NSW Court of Appeal clarifies the standard of care owed by auditors3 September 2018 | Professional Indemnity & Financial Lines
Recently, the NSW Court of Appeal has had cause to consider the scope of the duty owed by the auditor of a self-managed superannuation fund and whether a breach of that duty was causative of the loss suffered. The Court of Appeal agreed with the trial judge that the auditor owed a broad duty to ensure that the financial reports presented a fair description of the circumstances described in the report. However, it unanimously allowed the appeal on the question of causation, notwithstanding that it agreed with the trial judge that the corporate trustee would not have behaved differently had the description in the financial reports been more accurate.
- Whether auditor of self-managed superannuation fund was negligent?
- Whether liability could be apportioned with alleged concurrent wrongdoer?
- Whether appellant directors lacked financial sophistication to protect their interests?
The appellant, Cam & Bear Pty Ltd (Cam & Bear), was the trustee of a self-managed superannuation fund (Fund) established by Dr Lance Bear and his wife, Jennifer Campbell, who were also beneficiaries. A close friend, Anthony Lewis, was engaged to manage the Fund’s investments.
In 2005, Dr Bear decided to restructure his investments in the Fund to have more of its assets held as cash. The Fund subsequently began investing in companies which Mr Lewis owned, including Lewis Securities Ltd (Lewis Securities). In relation to the cash contributions, Dr Bear understood that his investments were in secured products which could be accessed and retrieved at any time.
John McGoldrick, the respondent, was an accountant who audited the accounts of the Fund, including for the relevant financial years ended 30 June 2003 to 2007. Databank Investment Services Pty Ltd (Databank) prepared the financial accounts each year.
In September 2008, Dr Bear sought to withdraw cash from the Fund. However, due to liquidity issues, this was not possible. In early November 2008, Lewis Securities went into voluntary administration and was wound up soon after.
These proceedings arose out of a claim for damages for negligence and misleading and deceptive conduct, commenced by Cam & Bear against Mr McGoldrick.
At trial, it was alleged that Mr McGoldrick had breached his duty of care and engaged in misleading and deceptive conduct by:
- failing to qualify in the audit reports which he signed and certified the possibility that the assets reflected in the Fund’s financial statements as ‘cash’ were unsecured loans to Lewis Securities, which were not guaranteed to be recoverable; and
- including a statement in the audit reports which suggested that the financial statements “presented fairly…the financial position of the Fund and the results of its operations and cash flows”.
Dr Bear received financial accounts for the Fund each year, which comprised audit reports. He said he would scan the audit reports and stated that “[a]t no time did I notice any special warning about the Fund or any note that was a cause for concern…I assumed that everything was in order with the Fund”. On this basis, Mr Bear made contributions to Lewis Securities, however this was premised on the belief that another of Mr Lewis’ companies, LSL Holdings Pty Ltd (LSL Holdings), held the cash in accordance with the entries in the annual financial statements.
Mr Bear gave evidence that he believed that the references to “Cash - LSL Holdings P/L” referred to cash being held by LSL Holdings, however, he did not undertake any research of his own. He also said Mr Lewis had told him that one of his companies was LSL Holdings.
On the contrary, Mr McGoldrick stated that when auditing the Fund’s financial statements, he queried the description of the amounts held on the Fund’s behalf as ‘cash’ with Mr Lewis and Databank and was led to believe that Dr Bear and Mrs Campbell were agreeable to the monies being held as unsecured loans. However, Mr McGoldrick did not directly communicate with Dr Bear or Mrs Campbell to confirm this.
Critically, the trial judge considered the oral evidence of auditing and accounting experts, who agreed that it was likely that a competent auditor would have made enquiries about the financial condition of LSL Holdings. In the event this had taken place, Mr McGoldrick would have ascertained that LSL Holdings had a significant deficiency in assets, which in turn would have created doubt as to the recoverability of the ‘cash’ balances before 2008. Both experts also agreed that the items described in the relevant financial statements did not meet the ordinary definition of ‘cash’, according to Australian Accounting Standard 28.
Rothman J found that Mr McGoldrick had been negligent and engaged in misleading and deceptive conduct, however concluded that this conduct had not caused Cam & Bear any loss. This was because:
- Dr Bear placed a significant amount of trust in Mr Lewis, which was a reason why he did not research the financial viability of LSL Holdings; and
- Dr Bear stated that it would have made no difference to him, had the financial statements recorded ‘Loan to LSL Holdings’ instead of ‘Cash to LSL Holdings’.
The Appeal Decision
Cam & Bear appealed, arguing that Rothman J did not sufficiently consider the issue of causation and had erred in his conclusions as to contributory negligence and proportionate liability.
The appeal succeeded as Judges McColl, Macfarlan and White found that Mr McGoldrick breached his duty of care to Cam & Bear by not:
- making proper enquiries, and by not identifying and advising on the uncertainty surrounding the recoverability of the assets described in the financial statements as ‘cash’ in the financial statements or to Cam & Bear; or
- alternatively, qualifying the audit certificates.
In relation to causation, the Court considered this to be proved, given Dr Bear provided evidence that he would have taken action to arrange for the loans to be recovered had he been aware, at any time, that the repayment of loans were not guaranteed.
Cam & Bear was awarded damages for its loss, after a 10% contributory negligence deduction was applied on the grounds that Dr Bear should reasonably have considered the caution of depositing significant amounts of money with his friend’s company. Evidently Mr McGoldrick’s negligence was considered to be the significant cause of Cam & Bear’s loss, with 90% responsibility being apportioned to Mr McGoldrick, given that Dr Bear and Mrs Campbell were not sophisticated investors.
Interestingly, the Court was not satisfied that Databank was a concurrent wrongdoer and therefore did not apportion any share of the loss to it. While Databank compiled the financial statements, without any evidence to establish the basis upon which it was engaged, negligence and/or misleading conduct could not be established. Rather, the inaccuracies in the financial statements were found to have arisen from the implication in the audited statements that the relevant ‘cash’ amounts were readily recoverable from LSL Holdings.
This decision highlights an auditor’s responsibility to ensure that financial statements are presented fairly and accurately reflect the financial position of the entity. It reminds all professionals that a court is unlikely to reduce the amount of damages payable by the alleged negligence of a plaintiff, in circumstances where the very purpose of the professional’s duty was to prevent the kind of loss that occurred. Similarly, the outcome identifies the difficulties of successfully relying on the proportionate liability regime in cases where a party is unable to establish the basis upon which the purported concurrent wrongdoer was engaged. The Court of Appeal’s inability to establish Databank’s concurrent liability has also been subsequently referred to in the decision of Hampshire Assets and Services v Blackman  NSWSC 1096.