March 26, 2012 Articles

Defending Audit-Malpractice Cases: The Audit-Interference Rule

The rule may restrict the type of client conduct that counts for purposes of apportioning fault.

By James H. Bicks and Robert S. Hoff – March 26, 2012

Getting a routine financial-statement audit is not the equivalent of buying an insurance policy. Auditors perform targeted procedures designed to provide reasonable assurance on whether a client’s financial statements are free of a material misstatement, whether caused by error or fraud. A financial-statement audit is not designed to root out fraud. Yet, when fraud or other bad acts have occurred during the period under audit, a lawsuit may be around the corner. When that lawsuit arrives, one of the key issues is often whether and how the client’s own negligence can be considered by the court or a jury.

For example, when an audit client has been the victim of embezzlement by its employee and claims the auditor was negligent in failing to catch the fraud, the auditor might argue that the client itself was negligent by failing to supervise the embezzler or by failing to follow its established internal controls. This sounds like a straightforward comparative-fault defense. But in some jurisdictions, auditors must contend with the “audit-interference rule.” The audit-interference rule may restrict the type of client conduct that counts for purposes of apportioning fault. In jurisdictions adopting the rule, an auditor may only assert a comparative-fault defense where it can establish that the client’s negligence “interfered with” the auditor’s performance of its duties.

Thus, the audit-interference rule can dramatically alter an auditor’s ability to defend a malpractice case. For example, in the above hypothetical, the audit-interference rule would preclude the auditor from relying on evidence that the client’s failure to follow its established internal controls allowed the embezzlement to go unchecked unless the auditor could show that the company’s failure to follow its internal controls interfered with the auditor’s ability to perform the audit. Absent other evidence, such as client misrepresentations to the auditor, this hurdle may be difficult to clear.

As we discuss below, the audit-interference rule is incompatible with the nature of the auditor-client relationship, in which both the auditor and client have important and distinct responsibilities. It is also inconsistent with modern comparative-fault rules, which seek to encourage parties to exercise their responsibilities with due care and to apportion fault among all wrongdoers.

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