A Fundamental Weakness in Auditing: The Need for a Conspiracy Theory

The existence of a conspiracy may make the detection of a fraud by an auditor less probable, because of the ability of conspirators to falsify apparently independent items of evidence. At the same time, the existence of a conspiracy makes detection by management or other agencies more probable because of the chance that one of the conspirators or someone who has been approached to join the conspiracy will report the fraud. However, the discovery of major conspiracies to commit fraud and financial crime in companies, such as Enron and the Madoff Investment Securities case, where the auditor was himself convicted as one of the conspirators, suggests the need to re-evaluate the reasonability of asking auditors to assess the risk of a criminal conspiracy existing and the probability of financial crimes committed by the conspirators remaining undetected. This paper proposes a model for the auditor to use in making such an assessment, thereby enhancing the auditor's assessment of the reliability of the overall audit.