Auditor responsible for SMSF’s losses, NSW Court of Appeal finds

There is a greater onus on auditors because they are there to check the figures and protect the SMSF’s trustee and members from abuse.

A recent New South Wales case highlights and redefines the very high standard of care expected from auditors, accountants and other professionals when providing services.

By Zilla Efrat

A recent court ruling is a wake-up call for auditors to ensure they obtain sufficient evidence to support their opinion in any audit, no matter how small.

In this ruling, NSW Court of Appeal case of Cam & Bear Pty Ltd v McGoldrick [2018] NSWCA 110, the NSW Court of Appeal found that by failing to provide warnings about the recoverability of assets, the auditor of a self-managed superannuation fund (SMSF), was responsible for 90 per cent of this SMSF’s loss.

The investments in the SMSF, set up for the appellants, Dr Bear and his wife, were managed by Anthony Lewis, a friend of Dr Bear, through his company Lewis Securities.

Lack of qualification

McGoldrick, the auditor of the SMSF between 2003 and 2007, did not qualify the fund’s financial accounts in any of these years. Yet the SMSF’s financial statements contained entries which referred to “cash”, when these were actually unsecured loans to LSL Holdings, a company controlled by Lewis.

The auditor did not investigate these entries or advise the appellants that they might not be able to recover the money in question.

In September 2008, Dr Bear tried to withdraw cash from his SMSF, but Lewis attempted to dissuade him and although Dr Bear insisted, no cash was provided. Two months later, Lewis Securities went into voluntary administration.

The matter landed up in the Supreme Court.

According to Hall & Wilcox senior associate William Madani, the court found that McGoldrick should have made proper enquiries about the financial position of LSL Holdings’, a company backed by Lewis Holdings which had a significant deficiency in assets. That would have alerted him to the risks involved with the cash balance and once known, he would have been obliged to inform the appellant about these.

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However, the Supreme Court ruled that McGoldrick’s breaches did not cause Dr Bear’s SMSF’s losses. Indeed, Dr Bear told the court that he would not have acted any differently if he had been informed that the account entries were “loans”, not “cash”.

On appeal, however, it was argued that the Supreme Court had taken a narrow approach when looking at what Dr Bear would have done if he had been told.

A question of “cash”

The Court of Appeal accepted that plaintiffs would not have behaved differently. However, it maintained that the auditor should have qualified his audit report to indicate that there were doubts as to whether the items marked “cash” could be recovered.

In his evidence, Dr Bear said a qualification would have led him to withdraw his investments, prompting the court to decide that McGoldrick caused the loss.

David Short, a partner at Hall & Wilcox, says the decision is important because it’s been made by a higher court and published.

“The case also reminds auditors of their duties … It is a reminder of the very high standard of care expected from professionals when giving recommendations. Whether you are a lawyer, accountant or auditor, you have to be very sure about the appropriateness of the advice you are providing,” he says.

Increased auditor responsibility?

Claire Grayston, policy adviser - audit & assurance at CPA Australia, says: “On the face of it, the Appeal Court’s ruling could suggest that auditors may have increased responsibilities in that the auditor was being held responsible for the performance of the investments.

“Some investors choose to take great risks. That’s their choice. Auditors are not responsible for the investment decisions of their clients,” she says.

But this case wasn’t about investment decisions.

“The case was really about not doing a sufficient audit or obtaining enough evidence about the valuation of ‘cash’ in the financial statements,” says Grayston.

"Whether you are a lawyer, accountant or auditor, you have to be very sure about the appropriateness of the advice you are providing." David Short, Hall & Wilcox

“All the auditor did was to get a representational statement from Lewis and the SMSF’s administrator. But representations are not adequate evidence. Statements from management or their agents are not sufficient on their own. 

“You have to get independent evidence for every material balance and this was a significant balance. It amounted to nearly half the value of the fund. But all McGoldrick did was take Lewis’s answers at face value.

“If he had done a bit of investigating, he would have understood that the money was in fact a loan to a company that was sustaining losses and that it couldn’t be classified as cash and might not be recoverable. The Court of Appeal placed a very high importance on these failings by finding the auditor responsible for 90 per cent of the loss.”

Grayston says the case has several messages for auditors and SMSF auditors in particular.

Professional scepticism needed

“To give an opinion, you need to be able to back it up and if you can’t get enough evidence, you have to qualify your opinion. In assessing the evidence, it is critical you apply professional scepticism, including considering whether evidence has been obtained from an independent and reliable source.” 

Similarly, Michael Davison, senior policy adviser – superannuation at CPA Australia, says: “Best practice in auditing standards is that you have to have certain level of proof and you have to be comfortable that what is presented is true and correct.”

Drew Fenton, a director at specialist insurer Fenton Green, adds that the judgment is also a reminder of the importance of the qualitative aspects to an audit, even if the numbers stack up.

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Grayston notes that in this case – and as happens so often with many SMSFs – the auditor engaged directly with the adviser and had no direct dealings with the actual superfund trustee.  

“I am not saying this would have fixed this problem entirely, but auditors must communicate directly with the SMSF trustee. That’s their client. In this case it may have highlighted Dr Bear’s lack of financial sophistication and reliance on Lewis’s advice. 

“Ultimately, this contributed to the Court of Appeal finding Dr Bear only responsible for ten per cent of the loss.” 

Consider your fees

Grayston believes the shortcomings in the audit may indicate that the audit fees charged were inadequate and that the case is a good reminder to auditors not to accept a fee that is too low. 

“Auditors should charge a sufficient fee for the work needed. If they are undercut by other auditors, they need to let the work go, rather than risk compromising the adequacy of the audit.” 

Similarly, Madani says some auditors will do SMSF work for a nominal fee, but don’t really realise the risks they are taking on. 

“There’s not a lot of money in it sometimes, but the consequences can be quite significant. To put it another way, the amount you charge does not impact your obligations as a professional.”

Professional Development: Audit of SMSFs: designed to help you understand the requirements surrounding the audit of SMSFs.

Grayston adds: “Although an SMSF audit is a very small audit and you may not receive a very large fee, it is still a very important engagement and you are there to help to protect the assets of the SMSF. 

“It is, after all, the retirement savings of your clients and critically important to them. That’s why there is so much regulation around SMSFs.”

Grayston says SMSF auditors should also bear in mind that SMSF trustees are often unsophisticated investors and rely heavily on their advisers and auditors. 

“This does put a greater onus on auditors because they are there to check the figures and protect the SMSF’s trustee and members from abuse,” she says.

Professional indemnity implications

For his part, Fenton says: “There’s no question, in our view, that this case does increase the profile of the audit and the exposure that an auditor has in relation to an SMSF and dare I say other audits.

“It also has implications for professional indemnity [PI] insurance. Presumably, this will be a legitimate claim under the auditor’s PI – it was deemed to be negligent within the auditor’s role.”  

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