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Fraud can be an auditor's defense.

A Pennsylvania federal court ruled that business owners who engaged in fraudulent conduct could not sue their auditors, but third parties who relied on the auditor's reports could. The owners and top management of Housing Mortgage Corporation were involved in a massive scheme to defraud HMC's creditors, Specifically, HMC's owners diverted funds front escrow accounts held by HMC and misused millions of dollars in loans. The corporate entity and various third-party plaintiffs who extended financing to the company sued Grant Thornton, which had prepared HMC's 1989, 1990 and 1991 audits. They alleged that the firm had failed to investigate and detect suspicious actions by HMC's management which, if explored, would have revealed fraud.

The auditor asserted that HMC's owners and management were all involved in a scheme to defraud HMC's creditors and, therefore, no one at HMC relied on the auditor's audit reports. The court ruled for the firm, saying that when owners dominated the corporation's operations, their knowledge of fraud was the same as the corporate plaintiff's knowledge.

However, the court took a different view regarding third parties, who in this case were known to the auditors, and allowed them to proceed with an action. HMC had an obligation either to provide these parties with a single audit report or to allow each party to send a team of auditors to review HMC's financial statements. That is, third parties have a right to a proper audit. Since these parties were intended beneficiaries of the auditor's work product, the court rejected the firm's motion to dismiss this claim.

This case is significant to accountants because it recognizes management fraud as an auditor defense against a client's action. However, it does allow third parties to bring a case against a firm, if they are specifically named or acknowledged by the auditor. (PNC Bank, Kentucky, Inc. v Housing Mortgage Corp. 899 F.Supp, 1399)
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Title Annotation:PNC Bank, Kentucky, Inc. v. Housing Mortgage Corp.
Author:Baliga, Wayne
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Jul 1, 1996
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Next Article:Reckless conduct sufficient to sustain fraud claim.

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