How Professionally Skeptical are Certified Fraud Examiners? Joel Pike Gerald Smith

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1 How Professionally Skeptical are Certified Fraud Examiners? Joel Pike Gerald Smith Sixth Annual Fraud & Forensic Accounting Education Conference May 17, 2012

2 What is Professional Skepticism? Proposed ACFE Standard Measuring Aspects of Professional Skepticism Results Plans for Future research 2

3 What is Professional Skepticism? General Definitions PCAOB (2007) Center for Audit Quality (2010) Grenier (2011) Nelson (2009) Hurtt (2010) Skeptical Thoughts or Actions? 3

4 Oxford English Dictionary Skeptical attitude in relation to some particular branch of science; doubt or incredulity as to the truth of some assertion or supposed fact. Also, disposition to doubt or incredulity in general; mistrustfulness; skeptical temper. Wikipedia Skepticism has many definitions, but generally refers to any questioning attitude towards knowledge, facts, or opinions/beliefs stated as facts, or doubt regarding claims that are taken for granted elsewhere See also: Critical Thinking Critical thinking is thinking that questions assumptions. It is a way of deciding whether a claim is always true, sometimes true, partly true, or false. Critical thinking is an important component of most professions. 4

5 PCAOB Professional skepticism is defined as an attitude that includes a questioning mind and a critical assessment of audit evidence. (AU ) As a result of the inspection process, the Board has expressed concern that auditors, when considering the risk of fraud, do not, as required, adequately set aside any prior beliefs the audit team members may have that management is honest and has integrity (Observations on Auditors Implementation of PCAOB Standards Relating to Auditors Responsibilities with Respect to Fraud Release No January 22, 2007) Concern expressed that auditors are not sufficiently skeptical with regards to indicators of fraud. Standards on Auditors Responsibility to Detect Fraud amended 2010 The auditor should conduct the engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the entity and regardless of the auditor s belief about management s honesty and integrity. Furthermore, professional skepticism requires an ongoing questioning of whether the information and evidence obtained suggests that a material misstatement due to fraud has occurred (AU ) 5

6 Center for Audit Quality Professional skepticism is defined as a questioning mindset and an attitude that withholds judgment until evidence is adequate promotes risk awareness and is inherently an enemy of fraud. Skepticism involves the validation of information through probing questions, critical assessment of evidence, and attention to red flags or inconsistencies. Skepticism does not mean a lack of trust. Rather, it means, I trust you, but my responsibilities require me to confirm what you and others tell me. Some refer to this as the trust but verify approach. (Deterring and Detecting Financial Reporting Fraud: A Platform for Action) 6

7 Jon Grenier (Encouraging Professional Skepticism in the Industry Specialization Era, Working Paper March 2011) Professional skepticism is defined as an attitude that includes a questioning mind and a critical assessment of audit evidence. (AU ) He introduces the idea that a questioning mind should include questioning one s own judgments and decision making processes. In an experiment using industry specialist auditors, he finds that (a)s auditors amass industry experience, they make more automatic, intuitive judgments. Priming industry specialists to be skeptical of audit evidence, therefore, has little influence on their judgments. However, priming specialists to be skeptical of their otherwise automated judgment and decision making does substantially alter their decision processing. They begin to consider the potential fallibility of their professional judgments and potential management fraud. Of perhaps more concern, he finds that (u)nprimed specialists are less concerned with unknown misstatements and fraud than are unprimed non-specialists. In fact, none of the 19 unprimed specialists generate a fraud explanation. 7

8 Mark Nelson (A Model and Literature Review of Professional Skepticism in Auditing, Auditing: A Journal of Practice & Theory November 2009) Begins by reviewing the professional standards referenced above He classifies the standards as referring to two types of skepticism: A neutral view (t)he auditor neither assumes that management is dishonest nor assumes unquestioned honesty (AU ) Some academic literature adopts this view. A presumptive doubt view because of the characteristics of fraud, the auditor s exercise of professional skepticism is important when considering the risk of material misstatement due to fraud... The auditor should conduct the engagement with a mindset that recognizes the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the entity and regardless of the auditor s belief about management s honesty and integrity. Furthermore, professional skepticism requires an ongoing questioning of whether the information and evidence obtained suggests that a material misstatement due to fraud has occurred (AU ) Most academic literature adopts this view (f)or example, Shaub (1996) equates skepticism with suspicion (and as the opposite of trust). Hogarth and Einhorn (1992, 40) define a skeptic as being someone who is highly sensitive to negative evidence but ignores positive evidence, and McMillan and White (1993) view an auditor as skeptical if the auditor is more sensitive to evidence that reduces the risk of failing to detect errors in the client s financial statements. For the remainder of his paper, he uses the presumptive doubt view. 8

9 Kathy Hurtt (Development of a Scale to Measure Professional Skepticism, Auditing: A Journal of Practice & Theory, May 2010) Proposes that professional skepticism is a multi-dimensional individual characteristic. As an individual characteristic, professional skepticism can be both a trait (a relatively stable, enduring aspect of an individual) and also a state (a temporary condition aroused by situational variables). Her instrument is designed to measure six dimensions of skepticism as a trait. Three dimensions relate to the neutral view: Questioning Mind Suspension of Judgment Search for Knowledge One dimension relates to the presumptive doubt Interpersonal Understanding She also proposes two characteristics that make skeptical actions based on skeptical thoughts more or less likely: Autonomy Self-Esteem 9

10 So far, the discussion has been mostly based on auditors, although their responsibility to detect fraud has been part of the discussion How does this apply to CFE s? Textbooks suggest (f)orensic accountants and fraud examiners generally maintain a high degree of professional skepticism a level that probably exceeds that of the traditional auditor because the nature of their work is different. Forensic professionals understand that skilled fraudsters often manipulate the data provided by altering documents or limiting the amount and timing of data made available to the opposing side. (Kranacher, Riley, Jr., & Wells, 2011). 10

11 They use a definition of professional skepticism that is derived from the standards for auditors, but encompasses additional elements as well. Professional skepticism can be broken in to three attributes: Recognition that fraud may be present. In the forensic accounting arena, it is recognition that plaintiff and/or the defendant may be masking the true underlying story that requires a thorough analysis of the evidence. An attitude that includes a questioning mind and a critical assessment of the evidence. A commitment to persuasive evidence. This commitment requires the fraud examiner or forensic accountant to go the extra mile to tie up all loose ends. These three attributes listed above directly relate to the presumptive doubt view, the neutral view, and finally the need to act on skeptical thoughts. 11

12 The ACFE Board of Regents approved in January, 2012 a new set of Proposed Professional Standards for Certified Fraud Examiners The CFE Code of Professional Standards shall apply to all members and all Associate members of the Association of Certified Fraud Examiners. The use of the word member or members in this Code shall refer to Associate members as well as regular members of the Association of Certified Fraud Examiners. 1.7 Due Professional Care CFEs shall exercise due professional care in the performance of their services. Due professional care requires diligence, critical analysis, and professional skepticism in discharging professional responsibilities. 12

13 Measuring Aspects of Professional Skepticism 13

14 Questionnaire administered measured the six factors identified by Kathy Hurtt (2010) Questioning Mind A disposition to inquiry, with some sense of doubt Suspension of Judgment Withholding judgment until appropriate evidence is obtained Search for Knowledge A desire to investigate beyond the obvious, with a desire to corroborate Interpersonal Understanding Recognition that people s motivations and perceptions can lead them to provide biased or misleading information Autonomy The self-direction, moral independence and conviction to decide for oneself, rather than accepting the claims of others Self-Esteem The self confidence to resist persuasion and to challenge assumptions or conclusions Maximum possible score is 180 on a thirty item questionnaire We calculate a total score not broken down by factor 14

15 Kathy Hurtt (2010) 147 upper division accounting students Mean score 132.7, standard deviation 15.9, range 77 to 175 Pike has administered this questionnaire to over 1,000 students in 36 sections of his auditing class over the last 9 years. Scores are remarkably consistent with this only one section was significantly different (and that was lower). 200 professional auditors Mean score 138.6, standard deviation 12.6, range 111 to 173 Professional auditors score, on average, significantly higher (p<.001), than students 102 attendees at two local ACFE Chapter Meeting (78 with CFE Certification) Mean Score (141.0) standard deviation 11.9 (11.8), range (111 to 167) Scored, on average, significantly higher than professional auditors (p<.03) P<.04 for CFEs only (one tail T-tests) 15

16 Plans for Future Research 16

17 Increase Sample Size Sixth Annual Fraud and Forensic Accounting Education Conference Savannah, Georgia (May 15 to 17, 2012) Other ACFE Chapter Meetings? Analyze Demographic Factors Experience? Certifications? Type of Employment? Analyze each of the six individual factors to see if there are patterns which drive the differences from students to professional auditors and professional auditors to CFEs 17

18 Questions? 18