Melody Jones, a CPA with a Master's Degree in Finance, is the chairman and CEO of Yellow Mortgage Corporation (YMC), which sells loans to multiple investors, including Tom Rex Mortgage Corporation (TRMC). YMC hired the highly reputable audit firm Thomlinson Partnership, LLP, to audit its financial records.

Thomlinson provided a clean audit opinion certifying that RMC's financial position was fairly presented. TRMC purchased more mortgages from RMC based on this certification. However, Melody made a $3 billion bet with YMC's funds which turned out to be a disaster, which she skillfully hid from everyone, including Thomlinson. As a result, the purchases made by TRMC turned out to be worthless. She was hoping with the bet to triple the corporation's revenue.

Months before the discovery of Melody's alleged fraudulent activities, members of the Board of Directors of YMC, Melody, and other senior officers discussed the establishment of an internal audit committee appropriate for the corporation's size. Due to her position and influence, Melody convinced some members that setting up such a committee would be a needless expense. However, some directors and senior officers argued that YMC should at least follow the Sarbanes Oxley (SOX) Act, if not to the letter of the law, then in spirit, and set up the internal audit committee. Melody countered that since YMC was a private corporation, the provisions of SOX were not applicable, regardless of its size.

According to Melody, she always had problems with SOX as a matter of principle. She believes that the financial crisis of the 1990s and early 2000s allowed Congress to inject itself into the professional field of accountancy superciliously. Melody thinks that the promulgation of SOX usurps the authority of accounting institutions, such as the Financial Accounting Standard Board (FASB), and the formation of the Public Company Accounting Oversight Board (PCAOB) as an intended byproduct of SOX is ample evidence of Congress's intentions.

Melody strongly believes that principle-based regulations, such as the generally accepted accounting principles (GAAP) introduced in the 1930s by FASB with the approval of the governmental accounting standard board, are the ideal approach. These regulations were created by accountants for accountants. Conversely, she feels that the PCAOB, formed by SOX, is a "rule-based legislation" that is rigid and inflexible and undermines the well-established accounting principles that accountants advocate. In Melody's opinion, the responsibility of creating accounting standards and overseeing accountants should solely lie with professional accounting institutes, like FASB, rather than the federal government. As an accountant herself, she is convinced that accountants are in the best position to establish rules and principles that facilitate the creation of accurate financial statements for companies.

1. Considering Melody's argument that principle-based regulations are more amenable to change, what arguments as an accountant can you make to support or oppose her position? Do you agree or disagree with the enactment of the Sarbanes Oxley Act in 2002, which among other things, forces CEOs and CFOs of publicly held corporations to certify financial statements issued to the public?
2. Melody argued that she had made certain investment bets which she honestly believed were in the corporation's best interest at the time, and when the bets turned out to be worthless, she used her skills as an accountant to hide the losses. If the bets were indeed investments made on behalf of the corporation, what defense, if any, is available to her?
3. TRMC is suing Thomlinson for fraud and negligence because the company believes Thomlinson, as auditors, did not exercise the due care which an ordinary prudent auditor would have exercised in performing the audit, and since the company relied on the unqualified opinion to make more loan purchases. Is Thomlinson liable for fraud and negligence? Why or why not?
4. In light of Melody's fraudulent activities, what steps could TRMC and other investors take to protect themselves from such incidents in the future?