Role of Auditors in Due Diligence Process

The AICPA recently issued a draft white paper addressing the appropriate role of an issuer’s auditor in the securities offering due diligence process. The draft suggests that auditors should be playing a much more limited role than is currently the practice. For example, the draft states that it is not appropriate for an auditor to address in writing or orally questions from the underwriters regarding (1) specific line items in the financial statements, (2) the auditor’s required communication with the issuer’s audit committee, (3) internal control matters, (4) the auditor’s awareness of fraud or illegal acts, (5) the completeness of the MD&A, or (6) the completeness and accuracy of the registration statement.

The Securities Industry Association and the Bond Market Association recently issued a joint letter condemning the draft. They assert that adoption of the white paper “jeopardize[s] investor protection by putting an end to auditor involvement in due diligence and crafting disclosure” and “disenfranchise[s] investors and the public from the process.”

I find the white paper puzzling considering that in a public offering the auditor is a potential section 11 defendant along with the issuer, its directors and the underwriters. Hence, it is in all these parties best interests to strive for an accurate and complete registration statement and to that end to facilitate a thorough due diligence review. Greatly curtailing auditor participation obviously does not advance this goal. Granted, the auditor is only on the hook for material misstatements or omissions in the audited financial statements and not with respect to any other part of the registration statement.  But active participation in the due diligence process by the auditor may lead to the underwriter uncovering problems in the financial statements or to disclosure being added to the prospectus so that developments at the company after the date of the financial statements are not considered to have rendered the financial statements misleading. The whole point of section 11 is to motivate the parties that play a direct role in the public offering process (this includes the auditors) to get the registration statement accurate and complete so that investors can make an informed investment decision.  Many of the proposals in the draft white paper hamper this goal.
[Bill Sjostrom]