Compliance with IFRS as a defence against criminal charges

The  landmark case of United States v Simon (1969) 425 F 2d 796 (which is sometimes referred to as the Continental Vending case) involved criminal prosecution  of the  auditors for certifying  financial  statements which  they knew to contain false information. 

The president ofContinental Vending  Corp, Mr Roth  (who owned about one quarter of the company's shares),  had  borrowed  large sums of money from   an   associated   company,  Valley   Commercial    Corp,   which   was effectively  controlled   by  Roth.   Valley   had,   in   turn,   borrowed   from Continental in  order   to  finance  these  transactions.  During   1962,  Roth informed  the anditors  that Valley was unable to repay a $3.5 million loan to Continental because he was unable  to repay Valley.  However,  he subsequently pledged  collateral   (consisting  rnainly  of Continental shares worth less than  $3 million),  to Valley.

The auditors accepted  this arrangement and issued an unqualified  report

concerning the 1962 financial statements, which included a note stating  that the  loan  to Valley  was fully collateralised. Continental was subsequently liquidated, and  Roth  was convicted  and  imprisoned  for filing false statements and  related  offences

The  auditors were  sued  by  the  company   for  the  losses which  it  hadsustained, and  the suit  was settled  in 1967 for approximately $2  million. They were also prosecuted and convicted for failing to disclose in their report the dishonest transactions of which they had knowledge. The conviction was recorded    notwithstanding  the   fact   that   the   effect  of  the  fraudulent transactions was immaterial in terms of the financial statements as a whole, and need not have been disclosed in terms of generally accepted accounting practice.

The   auditors' defence   relied  largely   upon   eight  independent  expert witnesses all of whom  testified that  neither  generally  accepted  accounting principles  nor generally accepted  auditing practices  required  disclosure of the items in question. Rejecting the  relevance  of this evidence,  the judge instructed the jury that the 'critical  tese was whether the balance sheet fairly presented  the financial  position, 'without reference to generally accepted accounting principles'. The  key points  arising  from  the judgment may  be summarised as follows:

(1)  Proof that certified information is in compliance with generally accepted accounting principles  is evidence  which may  be very persuasive  but  is not necessarily conclusive evidence  that an auditor acted  in good faith.

(2)  The critical  test for financial statements is: do they fairly present the true state  of affairs?

(3)  Auditors have a duty  to reveal known  dishonesty  by a high corporate officer, irrespective of the materiality of the amounts concerned.

(4)  Sufficient evidence of criminal intent need 'not show that the defendants were wicked men with designs on anyone's purse which they obviously were not, but rather that they had certified a statement knowing it to be false'.

The  audit  manager and  two partners were fined a total  of $17,000  and their   practising certificates   were  revoked.  The   United States   Court   of Appeals refused to overturn the decisions of the lower court.  Friendly J made the telling statements that:

Generally accepted accounting principles instruct an accountant  what to do in the usual case where he has no reason to doubt  that  the affairs of the corporation  are being honestly conducted. Once he has reason to believe that this basic assumption is false, an entirely different situation  confronts him. Then  ... he must extend  his procedures to determine whether or not such suspicions are justified. If, as a result of such extension, or as here, without it, he finds his suspicions to be confirmed, full disclosure must be the rule.

The first law for accountants is not compliance with generally accepted accounting principles but, rather, full and fair disclosure, fair presentation. And, if principles did not  produce  this  brand  of disclosure,  accountants   could  not  hide  behind  the principles.

It simply cannot be true that an accountant  is under no duty to disclose when he has reason to believe that, to a material extent, a corporation  is being operated  not tocarry out its business in the interests of all stockholders but for the private benefit ofits

president.

The  outcome  of the case generated widespread  apprehension among accountants in the United  States, as it casts considerable uncertainty upon the  legal  propriety  and  therefore  the  utility  of auditing and  accounting standards, in a very general  sense, It  also established  that  auditors in  the United States have a legal duty to make full disclosure to shareholders if they have  reason  to believe that  the directors  have committed a dishonest  act which affects the financial statements, regardless of whether the matter needs to be disclosed in terms of GAAP, or whether  it is material  to the financial statements as a whole.