Entry 8 of 10 · 1933–1940

A signature is not enough: the business that existed on paper

American securities reform gave the independent accountant a bigger public role. McKesson & Robbins showed why the work behind the signature mattered.

McKesson & Robbins had invoices, transactions and impressive assets. The awkward detail was that a substantial part of the business described by those records did not exist.

The SEC’s later findings identified approximately $19 million of fictitious assets in the 1937 financial statements, including $10 million of inventory and $9 million of receivables. The documents had supported a wholly fictitious foreign crude-drug business.^{Note 1}

Even the president’s identity was false. Frank Donald Coster was Philip Musica, who had previously been convicted of commercial fraud. His brothers helped operate the deception.^{Note 1}

The episode is theatrical enough without embellishment. What makes it important for auditing is that it came after a major attempt to strengthen public confidence in financial reporting.

A new public audience

The US Securities Act of 1933 put independently certified financial statements into the framework for registered securities offerings. The 1934 legislation added the exchange and reporting framework. This was a substantial expansion of the public significance of accountants’ work, not the invention of independent auditing.^{Note 2}

Paul Miranti’s history describes the profession’s uneasy encounter with the responsibilities and potential liability of the new settlement. An accountant’s work was becoming part of an information system intended to serve investors who were far removed from the company’s management.^{Note 3}

The change in audience was crucial. A report could no longer be understood solely as something commissioned by managers for their own purposes. The public would rely on it.

But giving the signature a larger role did not, by itself, settle what work should lie behind it.

An entire cast of supporting documents

The McKesson deception supplied paperwork in the names of supposed vendors and intermediaries. Documents appeared to describe purchases, sales, custody and settlement. The SEC found that real foreign firms named as customers had not conducted the supposed business with McKesson.^{Note 1}

This was more than a number inserted into the wrong cell. It was a fabricated commercial story, with documents designed to support one another.

That distinction matters because corroboration can be theatrical. Five documents produced by the same deception are not five independent reasons to believe it. Their agreement may demonstrate how carefully the story was prepared.

The professional response included the American Institute of Accountants’ Extensions of Auditing Procedure in 1939. It recognised attendance at inventory-taking and direct confirmation of receivables as generally accepted procedures, with qualifications about practicability, reasonableness and the circumstances.^{Note 4}

It did not invent counting stock. Nor did it make the auditor a universal expert in valuing every material. Its importance lay in changing expectations about the evidence supporting an opinion.

The less cinematic findings

The SEC also addressed appointment, reporting lines, staff training and supervision. It criticised conditions associated with heavy reliance on temporary staff and the demands placed on partners. It proposed involving non-officer directors in arranging engagements and making the auditor’s responsibility to public investors explicit.^{Note 5}

These points are less memorable than a president with an assumed identity. They are also harder to dismiss as peculiarities of one spectacular fraud.

A modern team may know exactly which procedure would provide stronger evidence and still struggle to perform it if access is constrained, staffing is thin or a difficult finding has no effective route beyond management. Method and organisation are connected.

Digital evidence gives the old problem another setting. A polished statement, downloaded file or apparently external message must be assessed for its origin and reliability. The practical question is whether the auditor has reached an independent source or another part of the same manufactured story.

McKesson’s lesson reaches beyond the warehouse. Public confidence requires both credible procedures and conditions in which people can perform them properly.

The signature is the visible end of that process. It cannot do the work on its own.

Next: Enron and the temptation to declare the repair complete.

Sources

1. US Securities and Exchange Commission, In the Matter of McKesson & Robbins, Inc.: Summary of Findings and Conclusions, 5 December 1940, printed pp. 3–4. The approximately $19 million figure relates to the 1937 statements; the summary reports approximately $21 million by exposure in December 1938. ↩ ↩ ↩
2. SEC, The Establishment and Improvement of Standards Related to Auditor Independence, 1998, especially note 1, identifying the statutory provisions. The historical description concerns registered offerings and the reporting framework, not every sale of shares or every company. ↩
3. Paul J. Miranti Jr., Accountancy Comes of Age (University of North Carolina Press, 1990), pp. 148–152, on the 1933–1934 settlement. ↩
4. American Institute of Accountants, Extensions of Auditing Procedure, Statement on Auditing Procedure No. 1, October 1939, printed pp. 1–2 and sections on inventories and receivables. The retained copy carries a 1941 copyright notice for this 1939 statement. Its historical prescriptions are not presented as a current standards checklist. ↩
5. SEC, Summary of Findings and Conclusions, printed pp. 5–6, on appointment, responsibilities, organisation and supervision. ↩