McKesson & Robbins: The Fraud That Changed How Audits Are Done

In 1938, a multimillion-dollar fraud fooled Price Waterhouse and transformed auditing standards.

Nov 12, 2026

McKesson & Robbins: The Fraud That Changed How Audits Are Done

Key takeaways

The fraud: In 1938, McKesson & Robbins was exposed for reporting millions of dollars in fictitious inventory and receivables.
The auditors: Price Waterhouse failed to uncover the fraud despite substantially complying with prevailing auditing standards.
The reforms: The scandal led to new requirements for inventory observation and independent confirmation of receivables.
The lasting lesson: Compliance with auditing standards cannot replace professional scepticism.

In the aftermath of the Wall Street Crash of 1929, the US government introduced sweeping reforms intended to restore public confidence in financial markets.

The Securities Act of 1933 and the Securities Exchange Act of 1934 established a new regulatory framework, requiring public companies to provide investors with reliable financial information. Independent auditors were positioned as the foundation on which trust in the financial markets was to be rebuilt.

Over the following years, the newly established Securities and Exchange Commission (SEC) introduced regulations defining the format and contents of the financial statements to be filed by public companies and worked with the American Institute of Accountants (AIA) to formalise auditing standards.

Everything appeared to be on track — until the McKesson & Robbins scandal erupted on December 5, 1938.

A fraud built on paper

The company had been taken over in the mid-1920s by convicted fraudster Philip Musica and his brothers, operating under false names. Musica had reinvented himself as F. Donald Coster, a seemingly respectable businessman who became president of McKesson & Robbins, one of America’s largest pharmaceutical distributors.

Over the following decade, the brothers perpetrated an audacious fraud, right under the noses of their auditors, Price, Waterhouse & Co. (Price Waterhouse would eventually become one of the firms that formed today's PwC, following the 1998 merger with Coopers & Lybrand)

The brothers created fake paper trails that inflated company assets by millions of dollars, claiming that massive inventories of crude drugs were stored in Canada. However, it was nothing but smoke and mirrors. The Canadian company they claimed to work with, W.W. Smith & Co., did not exist, and neither did the inventory of drugs.

The deception was elaborate. The brothers manufactured invoices, shipping records and other documents to support fictitious transactions. They even forged credit reports to give the imaginary businesses an appearance of legitimacy.

According to the SEC’s subsequent investigation, McKesson & Robbins reported more than US$87 million in consolidated assets at the end of 1937. Approximately US$19 million of those assets were entirely fictitious, consisting principally of US$10 million in nonexistent inventory and US$9 million in fabricated receivables.

By the time the fraud was exposed in December 1938, the fictitious assets had grown to approximately US$21 million.

It was not the external auditors who uncovered the deception. McKesson’s treasurer, Julian Thompson, had become suspicious of the crude-drug business and had been trying to establish where the assets had gone. The fraud came into public view when the company was placed into receivership in December 1938.

How Price Waterhouse missed the fraud

Price, Waterhouse & Co. had audited the business for fourteen years without uncovering the deception.

The external auditors had not physically inspected the fictitious inventories, confirmed the accounts receivable directly with customers, or established that the Canadian businesses actually existed.

But in fairness to the auditors, physical inventory observation and direct confirmation of receivables were not mandatory auditing procedures at the time.

These practices were already used and recommended by some accountants, but they had not become universally accepted requirements.

The SEC launched an extensive investigation, holding public hearings in 1939 before publishing its findings in December 1940.

Its conclusions were revealing.

The Commission found that Price Waterhouse’s audits had substantially conformed to the procedures considered mandatory at the time. Nevertheless, it criticised the auditors for failing to exercise sufficient vigilance, inquisitiveness and analysis of the evidence available to them.

The SEC identified numerous circumstances that, if properly investigated, might have exposed the fraud. It also criticised the firm’s review of internal controls and its inadequate understanding of the business.

There was a further problem. The company’s president, who was orchestrating the fraud, had effectively controlled the appointment of the auditors and the scope of their work. The board of directors had played little part in these decisions.

The case therefore raised questions extending beyond audit methodology. How independent could an auditor be when the very person responsible for the deception could influence the extent of the examination?

Price Waterhouse argued that its work had complied with accepted standards and that auditors could not reasonably be expected to uncover an elaborate conspiracy involving senior management and falsified records.

The SEC did not impose sanctions on the firm. But its investigation exposed serious weaknesses in the auditing practices of the profession as a whole.

The scandal that transformed auditing

The fraud sent shockwaves through the financial ecosystem. If it was possible to hoodwink auditors so easily, then the entire edifice of trust in the markets was built on quicksand.

The SEC and the AIA moved rapidly.

In October 1939, the AIA published Extensions of Auditing Procedure, designed to address the gaps exposed by the Musica brothers’ fraudulent endeavours.

Under the new guidance, auditors were expected to observe physical inventory counts and obtain direct confirmation of material accounts receivable, wherever practicable and reasonable.

These procedures required auditors to go beyond the records supplied by company management and obtain independent evidence that the assets reported in financial statements actually existed.

The SEC also called for more rigorous examination of internal controls and greater independence in the appointment and oversight of auditors.

In February 1941, it introduced changes to its reporting requirements, obliging auditors to describe the scope of their examinations more clearly and disclose departures from generally recognised auditing procedures.

The scandal became a major turning point in the development of generally accepted auditing standards.

The revised procedures were also more labour-intensive, increasing the demands placed on audit firms examining large, complex businesses.

The establishment of modern audit practices

The McKesson & Robbins scandal fundamentally changed what auditors were expected to do.

Before 1938, auditors could examine a company’s records and supporting documents without necessarily verifying that the assets recorded in those documents actually existed. The reforms that followed made physical observation of inventories and independent confirmation of receivables central elements of the audit process.

But the SEC’s investigation revealed something more troubling than inadequate auditing procedures.

Price Waterhouse had substantially complied with the standards of its time. Yet the auditors had failed to question evidence that, with greater scrutiny, might have exposed the fraud.

The scandal demonstrated that auditing standards could not substitute for professional judgement and scepticism. Even properly executed procedures offered limited protection if auditors failed to challenge the information placed before them.

The profession responded by strengthening its standards and introducing new verification requirements. But the underlying question remained: what is an audit worth if following the rules does not provide reasonable assurance that the financial statements can be trusted?

It is a question the profession continues to confront nearly ninety years later.

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