- SMSF auditor sued for negligence
- Unsecured loans described as cash in SMSF financial statements
- Draft audit report supplied with all other fund documentation to fund trustee
In the NSW Supreme Court and NSW Court of Appeal an SMSF auditor was successfully sued for negligence, breach of duty of care and misleading and deceptive conduct.
These cases have caught many by surprise.
Before we discuss what these cases mean for SMSF auditors and potentially many others it is essential to understand some of the factual matters in both cases.
Cam & Bear Pty Ltd v McGoldrick – NSW Supreme Court
Cam & Bear Pty Ltd was the corporate trustee of the Lance Bear Pty Ltd Superannuation Fund. The fund members were a specialist medical practitioner (Dr Bear) and his wife (Ms Campbell).
The trustees had elected to invest monies with an entity that specialised in fixed interest securities. A related entity (Databank) administered the super fund. The trustee invested monies with the specialist entity and another related party both of which were placed into voluntary administration and then liquidation in the 08/09 financial years.
The trustee believed it held cash or share investments whereas it actually predominantly held unsecured loans although they were described as “cash” in the SMSF accounts. Dr Bear was adamant that he did not want the investments in the super funds to be loans but admitted that he had never asked the fixed interest specialist (Tony Lewis) where his money was being invested. He admitted that before October 2008 he had a “great deal of trust” in Lewis.
“Dr Bear wanted cash in the Fund because of the absence of a life insurance policy and because of his concern as to the insecurity of shares.”
In 2005, he requested that some of his share investments be liquidated so that he could have the money invested in cash style investments. It would appear that this money was also placed into unsecured loans.
He claimed that as trustee he had to be satisfied that the fund’s accounts “gave a fair and true result of the Fund and, in that regard, he relied on the auditor’s reports.” (par 57 of NSWSC case; my emphasis). Each year Dr Bear received a bundle of documents from the fund’s administrator which were delivered to him by Tony Lewis.
This bundle of documents included the unsigned auditor’s report and the trustee representation letter to the auditor.
The auditor was Mr John McGoldrick. He was appointed auditor for the 2003 to 2008 financial years. During all those years, he provided unqualified audit reports for the fund.
“Dr Bear took the view, from the documents, that Mr McGoldrick was the auditor and had prepared the Fund’s financial accounts, had audited the Fund and had prepared the Fund’s ATO returns.” (par 35 of the NSWSC case)
Dr Bear said he did not recall his understanding of Note 9 of the SMSF accounts which contained the definition of cash.
But he did say that by signing the trustee declaration (presumably on the SMSF Annual Return which we will look at in a moment and in the representation letter), he “had to be satisfied that the financial statement gave a fair and true result of the Fund and, in that regard, he relied upon the auditor’s reports.” And he also said that “he paid little or no regard to the disclaimer on the auditor’s report.”
Since the 2010/11 financial year the trustee has signed off the following on the ATO’s SMSF Annual Return: “I declare that current trustees and directors have authorised this annual return and it is documented as such in the SMSF’s records. I have received the audit report and I am aware of any matters raised. I declare that the information on this annual return, including any attached schedules and additional documentation is true and correct. I also authorise the ATO to make any tax refunds to the nominated bank account (if applicable)”. – emphasis added
This ATO SMSF Annual Return declaration has changed over time. For example for financial years between July 2002 and June 2007, the trustee signed that “I declare that the information in this tax return is true and correct.”
We do not know what sort of warranty the trustee gave McGoldrick via the trustee’s representation letter. But as an example, the 2011 pro-forma representation letter in GS 009 Auditing Self-Managed Superannuation Funds said, “We acknowledge our responsibility for ensuring that the financial report is in accordance with the accounting policies as selected by ourselves and requirements of SISA and SISR, and confirm that the financial report is free of material misstatements, including omissions”.
It is worth pointing out that since the SIS Act commenced and for nearly all the time that McGoldrick audited this particular fund, there was a requirement for trustees to “keep such accounting records as correctly record and explain the transactions and financial position of the entity” so that accounts, statements and returns can be prepared and to “keep its accounting records so as to enable those accounts, statements and returns to be conveniently and properly audited in accordance with this Act”.
The most current version of the SIS Act says that SMSF trustees must ensure “accounting records that correctly record and explain the transactions and financial position of the entity are kept” and are “kept in a way” that accounts, statements and returns can be prepared and “the accounting records of the entity are kept in a way that enables those accounts, statements and returns to be conveniently and properly audited in accordance with this Act”.
In September and October 2008, Dr Bear told Tony Lewis that he wanted to withdraw money from his SMSF to assist with the purchase of commercial premises however Lewis attempted to dissuade him from this course of action. Lewis said that if Dr Bear was insistent then he would have a cheque drawn (which never arrived) but by November 2008 Lewis’ businesses collapsed.
In 2003 the super fund had invested $428,000 and by June ’08 had almost $1.6m in “cash” investments.
The fund’s balance sheet contained the line item “Cash - LSL Holdings …” was used. LSL Holding was one of Lewis’ entities.
McGoldrick initially asked the super fund administrator, Databank, why this description had been used and said Lewis told him that the trustees were happy with this description. McGoldrick said he considered the “Cash – LSL…” was equivalent to cash because it was “at-call” but had no independent evidence to justify this belief.
McGoldrick considered that his relationship was with the fund administrator and “at no stage” did he deal with Dr Bear or his wife.
Until 2007 he was aware the SMSF administrator gave the fund’s accounts and other documentation to Lewis so he could personally deliver them to Dr Bear.
McGoldrick accepted that the money invested with LSL Holdings was neither cash in hand nor a demand deposit but an unsecured loan.
A key issue was why did Dr Bear elect to invest his money with LSL Holdings and not Tony Lewis’ more public entity Lewis Securities. Lewis suggests, via an affidavit, it was because LSL Holdings paid an interest rate of about 1% higher compared to Lewis Securities but it is unknown if Bear and Campbell knew investing money with LSL Holdings involved unsecured loans. Lewis does not deny that the fund’s trustees had a preference for cash and cash equivalents.
The plaintiff’s expert (Richard Rassi) “expressed the opinion that a competent auditor, faced with the entry in the financial statements, would be required to make appropriate enquiries and undertake adequate procedures to ascertain the nature, existence and valuation of the item described as “Cash” in the statements of LSL Holdings … a significant proportion of the assets held by LSL Holdings represented unlisted assets, non-performing assets and non-current assets, which, on their face, would not ordinarily be readily realisable. Moreover, there was an excess of liabilities over assets held by LSL Holdings at each of the reporting days between 2003 and 2007”.
Further, “if the auditor were to have requested and received a set of financial statements from LSL Holdings, he would have noted, as early as 2002, that LSL Holdings had a deficiency of assets”, requiring the auditor to qualify his audit report. “The deficiency of assets grew each year from 2002 through to 2008, which, in the opinion of Mr Rassi, should and would have created sufficient concerns and doubt in the mind of the auditor as to the recoverability of the balances before 2008.”
Both the defence and plaintiff’s expert witnesses agreed that “there was no obligation to consider the financial condition of LSL Holdings, as the decision about what procedures and (sic) auditor undertakes is a matter of professional judgement”. However the plaintiff’s expert expressed the view that “given the materiality of the balance held in LSL Holdings and the risk of valuation misstatement associated with balances held with related parties, it is probable that a competent auditor would have considered the financial condition of LSL Holdings … in order to form an opinion about the recoverability and liquidity of the asset described as ‘Cash’.”
Communicating with those charged with governance
“The auditor is not required to inform the Trustee of the Fund of the financial condition of LSL Holdings, but an auditor is required to communicate with those charged with the government (sic) of the Fund (i.e. the Trustees) at the beginning and completion of the audit and, otherwise, during and at the end of the audit process if there were a material matter to report. There was no communication between Mr McGoldrick and the Trustee.” (par 152 of the NSWSC case)
Duty of Care
“… the conclusion is inevitable that the defendant has breach his duty of care towards the plaintiffs.”
The Supreme Court’s view on the role of an auditor
“An audited account, by definition, certifies that the financial statement audited represents fairly the state of affairs of the entity, for the year passed.” (par 204 of the NSWSC case)
Supreme Court Findings:
Initially plaintiff’s contributory negligence – 35%; Databank – 39%; McGoldrick – 21.6%. The Supreme Court initially determined that plaintiff should pay McGoldrick’s costs however after taking submissions it determined that each party should pay their own costs.
Cam & Bear Pty Ltd v McGoldrick – NSW Court of Appeal
The SMSF trustee appealed this case because it believed it deserved to be paid compensation for damages and/or were not contributorily negligent for any of the money lost.
McGoldrick attempted to argue that Databank were more liable than he because it had been paid $40,000 to administer the fund – presumably over the 5 year period in question – and secondly because it was responsible for administering the fund including preparing the fund’s accounts. The Court of Appeal rejected these views because the terms on which Databank was engaged were not presented to the Court and it therefore had no evidence.
Cam & Bear attempted to claim that the Supreme Court placed “too much weight on Dr Bear’s trust in Mr Lewis and the effect that would have had on any disclosure that Mr McGoldrick may have made to Dr Bear”.
The Court of Appeal did accept that Cam & Bear did prove that McGoldrick’s actions “caused it to continue to make payments to LSL Holdings that it would otherwise not have made”, and that “there was no evidence to support McGoldrick’s” submission that Dr Bear knew that he ‘would be investing in less safe investments but at a higher interest rate’. The Court of Appeal clearly decided to ignore or place no weight on the Tony Lewis affidavit referred to above.
Nevertheless the Court of Appeal agreed that Dr Bear had “great confidence in Mr Lewis” but Bear “lacked the experience and expertise to grapple with the concepts involved”.
The Court of Appeal also picked up on the issue that Dr Bear received the draft audit report together with the accounts, “The financial accounts that Dr Bear received each year had audit reports attached. He said his practice was to scan the audited reports and that: ‘At no time did I notice any special warning about the Fund or any note that was a cause for concern. [Each audit report] contained usual materials for an audit report. I assumed everything was in order with the Fund.’ ”
The Court of Appeal then went onto say, “On the other hand, Mr McGoldrick was a very experienced accountant and auditor who was engaged for the purpose of protecting the Fund and its trustee against financial risks that included the very type of risk that eventuated, namely that loans forming part of the Fund’s assets might not be recoverable because of the poor financial position of the debtors. For the reasons given earlier, Mr McGoldrick was clearly negligent in failing to make proper enquiries as to the recoverability of the amounts held by LSL Holdings and failing to report the results of those enquiries to the appellant trustee.” (my emphasis).
A great deal of concern has been expressed about the highlighted words above with many wondering if the Court of Appeal justices have expanded the role of auditors. The reality is that in this particular case, the trustee had invested money into unsecured loans that were described in the fund’s accounts as “cash” and the Court of Appeal believed the SMSF auditor had, given the material investment that the fund had made into these loans, not completed sufficient checks to verify the accuracy of how the asset was described in the financial accounts and, in any case, the ability of the trustee to recover its money in the event of default.
When assessing Dr Bear’s contributory negligence, the Court of Appeal found that he “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 Dr Bear’s lack of financial sophistication should reasonably have considered the prudence of supplying significant amounts of money to Mr Lewis’ company.” “…that lack of sophistication and his reliance upon the annual supply of audited accounts however limits the criticism that can be made of him.” And, “Mr McGoldrick’s negligence should in my view be regarded as of significantly greater importance in causing the damage than the low-level negligence of the appellant.”
As can be seen overall the Court of Appeal case reveals no details that were not already exposed in the initial trial.
Court of Appeal Findings
The trustee was not entitled to damages.
Plaintiff’s contributory negligence – 10%; McGoldrick – 90%. Each party was ordered to pay their own costs.
Each year Mr McGoldrick was paid $350 for his services. How well can an audit, in compliance with the audit standards and SIS Act compliance checking, be performed for this fee?
These cases should remind SMSF auditors that they are providing a valuable service and deserve to be suitably remunerated for it.
It is important for all SMSF auditors to consider how they approach the provision of their documentation to clients. In this particular case the auditor had no direct communication with the trustee however the unsigned audit report was delivered with the fund’s accounts. The delivery of this unsigned audit report, together with the fund’s draft financial statements and presumably draft SMSF annual return, was used against Mr McGoldrick in these court cases.