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This paper, which in part includes historical analysis, examines the following questions: (a) Whose duty is it to guard against fraud, misappropriation and defalcation perpetrated by the employees? (b) To what extent are auditors and directors directly responsible for such detection and prevention? The issue will be analysed and explored from cases originating from the UK and Australia.

The term ‘policy’ as used by the judges is mainly concerned with whether third parties should be allowed to recover economic loss suffered by them as a result of professional negligence. The answers to the question of recovery of economic loss in negligence are not easy, as judges seem to be divided on this issue. Some judges feel that in some cases beyond physical damage and reliance, economic loss should be recoverable in negligence, while others fear indiscriminately opening the floodgate of liability.

Forgery is not an oft‐discussed subject. Detailed discussion of forgery by banks and other financial institutions all over the world is a taboo, ‘for fear of sowing the seeds of fraudulent schemes in other ingenious heads’. This is obvious. For once a loophole is identified and discussed, it has to be permanently plugged and sealed, which the bankers perhaps find an arduous task as it costs money and leads to the necessity of cumbersome and time‐consuming procedures being adopted. This paper will analyse the offence of forgery, the definition and the modus operandi of forgery and a sample of forgery cases in the UK and the USA.

Discusses the different roles played by directors, shareholders and auditors in ensuring the success of a company. Outlines the responsibilities of the directors, pointing out the risks that directors may bully auditors; also that a persistently questioning director, especially a non‐executive director, will be labelled as a trouble maker and not be listened to. Argues that shareholders and auditors cannot be linked in a way that would effectively supervise the conduct of directors. Concludes that directors need to be properly monitored: shareholders have failed to do this, so the audit committee needs to ensure that directors do their duties. Shows how an effective audit committee can be set up.

Explains the audit process: its purpose is to check that balance sheet and profit and loss accounts have been prepared properly and give a true view of the company’s affairs. Shows why this is needed, plus the statutory requirement, engaging an auditor, the contractual relationship between accountant‐auditor and client, the audit plan, materiality (ie what is important), and internal control (ie how the company is safeguarding its assets). Focuses next on the financial report, distinguishing between qualified and unqualified audit reports: a qualified report is issued when the auditor cannot form an opinion and the financial statements do not conform to the UK GAAP, and gives an example: the Butt Mining Company and auditing firm Ernst and Young. Ends with the Polly Peck International case, where the limitations of the annual audit process were illuminated.

Analyses, from reported cases, the causes of failures in business and the lessons that can be learnt. Explains risk management and insurance, the differences between salaried employment and self‐employment, business size, borrowing and financing the business. Gives some case studies which focus on lending to property developers and covers issues relating to the business of the developer, loan recovery, overcommitment and damage limitation, and borrowing to repay past debts. Concludes that lenders in these cases seemed relatively unconcerned with borrowers’ abilities to run their businesses properly, why they wanted the money, or the success of the businesses; they were satisfied with sureties of property as security, while judges seemed reluctant to penalise their irresponsibility. Recommends how this should be remedied.

Focuses on independence as an essential component in preventing audit failures and why the audit profession needs to maintain independence to improve its services. Outlines the Code of Professional Conduct from the Accountancy Body, and the draft rules on ethics by the joint accountancy committee in 1993. Indicates what the threats are to independence: being indebted to a client company, receiving a recurring fee which is over 15% of the practice’s gross fee, accepting a loan from a client or goods and services on favourable terms, owning shares in it, and so on. Suggests that responsibility for appointing auditors should be handed back to shareholders, that auditors should be rotated every three years, and that a limit be put on the proportion of the auditor’s income from a single client.

Defines fraud as deliberate deception to obtain illicit material gain, and includes embezzlement and asset misappropriation in the definition. Assesses what constitutes auditors’ breach of duty to clients, and who is responsible for fraud monitoring and reporting, and refers to the UK Auditing Practices Committee guidelines. Analyses some causes of failure to prevent fraud; these include lack of clear responsibility for preventing it, and regarding security as too expensive. Argues that it is the responsibility of company management to prevent fraud by maintaining proper accounting records, rather than relying on auditors to detect it, although in the UK auditors are responsible for detecting material fraud. Considers auditing an art rather than a science, and opposes suggestions that auditors should assess the financial viability of a company; auditors’ responsibilities already tend to exceed their powers as whistleblowers.

Describes the 19‐point code of corporate governance produced in 1991 by the Cadbury Committee, which was set up by the Stock Exchange, the Financial Reporting Council and the accounting profession; the aim was to improve the standard of corporate governance in Britain. Outlines its narrow terms of reference, which were to spread the boardroom practices of the best run companies to the rest, rather than to reform practice; the main issues covered were board responsibilities, directors’ qualifications, audit rotation, audit committee and auditor liability. Lists the Confederation of British Industry’s reasons for rejecting some of its proposals, proposals rejected by the Committee itself, general criticisms of the report, and Canadian reaction to it as expressed in the Toronto Stock Exchange committee report. Concludes that the Code, though voluntary and lacking enforcement power, is likely to impact on auditors, upon whom it relies as watchdogs to alert the public, especially as it criticises them for charging high consultancy fees.

Shows how the Securities and Exchange Act and the Racketeer Influenced and Corrupt Organizations Act 1970 (RICO) in the USA impose additional burdens on auditors in the detection of accounting errors, irregularities and fraud, compared with other countries like the UK; this is in addition to the generally high levels of US litigation against professional people because of factors like contingency based legal fees, class actions, and jury trials. Outlines the history of protection of investors by law since the stock market crash of 1929, the Acts’ provisions, and cases arising from them: the Securities Act is concerned with disclosure, and the Exchange Act with trading in securities. Moves on to the provisions of the RICO, which makes accountants criminally liable for mail and securities fraud and for knowingly issuing negligent audit reports, arguing that the original intentions of the Act have widened so far that accountants have become insurers of business failures at triple the losses suffered by the businesses.