In 1995, Giles Nadeau was a bright, upcoming audit manager in the Winnipeg office of a national public account¬ ing firm. He was an excellent technician and a good "people person." Giles also was able to bring new business into the firm as the result of his contacts in the francophone business community.

Giles was assigned a new client in 1996, XYZ Securities, Inc., a privately held broker-dealer in the secondary market for Canadian government securities. Neither Giles nor any¬ one else in the Winnipeg office had broker-dealer audit expe¬ rience. However, Giles was able to obtain audit aids for the industry from his firm's national office, which he used to get started.

Giles was promoted to partner in 1997. Although this was a great step forward for him (he was a new staff assistant in 1987), Giles was also under a great deal of pressure. Upon making partner, he was required to contribute capital to the firm. He also felt he must maintain a special image with his firm, his clients, and within the francophone community. To accomplish this, Giles maintained an impressive wardrobe, bought a Cadillac Seville and a small speedboat, and traded up to a nicer house. He also entertained freely. Giles financed much of this higher living with credit cards. He had Ameri¬ can Express, Diners Club, en Route, and Visa cards and ran up a balance of about $40,000.

After the audit was completed and before the 1998 audit was to begin, Giles contacted Lynda Oakes, the CFO of XYZ Securities, with a question. Giles had noticed an anomaly in the financial statements that he couldn't understand and asked Oakes for an explanation. Lynda's reply was as fol¬ lows: "Giles, the 1997 financial statements were materially misstated and you guys just blew it. I thought you might realize this and call me, so here's my advice to you. Keep your mouth shut. We'll make up this year the loss we covered up last year, and nobody will ever know the difference. If you blow the whistle on us, your firm will know you screwed up, and your career as the star in the office will be down the tubes."

Giles said he'd think about this and get back to Lynda the next day. When Giles called Lynda, he had decided to go along with her. After all, it would only be a "shift" of a loss between two adjacent years. XYZ is a private company and no one would be hurt or know the difference. In reality, he was the only person exposed to any harm in this situation, and he had to protect himself, didn't he?

When Giles went to XYZ to plan for the 1998 audit, he asked Lynda how things were going and she assured him they were fine. He then said to Oakes, "Lynda, you guys are in the money business. Maybe you can give me some advice. I've run up some debts and I need to refinance them. How should I go about it?"

After some discussions, Lynda volunteered a "plan." She would give Giles a cheque for $15,000. XYZ would request its bank to put $60,000 in an account in Giles's name and guar¬ antee the loan security on it. Giles would pay back the $15,000 and have $45,000 of refinancing. Giles thought the plan was great and obtained Lynda's cheque for $15,000.

During 1998 through 2000, three things happened. First, Giles incurred more debts and went back to the well at XYZ. By the end of 2000, he had "borrowed" a total of $125,000. Second, the company continued to lose money in various "off-the-books" investment schemes. These losses were cov¬ ered up by falsifying the results of normal operations. Third,

the audit team, under Giles's leadership, "failed to find" the frauds and issued unqualified opinions.
In 2000, Lynda had a tax audit of her personal 1999 return. She asked Giles's firm to handle it, and the job was assigned to Bob Smith, a tax manager. In reviewing Lynda's records. Smith found a $15,000 cheque payable from Oakes to Nadeau. Smith asked to see Nadeau and inquired about the cheque. Giles somewhat broke down and confided in Smith about his problems. Smith responded by saying, "Don't worry Giles, I understand. And believe me. I'll never tell a soul."
In 2000, XYZ's continuing losses caused it to be unable to deliver nonexistent securities when requested by a customer. This led to an investigation and bankruptcy by XYZ. Losses totalled in the millions. Giles's firm was held liable, and Giles was found guilty of conspiracy to defraud. He is still in prison today.
Required

a. Try and put yourself in Giles Nadeau's shoes. What would you have done (be honest with yourself) when told of the material misstatement in the 1997 financial statements?

b. What do you think of Bob Smith's actions to help Giles?

c. Where does one draw the line between ethical and unethical behaviour in the situations described in this case study?