32.4 HOW CORPORATE AMERICA AND EXTERNAL AUDITORS ACTUALLY VIEW
THE INTERNAL AUDIT FUNCTION. Views as how internal auditors can assist man-
agement in meeting the requirements of regulatory bodies, such as the SEC, the De-
partment of Defense, and the banking regulators (i.e., the Federal Reserve, the Comp-
troller of the Currency, the Federal Deposit Insurance Corporation, and numerous
state regulatory agencies) have been rapidly evolving. As banking regulators have
been constrained from growing their own budgets, they have put pressure on finan-
cial institutions to improve the quality of their internal audit functions. In conjunc-
tion with these efforts, external accountants have informed cost-conscientious man-
agers that better internal audit functions enable the former to reduce their efforts and,
accordingly, the fees they charge. There have been numerous situations where this
has indeed been borne out. However, there are those who argue that this has not been
substantiated. It is quite possible that the increased use of internal auditors for other
management functions reduce their time spent on testing the system of internal con-
trol and therefore the ability of external auditors to rely on the internal audit work to
effectively reduce the scope of their own audit testing of the various systems.
The task of substituting internal audit efforts for external audit work has been
more successful with external regulators who do not have the financial and staffing
resources that corporations do. Regulators have put pressure on corporations to put
more money into their internal audit functions. This allows regulators to focus on the
effectiveness of the internal auditor’s work versus performing the work themselves.
In fact, more recently, bank regulators have asked that the internal audit work not be
performed by the external auditors lest their independence be impaired.
As indicated previously, both external and internal auditors have argued that they
should not be responsible for the detection of fraud. They feel that management has
a comparative advantage here. Differences of opinion notwithstanding, the question
of fraud became significant in the 1980s. Frauds that drew widespread attention re-
lated to savings and loan associations, commercial banks, defense industries, as well
as insider trading activities. In the public view, these frauds were so blatant that it was
difficult to understand how the auditors could distance themselves from them.
Accordingly, auditors have adjusted their view on fraud. However, if they focus
totally on fraud, auditors will lose their value and credibility. Nevertheless, they are
resident experts that can help managers understand how frauds occur. As the con-
science of the organization, auditors are the best investigators of fraud. The biggest
mistake is to have a manager responsible for the area where fraud occurs, overseeing
the investigation. From a legal defense, as well as a corporate message, the inde-
pendence issue comes into play.
The following discussion provides a hypothetical case. The number one hotshot
trader who has made millions for the firm is having a bad month. He fraudulently ad-
justs his positions to hide the fact that he is having losses in the month that the com-
pensation committee is setting bonuses. His intention is to adjust his reported results
next month so that the firm is not out of money and his compensation is not adversely
impacted. If his manager reviews the facts and realizes how difficult it may be to re-
place the trader, he may look the other way.
Should not some independent individuals, such as the internal auditors, who are
executing the corporate culture gather the facts here? Managers have to be consistent
in their signaling of corporate messages. If the trader were retained, the informal
message would be “You can get away with anything if you make money for the firm.”
Consequently, it will be harder to keep drawing the line on what is acceptable be-
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