The Investors Overseas Services, Limited (IOS) was a Canadian company headquartered in Switzerland that offered diversified financial services, which included the management of mutual funds. IOS was founded in 1956 by Bernie Cornfield, a former Philadelphia social worker. One of IOS’s most successful mutual funds was its Fund of Funds (FOF). The FOF was also a Canadian company that had operations directed from Switzerland; however, its corporate records were maintained in Ferney-Voltaire, France. FOF’s total assets reached \($617\) million by the end of 1967.1 FOF incorporated FOF Proprietary Funds, Ltd. (FOF Prop) as an umbrella for specialized investment accounts that were managed by investment advisers.
FOF Prop’s investments were heavily concentrated in American securities. Each investment adviser had a duty to act in FOF’s best interests and to avoid a conflict of interest. In addition, they were compensated based on the realized and unrealized (paper) appreciation of their portfolios.2 Challenges Faced by IOS and Its Affiliates During the middle to late 1960s, IOS and its affiliates began to face several difficult conditions. The industry had become increasingly competitive as new funds entered the field. In addition, the entire industry was negatively impacted by a decline in stock market prices. The industry was also impacted by significant regulatory changes; that is, a number of national authorities had put more regulatory controls on fund selling.3 In 1966 the SEC brought charges that IOS had violated U.S. law by selling unregistered securities. As part of its settlement with the SEC, IOS and its affiliates agreed to the following restrictions:4 • Will not engage in any activities subject to SEC jurisdiction.
• Will cease substantially all sales of securities to U.S. citizens or nationals, wherever located.
• Will not buy more than 3 percent of the stock of any registered investment company.
• Will dispose of its interests in Investors Planning Corp. of America, a registered broker-dealer, and Investors Continental Services, Ltd., a wholly owned Investors Overseas subsidiary and also a registered broker-dealer.
• Will withdraw the SEC broker-dealer registration of five investment companies owned by FOF.
• Will not acquire a controlling interest in any financial organization doing business in the United States........

Case Questions

1. Based on your understanding of inherent risk assessment, identify three specific factors about IOS and/or FOF that would be likely to impact your audit procedures if you were conducting an audit of IOS and/or FOF.
2. If you were auditing FOF, would this memo impact your planned audit procedures? If so, what is the financial statement assertion that would cause you the greatest concern? Why?
3. Given that all of FOF Prop’s investments in natural resources had also been owned (or were currently owned) by a member of the King group, comment on why the existence of related parties (such as King Resources and FOF) presents additional risks to an auditor.
4. If you were auditing one of the transactions between King Resources and FOF, what type of evidence would you seek to examine to determine whether the transaction was consummated on an arm’s-length basis?