Auditor bears the risk

The NSW Court of Appeal handed down a decision on 23 May 2018 which will be of interest to auditors and their Professional Indemnity insurers.

The Court of Appeal was asked to consider whether an auditor, John McGoldrick, caused the losses incurred by the trustee of a self-managed super fund (SMSF), Cam & Bear Pty Limited, by failing to qualify the financial statements of the SMSF.

The earlier decision of the Supreme Court found that whilst Mr McGoldrick had breached his duty of care and made false and misleading statements in relation the SMSF’s accounts, those breaches and statements did not ultimately cause the loss claimed. This was overturned on appeal with the Court of Appeal finding that by failing to provide warnings about the recoverability of assets, Mr McGoldrick was responsible for 90% of the loss.

Background

The SMSF was set up for the benefit of Ms Jennifer Campbell and Dr Lance Bear in 1985. The SMSF’s investments were managed by a friend of Dr Bear, Mr Anthony Lewis. Contributions were made by Dr Bear to a company controlled by Mr Lewis, LSL Holdings.

Mr McGoldrick was the auditor of the SMSF between 2003 and 2007 and in each year did not qualify the fund’s financial accounts. The financial statements of the SMSF contained entries which referred to sums as ‘cash’, when in fact, unbeknown to Dr Bear, the amounts recorded in those entries were for unsecured loans to LSL Holdings. Mr McGoldrick did not investigate these entries or advise Dr Bear that he might not be able to recover the monies in question.

In September 2008, Dr Bear told Mr Lewis that he wanted to withdraw money from the SMSF, despite Mr Lewis’ attempts to dissuade him. Dr Bear never received the money and Mr Lewis’ company went into voluntary administration in November 2008.

The Supreme Court determined that Mr McGoldrick should have made proper enquiries of the financial condition of the company which held the monies via the unsecured loans and that would have alerted him to the risks associated with the investment, which he would then have been obliged to communicate to the trustee. However, in cross-examination, Dr Bear was asked if he would have acted any differently if the entries referred to ‘loans’ rather than ‘cash’. Dr Bear’s evidence was that it would not have made a difference to what actions he took. Coupled with Dr Bear’s misplaced trust in his old friend Mr Lewis, the Supreme Court found that the breaches by Mr McGoldrick did not cause the loss suffered by the plaintiff.

Decision

On appeal, it was argued that the Supreme Court had taken a narrow approach when looking at what Dr Bear would have done if he was told that the entries marked as ‘cash’ were unsecured loans.

The Court of Appeal found that whilst the primary judge was correct in concluding that Dr Bear would not have behaved differently if ‘cash’ had been recorded as ‘loans’, that was not a complete answer to the extent of Mr Goldrick’s breaches. Mr McGoldrick would also have had to qualify his audit certificate to indicate that there were doubts about the recoverability of the items marked as ‘cash’. That qualification, according to Dr Bear’s evidence, would have led him to withdraw his investments. The Court, therefore, accepted that Mr McGoldrick, in fact, caused the loss.

When considering contribution, the Court compared the respective standard of care of the parties and reaffirmed earlier decisions in relation to the standard of care required of professionals who make recommendations. The departure from the peer standard by Mr McGoldrick was far more significant. Liability was apportioned 90/10 against McGoldrick.

Comment

The Court of Appeal has taken a wide approach in relation to assessing the scope of duty owed by auditors and attempts to apportion responsibility to any significant degree may be difficult given the high standard of care expected from professionals giving recommendations.