Fraud is one of the most significant risks any business faces today. Failed fraud detection often results in costly claims for accounting firms, even when auditors follow professional standards.
In a recent Risky Records interview, defense attorney Ralph Picardi shared an eye-opening story of a $7 million fraud that went undetected for years. His insights shed light on how auditors can strengthen their practices, protect clients, and defend themselves when litigation arises.
Why fraud detection in accounting is so challenging
Fraud schemes are often designed to evade detection, and as Picardi explains, one of the most common audit-related claims is the alleged failure to detect fraud. Unlike tax errors or minor misstatements, these cases often involve trusted employees stealing in small increments over long periods of time.
The moving company case illustrates how such schemes slip under the radar.
In this instance, a long-time bookkeeper used a voided check scheme to siphon money for over a decade. Because the thefts were small and consistent, they stayed below materiality thresholds and did not appear suspicious during standard audit sampling. By the time the fraud was discovered, the company had lost millions.
For accounting firms, the lesson is clear: fraud detection in accounting is not always straightforward. Even when auditors follow professional standards, fraud can be structured in ways that make it challenging to uncover.
Also read: Top Six Misconceptions in Claims Handling: What Accountants Should Know
Internal controls matter
The moving company’s leadership transition was critical in enabling the fraud. The original owner enforced strong oversight, personally reviewing bank statements and maintaining tight control. After a new CFO took over, that culture of oversight disappeared. The bookkeeper, already deeply embedded in operations, suddenly had room to act without scrutiny.
Picardi noted two essential safeguards every auditor should emphasize with clients:
- Separation of duties: No single employee should control every stage of a financial process.
- Strong management oversight: Leadership must remain engaged, especially in small organizations where segregation is difficult.
Without both safeguards, companies create an environment where fraud can thrive. For auditors, documenting warnings to clients about these vulnerabilities is vital.
Comparative negligence as a defense
When the moving company sued its auditors, alleging failure to detect fraud, Picardi and his team relied on a legal principle called comparative negligence. This defense allows courts to assign blame proportionally between parties.
In this case, the jury could consider whether the audit firm met its professional standard of care and whether the client’s leadership bore responsibility for weak internal controls. Because the CFO failed to implement oversight and ignored risks, much of the fault shifted away from the accounting firm.
Ultimately, a $7 million claim was settled for about $100,000, a significant outcome for both the auditors and their insurer.
Documentation and skepticism are key
Picardi emphasized two practices that can make or break a defense case:
- Thorough documentation: Auditors should keep detailed records of guidance provided to clients, including management letters, emails, and follow-up notes. Documentation shows the firm met its professional duty, even if fraud later surfaces.
- Professional skepticism: Auditors at every level must maintain a questioning mindset. Changes in client leadership, unusual employee behavior, or inconsistencies in financial data should prompt deeper inquiry.
As Picardi put it, skepticism is not something auditors can switch on and off. It is a constant requirement of the profession.
Building stronger firm practices
While no system can guarantee the discovery of fraud, firms can reduce their exposure by strengthening internal processes. Picardi pointed to several best practices:
- Regular training to reinforce risk awareness and technical skills.
- Open communication across all levels of the audit team, so junior staff feel comfortable raising red flags.
- Internal inspections of past engagements to identify gaps and improve quality control.
- Careful client selection and ongoing engagement risk assessments to avoid relationships with high-risk companies.
Together, these steps create a culture of vigilance that improves fraud detection in accounting and positions firms for a stronger defense if a claim arises.
Also read: How to Defend CPA Against Malpractice Claims: Managing Litigation Risk
The big takeaway for accounting firms
The moving company case underscores a difficult truth: even when fraud persists for years, auditors may still demonstrate they acted reasonably under professional standards. What matters is not perfection, but diligence, skepticism, and documentation.
As fraud schemes and detection processes grow more sophisticated, accounting firms must prioritize risk management internally and with clients. This means reinforcing oversight, identifying vulnerabilities, and maintaining thorough records of all communications.
Having strong Professional Liability Insurance, tailored to the unique risks of fraud detection and accounting, is one of the best ways to ensure your firm is well-equipped to defend its work.
To learn more about how tailored coverage can protect your firm against claims of fraud detection in accounting and related risks, visit McGowan Professional’s Professional Liability Insurance page.