Mandatory Audit of Financial Reporting : A Failed Strategy for Dealing with Fraud

For three centuries, Anglo-American Governments have been creating regulation and governance reforms (including mandatory audit requirements) in reaction to fraud. The most recent attempt in the U.S. is the Sarbanes-Oxley Act (SOX). The Capital Markets Leadership Task Force Report in Canada (Boritz 2006) is consistent with this philosophy of providing comfort to investors that more mandatory audit procedures can protect them from fraud. I argue in this paper that government regulators have been selling investors a myth that auditing cannot live up to. Mandatory audit is an ineffective procedure for protecting investors from fraud. To protect investors from fraud, regulators can require all publicly traded companies to purchase fraud insurance. An alternative option is to de-regulate auditing, and let auditors find ways to create value for shareholders. The current regulatory system is distorting auditor incentives and has led to a short sighted audit profession. SOX (and the CMLTF report) do not fix any of the structural problems in accounting and auditing