SMSF Auditor held liable for SMSF Investment losses?

A judgement released earlier this year from the NSW Court of Appeal has the SMSF industry talking.

The court unanimously overturned the trial judge’s decision to rule that the auditor breached his duty of care and this breach caused the loss in the fund. A judgement was made against the auditor for 90% of the damages. 

Background 

Dr Bear and Ms Campbell were directors of Cam & Bear Pty Ltd. The corporate Trustee of their SMSF, Dr Bear engaged a good friend Mr Lewis to manage the investments of his fund and Databank (a company in which Mr Lewis held an ownership in) to manage the accounts of the fund. 

Dr Bear believed Mr Lewis would invest the fund’s assets in shares and cash. Dr Bear made ongoing monetary contributions to the fund which he believed was for investments in secured products. Dr Bear stated he was never informed by Mr Lewis that his contributions would be used for unsecured loans.

The Fund’s annual tax returns were completed by the fund’s accountant, Mr McIver from Databank, and audited by Mr McGoldrick.

Dr Bear had never met Mr McGoldrick nor discussed the Fund’s accounts with him. 

Mr McGoldrick signed unqualified audit reports for the years 2001-2007. 

The Fund’s financial reports recorded Dr Bear’s investments in the balance sheet as “Cash – LSL Holdings P/L (lance) and “Cash LSL Holdings P/L (Jenny)”  – not unsecured loans which they had later been identified as being.

In 2008, Dr Bear sought to withdraw cash from the Fund to establish a new medical practice but was unable to, and advised his contributions had been used for unsecured loans. 

Shortly after, Mr Lewis’ companies went into voluntary administration. Dr Bear, via the corporate trustee company, sued Mr McGoldrick for breach of duty of care for negligently recording and authorising his investments as “cash” when in fact they should have been recorded as “unsecured loans”. 

First Trial – Decision date 3 May 2017 

Justice Rothman found that Mr McGoldrick (Auditor) owed the corporate trustee a duty of care to qualify the financial statements of the Fund. Mr McGoldrick should have made proper enquiries of the financial condition of Mr Lewis’ investment company which held the monies in unsecured loans. In the event that Mr McGoldrick had made proper enquiries, he would have been alerted to the risks involved, requiring him to inform Dr Bear.  

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.

Justice Rothman found that the breaches by Mr McGoldrick did not cause the loss suffered by the plaintiff.  

Appeal – Decision date 23 May 2018 

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’, further consideration must be given to Mr McGoldrick’s duty to qualify his audit certificate and identify any potential risks of monetary contributions not being able to be withdrawn if needed. 

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. 

My Thoughts 

Having read both judgements it was clear that the Auditor breached his duty of care.  The auditor had access to inquire about the investments having worked in the same office as the administrator and investment manager and failed to act appropriately.  

A joint report tabled by opposing expert witnesses in the initial trial agreed that the following steps or inquiries should have been taken: 

  • Communication with those charged with governance of the fund, as well as the administrators and investment managers 
  • Request and review any agreements relating to the balance 
  • Request and review the financial reports of LSL Holdings (the company had a current net asset deficiency for several years) 
  • Enquires about the financial condition and going concern of LSL Holdings 
  • Written representations from the administrator, custodian investment manager and Trustee 
  • The existence of any financial guarantees or letters of support 
  • Communication with the Trustee to alert them to any concerns arising from the audit procedures and their potential impact. 

This is a wake-up call for lazy auditors who take the information provided to them at face value. You must have a healthy level of professional scepticism in this game. If in doubt make inquiries, don’t die wondering! 

Are you concerned that your auditor is missing something? Contact the Audit team at Partners Wealth Group on 03 8508 7800 for a comprehensive service at a competitive rate.

This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.