A legal precedent may be set for SMSF auditors after a court found a second auditor responsible for the lion’s share of an SMSF’s losses.
The Supreme Court of New South Wales, in the case of Ryan Wealth Holdings Pty Ltd v Baumgartner  NSWSC 1502, has apportioned liability for 80 per cent of losses to the auditor. It follows a NSW Court of Appeal decision in Cam & Bear Pty Ltd v McGoldrick  NSWCA 110, which apportioned 10 per cent of the SMSF’s losses to the trustee, Cam & Bear, and 90 per cent to the auditor, John McGoldrick.
It is a stark warning to self-managed superannuation fund (SMSF) auditors and highlights their need to:
- obtain evidence an investment strategy is in place and the investments align with the strategy;
- obtain evidence that investments are held at market value;
- notify the trustee of contraventions or qualifications of the auditor’s report;
- obtain representations from the trustee; and
- not comment on the suitability or appropriateness of the SMSF’s investments.
The Baumgartner case involved a series of investments through unsecured loans via facility agreements and in unit trusts for high-risk property developments associated with the adviser. The failed investments led to a A$2.7 million claim by the trustee, of which A$2.3 million was recovered.
It is the auditor’s responsibility to determine whether an investment strategy is in place and reviewed with due regard to risk, diversity, liquidity, ability to discharge liabilities and the insurance needs of SMSF members (Superannuation Industry (Supervision) [SIS] Regulation 4.09), as well as whether SMSF assets align with the strategy.
In the Baumgartner case, an investment strategy was in place but the auditor failed to check that the investments were in line with the strategy. Although this required “investing in such a way as to maximise member returns taking into account the risk associated in holding the investment” and “appropriate diversification in a long-term investment strategy”, the investments were in fact overwhelmingly concentrated in high-risk property ventures.
Some 90 per cent of assets were in “mortgage” loans for property development to Christopher Moylan, the SMSF’s investment adviser whose roles created a conflict of interest.
Further, the strategy required “at least 50 per cent of the fund assets shall be invested in assets which are convertible to cash within 90 days”, which was clearly not possible given the nature of the loans.
Market value investments
Australian Taxation Office (ATO) Assistant Commissioner, SMSF Segment, Dana Fleming, notes that “the ATO sees the [Baumgartner and McGoldrick] cases as highlighting the obligation of SMSF auditors to verify asset values in the financial statements”.
In the Baumgartner case, the bulk of loans and investments were worthless or of substantially compromised value.
“Under regulation 8.02B of Superannuation Industry Supervision Regulations 1994, assets must be valued at market value in the SMSF’s accounts and financial statements,” Fleming says. “SMSF auditors need to obtain sufficient appropriate audit evidence to support the value of a fund’s investments. It is not the auditor’s job to undertake a valuation, but the auditor should seek evidence that shows how the asset was valued, including the method used and the data on which the valuation relied. Interestingly, the most common contravention not identified or reported by auditors referred to ASIC [in 2018] was regulation 8.02B.”
Generally, auditors do not need to obtain their own valuation, but they do evidence of the asset’s market value, including appropriateness of the method used and reliability of data.
“If the auditor is unable to obtain sufficient evidence that material assets are valued at market value, they should qualify the financial and compliance report sections of the SMSF independent auditor’s report advising they have been unable to obtain sufficient appropriate audit evidence on asset valuations,” Fleming says. “They should also lodge an ACR [annual compliance report] if the regulation 8.02B contravention meets the reporting criteria and notify trustees in a management letter.”
Communicating contraventions of SIS legislation as well as any qualifications in the auditor’s report directly to the trustee is important. In the McGoldrick case, the timing of the SMSF trustee becoming aware of the true nature of the investments was critical in failing to limit losses. While the trustee in the Baumgartner case claimed timing was also critical, it was not proven.
An auditor can seek representations on the trustees’ understanding of a range of matters which could help draw attention to the nature of investments held or other key risks, such as the conflict of interest Moylan’s roles as investment adviser, accountant and owner of the property developments presented. The auditor can also seek representations on financial and compliance engagements, asking trustees to confirm matters material to the compliance engagement and that they have conducted the SMSF in full compliance with SIS legislation.
When not to comment
The court noted in the Baumgartner case that “the auditor would not express an opinion about the investment strategy per se, or its appropriateness for members, as opposed to whether that strategy [regardless of its appropriateness] had been given effect in the relevant financial year.” Although the auditor needs to report on compliance with the investment strategy, this need not and should not translate to providing investment advice on the appropriateness of investments.
The circumstances in the Baumgartner and McGoldrick cases would have created significant red flags if a reasonable quality audit had been conducted and raising them with the trustees may well have limited the losses suffered.
While both cases were pursued by the trustees, it is noteworthy that the ATO’s referrals of SMSF auditors to ASIC for enforcement action has been increasing year-on-year since SMSF auditor registration commenced in 2013. Only 15 auditors were referred to ASIC from 2013 to 2016, increasing to 22 in 2017 and 59 in 2018. The ATO expects the upward trend to continue in 2019 and attributes this to more effective data analysis, risk targeting and increased capabilities in identifying and addressing poor audit quality.
Claire Grayston is CPA Australia’s policy adviser for audit and assurance.
The SMSF auditor and verifying market values in an SMSF