is a private company and their financials are not available to SEC, so they should ask for audited financial reports. The PCAOB’s rules require auditors to provide “reasonable assurance” that the financial statements they’ve reviewed “are free of material misstatement whether caused by error or fraud (Johnson, 2010).” If possible she should recommend getting prior financial reports too, just to make sure they have a consistent cash flow to repay the loan they intend to take. But, before making these recommendations, she should check with superiors, just to make sure this is the acceptable approach to address the issue.
Blatch, M ( March, 2015). AICPA’s revised confidentiality rule and Sec. 7216. Retrieved from https://www.journalofaccountancy.com/issues/2015/mar/aicpa-confidentiality-rule.html
Johnson, S (April, 2010). What Is the Auditor’s Role in Finding Fraud?. Retrieved from http://ww2.cfo.com/accounting-tax/2010/04/what-is-the-auditors-role-in-finding-fraud/