DukeSmithwick, who is a licensed CPA was the chief executive officer ofBirch Hill, a publically traded company on the Nasdaq, allowed thetrading of shares of the company. Duck traded for the common stock ofthe company to one of his close relatives despite the criticalcondition that the firm was in. Duke used the prior informationleaked to him by the President of Birch Hill Company that theorganization was under negotiation with EastCrop for merger decision.It was anticipated that Duke continuously communicated with hiscousin Tom and therefore, it is most likely that Duke informed hiscousin on the intended decision of the company. Tom went ahead andmisappropriated the private information concerning merger by buyingshares in Birch Hill. Even after Tom informing Duke of the move, Dukedid not report the trade neither stopping him for the purchase of thestock.


1.Did Duke disregard confidentiality during his actions?

2.What three conditions are generally present when fraud occurs? Dothey apply to this case?

3.Assume the auditor is suspicious that Duke is committing anillegal act. What should the auditor do?

Discussionand analysis


Eventhough Duke is not the auditor of Birch Hill, as a licensed CPA andCFO of the company should understand the provisions concerningemployer’s confidentiality as provided under ET 501.10.

Accordingto 501-9, a member is required to maintain the confidentiality ofhis/her employer by not revealing any confidential information toanother party for personal gain. For clarity, confidentialinformation constitutes any exclusive information pertaining theintended decisions of the firm. Such information should be keptprivate to avoid any interested third party taking advantage of it.


Thethree conditions that generally present in the occurrence of a fraudinclude Pressure, opportunity and rationalization (Alvin, Elder &ampBeasley, 2010). The three condition are commonly referred to as thefraud triangle. The top corner that is pressure can cause theemployees to commit a fraudulent act. Such pressure may result infinancial needs, lifestyle, and emotional pressures. Opportunitiesallow the individual a chance to misrepresent the financial statementfor personal gain. On the other hand, rationalization allows theoffender of the illegal behaviour to justify their acts. AU-C 240provides the responsibilities of an auditor in relation to fraud.

Inthis case of Birch Hill Company, the three condition applies.Firstly, Duke Smithwick was led by emotional pressure and notifiedhis cousin Tom about the ongoing negotiation for a merger withEastCrop. Secondly, he misused his opportunity as the CFO as he couldget all the financial status and situation of the Company. He leakedthis information to Tom in advance. He also went ahead and failed toreport the trade of the stock most probably to hind the ongoingtransaction thus, rationalizing the fraud.


Ifthe auditor suspects that Duke Smithwick is committing an illegalact, then the auditor will be required to act in accordance with codeAU-C 250 concerning the procedures of the audit process. The codeprovides guidelines and procedures to be followed by an auditor whenan act of noncompliance has been suspected or identified.

AU-C250.17, states that, if the auditor identifies or comes aware ofinformation about non-compliance with the general laws andregulations, then he/she should seek a good understanding andthoughtful of the nature of the identified act and also investigatethe circumstances in which it has occurred. The code further providesthat the auditor should assess the materiality and the impact of theact on the financial statements.

AU-C250.18 continues and state that if the auditor has suspected an actof noncompliance, then the auditor should discuss the issue with themanagement. The auditor should discuss the matter with the managementat the higher level than those involved or suspected to havecommitted an illegal act. Therefore, as the auditor of Birch Hill, itis advisable to communicate the raised issues with the management atthe higher level than the CFO. However, the standard also providesthat if the management fails to provide adequate information to judgeon the compliance, the auditor is required to seek legal advice fromthe third party.

AU-C205.19states that, if the auditor cannot obtain sufficient informationconcerning the suspected noncompliance, he/she should assess andevaluate the impact of lack of the evidence for his/her opinion.

AU-C250.20provides that the auditor is required to evaluate the implications ofsuspected illegal act in relation to other aspects. The Auditorshould also assess the reliability of the representations and takethe appropriate actions regarding the assessed risks.


Dukehad besmirched the generally accepted audit standards by failing toadhere to the principle of confidentiality. As a professionallicensed CPA, he was expected to maintain the confidentialinformation of the employer and not reveal such information to thethird party for a personal gain. Therefore, he had committed a fraudin the first place by sharing the information about the negotiationswith EastCrop. Duke was also led by the emotional pressure that madehim misuse the opportunity and hence increasing the risk to fraud.There is therefore, a need for thorough investigation of thesuspected frauds. The auditor also needs to enquire more informationfrom the management and legal advisor pertaining the sale of stock toTom when the company was just to undergo mergers.


AlvinA., Elder J. and Beasley S. (2010). Auditing and Assurance Services14thEdition. Upper Saddle River: London

AmericanInstitute of CPA. (2015). Clarified Statements on Auditing Standards.Retrieved 02 November 2015.From http://www.aicpa.org/research/standards/auditattest/pages/clarifiedsas.aspx