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Auditors' Section 10A Reporting Obligation

“Likely” illegal acts

Section 10A of the U.S. Securities Exchange Act of 1934 requires that an auditor report to the Securities and Exchange Commission (SEC) when, during the course of a financial audit, an auditor detects likely illegal acts that have a material impact on the financial statements and appropriate remedial action is not being taken by management or the board of directors.

The standard implies that the auditor must determine:

(1) whether it is “likely” that an illegal act has occurred;

(2) if so, whether or not that illegal act could have a material impact on the company’s financial statements;

(3) inform the appropriate level of company management about the issue–most likely including senior executives and the board of directors;

(4) consider whether or not the company has taken appropriate remedial action; and

(5) if not, report the issue to the SEC.

Section 10A imposes reporting requirements on the auditor—specifically, to inform management of the possible illegal act and to ensure that the audit committee and/or board of directors are “adequately informed” of it. These reporting requirements are triggered unless the act is “clearly inconsequential.” 

Auditors should consider whether or not to ask for an independent investigation into the issue and obtain the results of the investigation. Such an investigation would potentially address the appropriateness of the company’s response and inform the auditor’s views on whether or not a report to the SEC is required. 

Should the company refuse to conduct an investigation, the auditor would then need to consider whether, in its judgment, a report to the SEC must be made.

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