Do audit opinions matter?

Blake Oliver asks whether audit opinions matter anymore. He employs the decision by the Second Circuit Court of Appeals upholding the district court's dismissal of the case against BDO USA for its botched audit of AmTrust to spring into his fervent diagnosis that the profession's main product — the audit — is not viewed as important. The audit report is too general to matter to a reasonable investor.

Oliver omits an important follow up. Jonathan Weil reports in The Wall Street Journal that a group of former Securities and Exchange Commission officials have protested the decision and have asked the court to rehear the case. The court said it would and asked the SEC to file a brief on the case. The SEC's report is due Feb. 16. This action shows that Oliver has jumped the gun, though he has provided an interesting interpretation of the initial decision.

What I find more interesting is the brief filed by BDO. While the firm is naturally trying to have the lawsuit dismissed, BDO seems to argue that the audit has no information content for the investment community. 

BDO relies on the Supreme Court case Omnicare Inc. v Laborers Dist. Council Constr. Indus. Pension Fund, which governs statements of opinion. The court held that statements of opinion are not actionable except in three cases: 

• They falsely describe the speaker's state of mind;
• They contain embedded statements that are untrue; or, 
• They omit material facts pertaining to the basis for the opinion. 

BDO claims that appellants do not demonstrate any of these cases, so the case must be dismissed. 

One should note that embedded in the audit report are the claims that the firm has followed generally accepted auditing standards, and the result is that the financial statements follow generally accepted accounting principles. These standards include tests to obtain reasonable assurance that they are free of material misstatement, including accounting fraud. Finally, the auditor claims that the description of their work omits no material facts and that the resulting financial statements do not omit material facts that investors need to understand the economic condition of the business enterprise. Accounting scandals will have one or more of these exceptions in operation.

Upon reading an unqualified opinion, investors are entitled to believe that the auditor has complied with GAAS, including the standards of competence, due professional care, independence and professional skepticism. Investors are entitled to believe that the financial reports are fairly stated and are free of material misstatements, including material accounting fraud. Further, investors are entitled to believe there are no material omissions pertaining to the audit report or to the financial statements.

Audit reports contain significant, material information. And this is true whether or not the auditor believes in their value.

This essay reflects the opinion of the author and not necessarily the opinion of his employer, The Pennsylvania State University.