- SMSF auditor sued for negligence
- Unsecured loans and other investments had impaired value
- Audit of SIS Compliance especially investment strategy important
Previous article against NSW auditor
Cam & Bear Pty Ltd v McGoldrick – NSW Supreme CourtRead more
This article discusses another case - Ryan Wealth Holdings Pty Ltd v Baumgartner  NSWSC 1502. It is my opinion that this case is likely to have a more significant impact on how audits – especially SMSF audits – are completed.
Important Background Information About This Case
Sole member of the Ryan Holdings Retirement Fund (RHRF) and sole director of its trustee company, Ryan Wealth Holdings Pty Ltd ("Ryan Wealth") was Ms Trudy Crittle.
In 2006 Crittle received over $7.3 million from a family law settlement. By this time she was of retirement age. Feeling too inexperienced to invest this money herself she asked her solicitor of 30 years, Michael Hill, who she could speak to. He introduced her to Chris Moylan, an accountant, tax agent and financial adviser.
Moylan was a director, shareholder and authorised representative of The Retirement Planning Specialists Pty Ltd which later changed its name to Moylan Retirement Solutions.
Moylan Retirement Solutions was declared insolvent and deregistered in August 2014. Moylan, Hill and other individuals involved in the RHRF investments were subsequently declared bankrupt and professional indemnity policies held by Moylan Retirement Solutions and a related accountancy practice both lapsed in 2013. In August 2016, ASIC banned Moylan from being a company director for 4 years.
The Court described Crittle as a truthful and reliable witness.
The duties expected to be undertaken by auditors
His Honour approvingly quoted from 1995 NSW Court of Appeal case which said, "The duties owed by an auditor to its client are high in the sense that the auditor hold himself or herself out as practising a highly skilled and exacting profession."
But that judgement went onto say, "Even so the Court must beware of imposing upon the auditor duties which go beyond the scope of what it is requested and undertakes to do." - Daniels v Anderson (1995) 37 NSWLR 438
The judgement also quotes approvingly from a 1960 Victorian Supreme case (Frankston and Hastings Shire v Cohen (1960) 102 CLR 607): "The main objects of any audit are: (a) To certify to the correctness of the financial position as shown in the Balance Sheet, and the accompanying revenue statements. (b) The detection of errors. (c) The detection of fraud. The detection of fraud is generally regarded as being of primary importance."
As we all know these are not the main purposes of an audit.
The judge in this Ryan Wealth Holdings v Baumgartner case also said, "I agree with the submission of the plaintiff that it had sought, by engaging the defendants, to protect against the very risk which was realised, namely, the risk that the financial statements of the Super Fund may be incorrect or the risk that there had been noncompliance with the SIS Act."
Impaired Value, SIS Compliance and Professional Standards Scheme
There is no doubt that a major part of this case involved impaired value of the investments that the super fund had made after seeking financial advice.
But it would be wrong to assume that it is only about this issue.
It also involves auditing of the fund for SIS Act and Reg compliance.
The engagement letter and how the relevant professional standards scheme was not mentioned was also a factor.
SMSF Audits Completed Under Audit Guide No. 4 – 2004 edition
Most of the transactions audited for the Ryan Holdings Retirement Fund, a SMSF, took place before 2008. As such they were audited using the Auditing and Assurance Standards Board's – then operated by the ICAA and CPA – Audit Guide No. 4 The Audit of Superannuation Funds – "AUG 4" which referred to other auditing standards.
Importantly AUG 4 referred to AAS 25 Financial Reporting by Superannuation Plans(the old accounting standard that applied to all non-SMSFs) which stipulated that assets should be valued at "net market value" (NMV). AUG 4 acknowledged that SMSFs are not reporting entities and therefore do not need to comply with this requirement, although it does say that the ATO does prefer that SMSFs use NMV. "If the auditor is unable to form an opinion in assessing the reasonableness of the valuation because of the uncertainty, and no expert valuation can be obtained, the auditor should consider qualification of the audit report…"
This preference to value assets at NMV was constantly referred to in the judgement. It was assumed to be a compulsory requirement.
AUASB and GS 009
Since 2008 the Auditing and Assurance Standards Board (AUASB) under the Australian Securities and Investments Commission Act has been established, it has issued GS 009 Auditing Self-Managed Superannuation Funds– which has been reissued a number of times. All versions of GS 009, compared to AUG 4, contain some important amendments which will be discussed throughout this article.
The SMSF's Investments
These were predominantly unsecured loans to a series of facility agreements:
- River Island Facility Agreement – the trustee agreed to lend up to $2.17m. Moylan and another man were guarantors of this loan. Moylan also executed the agreement on behalf of the SMSF trustee. MCD Holdings – refer below – was also an investor in this venture. Moylan was a director of this investment.
- Pacific General Facility Agreement – Ryan Wealth agreed to lend up to $2.5m. Hill was one of the parties that was guarantor of this loan. MCH Holdings was a founding unitholder and investor in this investment. This was a joint venture between MCD Holdings and Turnbull Hill Lawyers for whom Michael Hill worked for.
- MCD Holdings Facility Agreement – entity formally known as Moylan Business Solutions – the SMSF trustee agreed to loan up to $1.2 million as a "line of credit". Moylan executed the loan agreement on behalf of the lender and borrower. Moylan was a director and shareholder of this entity.
- Tomkins Facility Agreement – Ryan Wealth agreed to lend almost $617,000 as capital so that the lenders could reduce other debts. Moylan was director of one of the entities involved in this agreement, L& V Tomkins Pty Ltd.
The trustee also made the following investments in two unit trusts:
- Cartel Investments Unit Trust - $400,000. The trustee of this trust was MCD Holdings and was heavily invested in the Pacific General Facility Agreement.
- Limeburners Creek Unit Trust - $100,000. This trust invested primarily in River Island and MCD Holdings. Moylan was director of this trust's trustee.
Moylan used MCD Holdings to provide accounting and taxation services to Crittle and her SMSF. This entity prepared the SMSF's financial accounts for all relevant financial years. It was the accountant for the two trusts noted above that the SMSF invested in. Its principal place of business was in the same building as Turnbull Hill Lawyers.
In total $6.33m was invested in the above entities. That is approximately $1m was invested elsewhere – presumably in cash.
According to the judgement, Crittle "placed herself in Mr Moylan's hands, appointed him as her adviser and understood Mr Moylan would advise on investment decision". She had no other "plausible explanation" as to why the loans and investments were made and that Moylan had a direct and indirect interest in many of them. In response to these pleadings, the defendants argued that Crittle had signed some of the documents however appears to have no knowledge of many details of most of the investments and failed to present evidence of actually receiving advice about any of them. The Court determined Moylan had provided her with advice.
Amounts recovered from other parties
In mid-2013, Crittle became aware that there may be concerns with her investments after receiving a letter from another unitholder of the Limeburners Trust. To get to the bottom of what had happened and who was to blame she engaged the services of a forensic accountant and a firm of solicitors.
In time she recovered the following amounts:
- River Island Facility Agreement – just over $2.06m (net of legal fees)
- Pacific General Facility Agreement – just over $561,000 (net of legal fees)
- Tomkins Facility Agreement – $438,000 (net of legal and other enforcement costs) plus almost $217,000 repaid by the ATO
In total she received $3.28million – quite some way from recovering all her losses.
It was after completing this process that Crittle turned her attention to the auditors of her SMSF.
The engagement letters and the auditors ATO approved form
The defendants attempted to argue that the main purpose behind the engagement letters was to "effectively incorporate" the ATO approved SMSF audit forms. That is, the engagement letter set up the process whereby an auditor would produce a report to the trustees in the approved form.
Importantly, the Court rejected this assertion.
The defence admitted that it should not have provided unqualified audit reports in that the fund's financial statements were not prepared in accordance with the fund's accounting policies or presented fairly its financial position. That is, in effect the reports were "materially inaccurate". The defence admitted that various part of the SMSF's assets were effectively worthless or of substantially compromised value at the time it was completing the audit.
The defence admitted that it had "failed to exercise reasonable care in the preparation of the audit reports".
Moylan's Conflicts of Interest
The plaintiff's expert argued that the auditor had a duty to report to the trustee about Moylan's various and obvious conflicts of interest and the high level of risk associated with the loans and investments. The Court agreed.
Valuation of Assets
The defence argued that in relation to the fund's loan investments it should only have qualified the appropriateness of the adopted basis for valuing these assets.
They also argued that there was no evidence to establish that the other investments were not being carried at appropriate amount. The defence also argued here that it was not its task to "positively ascertain values and that it was not his role to assess the financial statements against the application of the accounting standards". (The trustee had made representations to the auditor that the accounting policies were appropriate and that all assets existed.)
His honour acknowledged that the roles and functions of an accountant and auditor are different and the latter isn't "a guarantor of a fair presentation of the financial reports". (Compare this with the comment quoted above from the 1960 Frankston and Hastings Shire case). The reality was that the SMSF's financial statements were materially inaccurate and didn't fairly present the fund's financial position. His honour concluded that the auditor's qualification should have, at least, stated these matters.
Consequently, in relation to the River Island Facility and the MCD Holdings Facility, the Court said "… having regard to the nature of the admissions made [by the defendant], and the nature of the irregularities" the auditor was in breach of contract and common law duties.
The defence admitted that the Cartel and Limeburners Trusts had no value which the defence failed to establish.
The Court rejected the defendant's argument that it could rely on the trustee's representation letter and it then concluded that the defence had failed to ensure that the fund's assets were valued at net market value as required by AUG 4.
"I agree with the submission of the plaintiff that it must follow from that admission that the defendants failed to ensure that all investments were valued at net market value and failed to exercise appropriate judgement in assessing the reasonableness of the value disclosed pursuant to AUG 4…"
The September 2015 version of GS 009 says, "It is not the role of the auditor to value the assets. The role of the auditor is to check that assets have been reported at market value, and assess and document whether the basis of establishing market value is reasonable and the valuation is reasonable in light of the SISA, SISR, and ATO guidelines."
The fund's investment strategy
Based on the judgement it would appear that the fund's investment strategy was a typical pro-forma document that is produced by most SMSF administration systems.
For example, it contained the following allowed asset classes – Australian equities, Australian property, Australian fixed interest and cash and short term securities and stated that the trustees could invest anywhere between 0% and 100% in each of these asset classes while at the same time claiming that investments would be made with due regards to risk, return, liquidity and diversity.
This investment strategy and other documents were picked apart by the plaintiff and the Court as an important weapon in this case.
The defendant argued that the 0% to 100% investment ranges "obliterated the need for diversification". The Court rejected this argument.
The 2008 and 2009 engagement letter given to Ryan Wealth Holdings by the auditor stated, "Our procedures with respect to regulation 4.09 [of the SIS Regulations] will include testing that you have an investment strategy and that you have given consideration to risk, return, liquidity and diversification and that the fund's investments are made in line with that investment strategy. No opinion will be made on the investment strategy or its appropriateness to the fund members."
The 2007 ATO approved audit form said that, "I have conducted tests … to provide reasonable assurance whether the trustee of the fund has complied, in all material respects, with the relevant requirements of" various SIS Act and SIS Regs provisions including Reg 4.09. "My procedures with respect to regulation 4.09 included testing that the fund trustee has an investment strategy, that the trustee has given consideration to risk, return, liquidity and diversification and that the fund's investments are made in line with that investment strategy." And "in my opinion the trustee of the fund has complied, in all material respects, with the requirements of the SIS Act or the SIS Regulations specified above" which, as already stated, included Reg 4.09.
The Court found the defendants had not exercised reasonable skill and care when failing to express any concern about Reg 4.09 non-compliance.
Importantly the plaintiff argued (at par 448 of the judgement) that the auditor did not adequately examine how well the trustee had invested in accordance with the fund's investment strategy SIS Reg 4.09 requirements:
- Reg 4.09(2) "preamble" – "Trustee must formulate, review regularly and implement an investment strategy that has regard to a fund's whole circumstance, including, but not limited to, the following:
- The 2007, '08 and 09 investment strategies were in writing and all had the same terms
- Based on the written judgement and, given the same terms, there did not appear to be much evidence that these strategies were regularly reviewed
- In relation to Reg 4.09(2)(a) – risk involved in making, holding and realising and likely return from investments having regard to objectives and expected cash flow requirements:
- The investment strategy said that the trustees wished to invest for the long term for the retirement needs of the fund's members and according to the membership profile of the fund (including ages, separate assets and personal investment preferences if any members had nominated them); the plaintiff alleged and the defendant didn't appear to have denied that they were aware of the sole member's age and that she was retired
- The auditor had identified loans to members as "high risk" and the auditor had no information indicating that this type of investment satisfied the above points and the fund's cash flow requirements
- The auditor had "no basis for a conclusion that the plaintiff had given effect to an investment strategy that had regard to the risk involved in making and holding the Super Fund's loans and investments, having regard to the Super Fund's objectives and expected cash flow requirements"
- In relation to Reg 4.09(2)(b) – composition of the super fund's investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification:
- The investment strategy said that risk would be minimised by investing in a spread of investments and investing directly in different types of assets
- But the fund was heavily concentrated into high risk property development ventures via unsecured mortgage loans
- Most of the property development ventures were in the same geographical area of the NSW Hunter region
- The trustee had therefore not satisfied this requirement
- In relation to Reg 4.09(2)(c) – the liquidity of the super fund's investments, having regard to its expected cash flow requirements:
- The investment strategy said the trustee would predominantly invest in investments that could be converted to cash within 90 days
- If investments were made that could not be converted to cash then at least 50% of the fund's assets will be invested in assets that can be converted to cash within 90 days
- The plaintiff alleged and the Court accepted that as trustee it had not complied with this requirement – without looking at the underlying investment documents we have no way of confirming this point
- Given the trustee had not complied with this requirement there was no basis for concluding that the fund's trustee had given effect to an investment strategy that satisfied this liquidity requirement
- In relation to Reg 4.09(2)(d) – the ability of the entity to discharge its existing and prospective liabilities
- The fund's sole liability was to pay accrued benefits to its sole member
- The defendants admitted that the bulk of the fund's investments, including the loans, were mostly worthless or had an impaired value and this should have been clear by the materials they had received during the audit
- There was no basis to conclude the plaintiff had given effect to an investment strategy that took into account the fund's ability to discharge its liabilities
The defendants did challenge these allegations. They said that based on the ATO's approved form their job was not to provide an opinion on the investment strategy or to enquire into the appropriateness of the strategy to fund members. We suspect many auditors would agree with this view.
However the Court rejected this view. The Court accepted the plaintiff's view that one of the jobs of the auditor was to determine whether each fund investment was made in accordance with the investment strategy with respect to the specified matters in Reg 4.09.
Clearly this is a very important issue and it would appear that it remains as such.
The 2018 ATO approved form says the following in relation to the activities conducted by an SMSF auditor:
"My responsibility is to express an opinion on the trustees' compliance with the applicable requirements of the SISA and the SISR, based on the compliance engagement. My procedures included testing that the fund has an investment strategy that complies with the SISA and that the trustees make investments in line with that strategy, however, no opinion is made on its appropriateness to the fund members.
"My reasonable assurance engagement has been conducted in accordance with applicable Standards on Assurance Engagements issued by the Auditing and Assurance Standards Board, to provide reasonable assurance that the trustees of the fund have complied, in all material respects, with the relevant requirements of … SIS Reg 4.09".
The example engagement letter in the 2015 version of GS 009 says, "Our compliance engagement with respect to investments includes determining whether the investments are made for the sole purpose of funding members' retirement, death or disability benefits and whether you have an investment strategy for the Fund, which has been reviewed regularly and gives due consideration to risk, return, liquidity, diversification and the insurance needs of members'. Our procedures will include testing whether the investments are made for the allowable purposes in accordance with the investment strategy, but not for the purpose of assessing the appropriateness of those investments to the members."
Communicating with those charged with governance
The Court determined that there was no reasonable reason why the auditor had not communicated with the trustee directly given Moylan's obvious conflicts of interest.
When did the trustee receive the audit reports?
In the Cam & Bear case, a key issue was the delivery of the SMSF audit reports.
In this current case, the Court found an inference that the SMSF trustee had "relied on the audit reports" even though the plaintiff was unable to provide any evidence that she had read or relied on the audit reports.
"Ms Crittle knew that the Super Fund was required to have an auditor; she thought their job was to scrutinise what work the accountants did; and her limited knowledge of the role gave her great comfort."
Was the SMSF trustee company also partly liable?
Yes – "I consider the plaintiff, through its sole director Ms Crittle, did depart from the standard of care that a reasonable person would have applied to protect his or her own interests; but the departure from that standard was very limited. Even a person with Ms Crittle's lack of financial sophistication or relevant occupational experience, should reasonably have considered the prudence of supplying significant amounts of money to Turnbull Hill Lawyers to be invested by Mr Moylan without further inquiry…"
Total compensation - $2.26m with 10% to be apportioned to the SMSF trustee and the remaining 90% ($2.034m) payable by the defendants
Of the $2.034m, 20% is payable by Moylan Business Systems and the remainder ($1.63m) by the auditor; Baumgartners.
Costs and interest have yet to be determined.
Read the case here
Ryan Wealth Holdings Pty Ltd v Baumgartner  NSWSC 1502 (8 October 2018)Read case