In a case heard by the Supreme Court of NSW, Ryan Wealth Holdings Pty Ltd v Baumgartner [2018] NSWSC 1502, the trustee of an SMSF, Ryan Wealth Holdings, initiated proceedings against their auditor Baumgartner Partners. You can access the judgement here.
Baumgartner Partners undertook audits for the fund for the financial years ending 2007 to 2009.
The sole director of the SMSF, Ms Trudy Crittle, claimed that as result of the failures of the auditor, David Keith Baumgartner, irregularities went undetected for many years and, when those irregularities were ultimately discovered, the opportunity to redeem money arising from a series of failed investments had been lost.
In the statement of claim filed, the plaintiff also claimed that the auditor’s conduct was in breach of their duties in contract and in tort, in contravention of their obligations as auditors under the SIS Act, misleading and deceptive and in breach of Commonwealth and state legislation.
Following a family law settlement, Ms Crittle sought financial advice from financial adviser Mr Moylan from Moylan Retirement Solutions and invested over $7 million in accordance with Mr Moylan’s advice.
In 2006, the plaintiff entered into a series of investments by way of unsecured loans pursuant to a series of facility agreements.
The plaintiff agreed to lend up to $2.17 million to River Island Property Holdings to assist in the development of certain properties located at Clarence Town and Wallalong.
Whilst the River Island Facility Agreement was executed by Mr Moylan as a guarantor, he also executed the agreement on behalf of the plaintiff – even though he was not a director of the company, the judgement stated.
The plaintiff also agreed to lend up to $2.5 million to Pacific General Securities for the construction of residential lots at Muswellbrook, Singleton, Tamworth and Bellbird.
In another agreement, the plaintiff agreed to advance up to $1.2 million as a line of credit for the Business, MCD Holdings.
The agreement was executed by Mr Moylan on behalf of MCD Holdings, and also by Mr Moylan purportedly on behalf of the plaintiff.
The plaintiff also agreed to advance up to $616,795 to L & V Tomkins to provide capital as a means of satisfying debts incurred in the operation of L & V Tomkins and related entities.
In May 2006, the sum of $400,000 was invested in the Cartel Investments Unit Trust. The trustee was MCD Holdings.
On 3 July 2006, the sum of $100,000 was invested in the Limeburners Creek Unit Trust. The Limeburners Trust had made significant loans to River Island and MCD Holdings.
Over the period 2012-2014, a number of the persons and entities associated with the property ventures, with respect to the loans and investments were placed into bankruptcy or liquidation.
In early 2013, the professional indemnity policies of insurance formerly held by Moylan Retirement Solutions lapsed.
In mid-2013, Ms Crittle received a letter from another unit holder in the Limeburners Trust expressing concerns about the financial position of the trust and its assets and proposing that an independent forensic accountant be appointed to investigate the affairs of the trust.
The plaintiff engaged a forensic accountant, Ms Joanne Phillips, and a firm of solicitors, RBHM Commercial Lawyers, to assist her to uncover what may have occurred.
The plaintiff took steps to recover the loans and investments of the SMSF by initiating legal action against the relevant borrowers or guarantors that were still solvent and third parties.
The plaintiff recovered $2,061,414 in respect of the River Island Facility Agreement, $561,435 in respect of the Pacific General Facility Agreement, the sum of $438,141.43 in respect of the Tomkins Facility Agreement. The plaintiff also recovered a further sum of $216,795 by way of repayment from the ATO in December 2013.
However, the plaintiff achieved no recoveries in respect of the other investments.
The defendants, in their defence, stated that given MBS had prepared the financial reports of the SMSF for each of the financial years ending 2006-2009, it owed the plaintiff a duty to exercise reasonable care and skill.
It also pleaded that Mr Moylan ought to have been aware that the financial reports did not fairly present the financial position of the SMSF.
The defendants contended that Mr Moylan knew that the loans were in default and had not been serviced or repaid and that, knowing those things, MBS must necessarily have had a high degree of culpability in adopting for the special purpose financial reports an inappropriate method of valuation of loans.
It was also submitted that MBS did not present fairly the financial position of the super fund at the relevant financial year.
However, Justice Michael Walton found that the defendants had a “significant ability” to prevent loss based on a range of factors.
“The defendants recognised that the loans and investments that had been made to entities connected with Mr Moylan were high-risk and that it might all [go] wrong [and] were aware that the pension from the super fund was Ms Crittle’s sole source of income,” said Justice Walton.
“The defendants admitted that the material available to the first defendant did not support an expression of an unqualified opinion that the super fund’s financial report for each financial year presented fairly in all material respects and had insufficient material to be able to form and express an unqualified opinion as to compliance with the SIS Act and SIS Regulations.”
Justice Walton stated that while MBS may have had a duty to communicate matters to the plaintiff, the terms of the MBS retainers were not before the court to draw any particular conclusions in that respect.
“I accept the submission of the plaintiff that the defendants had a far higher degree of culpability than MBS. Had the defendants performed their role competently, the deficiencies in the accounts and operations of the super fund would have been exposed,” said Justice Walton.
“The defendants’ failure to undertake this task was, to accept further submission of the plaintiff, the immediate, patent cause of the loss.”
Justice Walton concluded that the plaintiff was able to prove that they had “suffered loss and damage by reason of any delay in the exercise of the legal rights that it, in fact, exercised in 2014 in connection with claims against Turnbull Hill Lawyers, the guarantors of the Pacific General Facility Agreement and claims in relation to the Tomkins Facility Agreement”.
“From 15 May 2008, the plaintiff had an available claim against the borrowers and guarantors for recovery of the funds which had been loaned as evidenced by the causes of action, which were viable and resulted in the plaintiff recovering monies once Ms Crittle had discovered the true position of the super fund in 2013-14,” stated Justice Walton.
“If the recovery action had been commenced in 2008 rather than in 2013-14, there was a real and substantial – not merely speculative – prospect the plaintiff would have made the recoveries at an earlier point in time, which properly results in compensatory loss of the use of those monies from 2008 to the date the recoveries were made.”
The court determined that the plaintiff should be awarded damages from the defendants for a sum of $2,260,140 exclusive of any claim for interest from 31 August 2017.
“That amount is to be apportioned 10 per cent to the plaintiff and 90 per cent to the defendants for the contributory negligence of the plaintiff. Further, that amount is to be apportioned 20 per cent to MBS and 80 per cent to the defendants for the proportionate liability of MBS,” the judgement stated.
This follows a similar decision by NSW Court of Appeal on Cam & Bear Pty Ltd v McGoldrick which also held an SMSF auditor responsible for losses incurred by an SMSF.
The financial adviser and the SMSF accountant should also have been made liable in this case (really the culpable parties here).
The financial adviser was the one who steered the trustees to invest in the entity to start with.
Some SMSF accountants have worked it out in their heads that they are just preparing the accounts not auditing them hence they are not responsible for compliance issues such as this. This is irresponsible and negligent thinking (unethical too).
There are simply too many financial advisers and accountants that hold themselves out as SMSF experts but the reality of it is that they don’t know enough about SMSFs (there very few real experts in the market).
In some cases, when a SMSF auditor starts asking too many questions the parties that howl the loudest would be the financial adviser and the SMSF accountant (some would even say – no we would not be providing any more information or that the auditor is too pedantic and difficult). Trustees too would raise a protest and when the auditor raises an audit qualification they brand issues raised as a falsehood and then go their own merry way anyway.
If you follow the fee chain, it is normally the auditor that charges the least. SMSF audit is viewed by everyone concerned including the government (except the auditors) to be just a necessary evil. Yet when things go wrong it is the SMSF auditor alone that is made liable.
Hopefully, in future lawsuits, judges and lawyers take the above factors into consideration. Sometimes lawyers and judges’ commercial awareness is not attuned to the real world. To be fair, not everyone understands the SMSF Industry very well.
This case is also symptomatic of the fact the SMSF professionals have shot themselves in the foot by fighting over work on the basis of who provides services at a lowest cost and based on volume. Let’s be real here, taking too much volume of work with very low fees is a recipe for disaster as the stress it creates for people involve become unhealthy (physically, mentally and financially) over time.
This is fallout from SIS Part 23 not providing SMSF financial assistance for losses as a result of fraudulent conduct in investments (remember Trio?) … as the fraudulent party is usually insolvent, that leaves the auditors PI as a pot of gold
The Auditor’s PI would not have been tapped, had he done his job properly
Hidden in the judgement is also this – the Court found that the auditor should have notified a breach of the investment strategy regulations as the fund was not adequately diversified and investments were not in line with providing for retirement, and certain covenants in the strategy had not been complied with (50% fund assets required to be convertible to cash in < 90 days). So we will now be auditing all investments for financial needs of the members ... all while not providing financial advice?
A SMSF Auditor has to conduct a Financial Statement Audit, as well as a Compliance Audit, not as some would suggest, attest to compliance with SISA and the trust deed or, to provide financial advice.
A Financial Statement Audit requires auditors to attest to the existence, value, and title of items on the balance sheet. Sampling can be used but, to suggest you don’t have 100% sampling of unlisted investments is risky.
If the Accountant preparing the statements isn’t undertaking correct reporting, it falls to the Auditor.
The cascade is that it starts with the trustee, rolls to the Accountant, and then the auditor. If it slips through all nets, you have a problem.
Agree, SMSF audit fees should reflect the time required to do both the Compliance Audit as well as the Financial Statement Audit. I suspect that only the Compliance Audit is prioritised and/or, there is a shortfall on the understanding of what SMSF auditing entails.
The missing link is all this are the professional bodies that have the ultimate oversight of Accountants preparing financial statements. They need to be more active in conducting reviews to ensure the veracity of the financial statement production. SMSF financial statement preparation can be complex, compared with other financial statements for closely held entities, and should only be assigned to those with the requisite knowledge.
If the auditor had done his job he would
have insisted on either an arm’s length valuation of those ‘investments’ or a director’ s valuation, the latter including how she had arrived at the valuation.
Directors valuations are worthless unfortunately, about as worthless as the trustee / directors representation letter.
I guess an auditor’s role is now to offer financial advice. Should trustees invest in anything other than banks or listed equity – we will now tell them annually (perhaps triennially thanks Scomo) that their investments are technically worthless and high risk. Apart from Australia’s leading SMSF firm – SMSF auditors play a valued if not integral role for all SMSFs.
Following the Cam & Bear decision, the Courts appear to be happy to look deeply into SMSF transactions that resulted in a loss and apportion blame to auditors that may have missed tell tale signs of fraud, misappropriation and not been on top of high risk investments. And to think we thought auditors were there to ensure a SMSF complied with the deed and SIS Act. These negligence decisions, heavily weighted against fund auditors will scare a lot of auditors out of their profession. Particularly coupled with the three year rule. On that I wonder how the three year rule works in the case of a continuously complying fund that invests in high risk investments.
Another step forward in people not being accountable for their own actions. OK if a financial adviser has given bad advice but not to penalise the SMSF auditor. Disgraceful! Watch SMSF auditors’ fees rise to all of us as a result!
From the judgement the Member / Trustee was dependent upon the adviser Mr Moylan.
Unsecured loans were made to associated entities of Mr Moylan. Loan documents were signed on behalf of trustee by the adviser. & were incorrectly described in the financial statements as Mortgage Loans.
These facts should have at least raised additional inquiry from the auditor.
The Court has determined that the trustee partly contributed to the loss (10%). Howevet the widowed Trustee has every right to expect the auditor to do his job and undertake basic tasks to question the collectability / value of fund assets.
Agreed. All “Unsecured Loans” from SMSFs to any party should be valued at $0.
Hear, hear. Blame the auditor for everyone else’s failings. He’s the one with a PI policy.
Very damning judgment against Mr David Baumgartner.
In recent years there has been huge downward pressure on audit fees. One wonders whether this race to the bottom on fees is causing auditors to cut corners.
The ATO is now actively assessing low cost auditors.
This case might be the trigger for auditors to assess the value of services.
I am interested in learning how ATO finds out how much does the SMSF auditors charge?
I know one way for ATO to do this is to look up the SMSF auditor’s name from Annual SMSF return and lookup the fees deduction field from the same Annual SMSF return.
Is there any other method ATO figures it out?
The reason I ask this is because some auditors charging low fees might not be detected by ATO as low fees charging auditors in above method.
For example I know some Australian SMSF auditors in India who only work on outsourced audit. They will charge low fees for SMSF audit from Australian CA/CPA/IPA firm. But the Australian CA/CPA/IPA firm will charge higher audit from the fund. This will result higher SMSF audit fees deduction being reported in Annual SMSF Return, and the ATO wouldn’t know the auditor charged low fees, and the auditor wouldn’t fall in ATO’s potential assessment range.
The ATO added a seperate box on the SMSF Annual (Tax) Return for the audit fee deduction about 5 years ago. The ATO’s stated reason at the time was their concern over perceived “cheap” audits and that they wanted to monitor this, saying that the didn’t believe an SMSF audit of $500 or less could be done properly.
Interestingly, at a recent SMSF audit conference the ATO conceded that position saying that of the audit firms they had examined, they agreed that with technology that has emerged, it probably could be done cheaper.
While that may be so for listed investments and realestate that can be confirmed instantly, it’s no excuse for not doing extra work to confirm existence, ownership & valuation of unlisted investments in private companies or trusts.
Smsf trustee apparently had no idea what she was investing in and no direct knowledge or involvement in how funds were advanced. What was she doing in an smsf?
Or is this another case of who else can I blame?
Financial qualifications to SMSF audit reports must now become the norm for any investments in unlisted companies, trusts or JV’s by SMSFs.
Financial and SMSF advisers need to take a more active role in adequately explaining the additional admin and audit costs that are inherent in such investments, BEFORE they are undertaken.
Far too often there is significant eye-rolling and displeasure by trustees and their advisers when a SMSF accountant or auditor requests copies of financial statements and valuation of such an investment, or even to bear the costs of company searches.
Promoters of such investments need to be on notice that if they aren’t prepared to supply such information, or have their entity audited voluntarily, then they should not target or accept SMSF investors.
Far too often the auditor is forced to absorb the cost of chasing this information and when it is not forthcoming, the risk of signing off an SMSF audit.
No more. If you want your SMSF to invest in such things, be prepared to pay $5,000 p.a. for an audit, not $500, and factor that into your investment decision!