Two different court cases have held SMSF auditors responsible for investment losses in recent months. The first case, Cam & Bear Pty Ltd v McGoldrick, was a decision by the NSW Court of Appeal, which ruled that the auditor was negligent in failing to make proper enquiries as to the recoverability of certain investments held in the fund and report back to the trustee.
The second, more recent case, Ryan Wealth Holdings Pty Ltd v Baumgartner, similarly found that the auditor’s failure to detect irregularities in the fund over a number of years meant the SMSF trustee was unable to redeem money lost on a series of unsecured loans.
Tactical Super director Deanne Firth said in both instances, the trustees of the SMSF invested with a trusted friend or adviser, who also owned a percentage of the firm preparing the financial statements of the SMSF and who ultimately scammed them out of their investment.
In light of these two cases, she said SMSF auditors may want to consider adding a qualification to the audit report where an SMSF invests in unlisted unit trusts, private companies and unsecured loans.
“In a lot of cases, it is difficult to confirm the accuracy or value of private companies. It is even more difficult to get information as to the recoverability of unsecured loans,” said Ms Firth.
SMSFs that have all their assets in a property also place auditors in a difficult position, she said, as they are unlikely to have sufficient cash flow to pay pensions and unless there is a reversionary pension in place, they will also have to dispose of the property on the death of a member because you cannot do a journal to transfer a death benefit to another member account.
There are also many trustees who make risky investment decisions, such as whiskey barrels or currency trading, she added.
While SMSF trustees are supposed to be sophisticated investors, make their own investment decisions and understand them, she said these court cases have shown that not only do trustees not understand their role and responsibilities, but when losses are made, the only reliable source of recoverability is the auditor’s professional indemnity insurance.
“Ms Crittle deposited over $7 million dollars into an account and had the advice of a financial planner with an AFSL. Yet even though she had significant funds in her SMSF and was taking advice from a financial planner, she was not considered to be sophisticated and therefore her contributory negligence was reduced,” she cautioned.
Ms Firth said there are a number of important takeaways that auditors should take note of from these cases in order to protect themselves from litigation, including good communication with those charged with the governance of the fund as well as administrators and investment managers where necessary.
They should also request and review any agreements relating to the balance to understand the arrangements including the rights and obligations of the parties, she said.
In addition, the auditor should also request and review the financial reports of investments and make enquiries about the financial condition of the investment with corroborative evidence and cash flow projection.
They should also obtain written representations from the administrator, custodian, investment manager and trustee and identify whether there are any financial guarantees or letters of financial support.
It is also vital, she said, that the auditor communicates with the trustee to alert them to any concerns arising from the audit procedures and the potential impact on the accounts and auditors report from such concerns.
“Communication directly with the trustee is essential, whether it be via management letter or as a qualification to the audit report,” said Ms Firth.
SMSF auditors, she said, may need a standard qualification paragraph for some of the more complicated types of investments.
“It might be something like: ‘We are limited in our ability to accurately value unlisted unit trusts and private companies without a formal valuation. Accordingly, as the evidence available to us was limited, our audit procedures in respect to the X investment had to be restricted. We are therefore unable to express an opinion on the value or recoverability of your investment in X unit trust’,” she explained.
“Meanwhile, I’m not looking forward to my PI insurance renewal notice this year as no doubt our insurance providers have been watching these cases and reassessing our premiums accordingly.”
Here come the peanut gallery comments that the auditors are lazy yet it is the accountants busting them on price and being pathetic in their preparation of the audit files which adds to the headache for most SMSF Auditors. ATO and ASIC should thoroughly review many more accountants and revoke Tax Agent SMSF rights from those who have NFI what they are doing in this space.
Financial Qualifications DO NEED to be reported if they are greater than 5% of the funds assets or greater than $30,000. SISR 8.02B has been a reportable section from 1 July 2012. What is unclear is what the fund can do about it, if selling it is not possible?
The Auditor should be requesting the financials of the unlisted investment and, if they are carrying assets at cost, ask for entity representation of the value (Director/trustee signoff).
This is not something the Auditor should own. It’s the trustee’s responsibility.
If the evidence remains unsatisfactory for the Auditor to form an opinion, an Emphasis of Matter paragraph should be included in the Audit Report or, a qualification, if the materiality of the asset warrants that.
The Audit Finalisation/Management Letter should reference the inclusion of an Emphasis of Matter Paragraph and/or qualification.
[The SMSF Annual Report requires an answer to whether the Audit Report is qualified so, it does feed into the ATO data mine.]
The Auditor can’t own this and, as both recent judgements against SMSF Auditors showed, the court assigned primary liability to the Auditor as it considered that the Auditor’s expertise should have revealed a potential risk and they should have notified the trustee. The judgements didn’t state that the Auditor was responsible for fixing it. Had the auditor actually audited the SMSF in Cam and Bear, (the evidence provided) indicates the trustee may not have taken any action as it was very trusting of it’s adviser who was considered a close friend. I don’t think case law has in anyway extended the duties of a SMSF Auditor.
Hmmm. Be warned. Auditing standards need to be applied. You can’ just have boiler plate modified audit reports.
Financial qualifications to SMSF audit reports are already commonplace amongst auditors who know what they are doing. They should be standard for non-listed trusts or companies. How often is it difficult to even get financial statements on these entities, let alone a market value. The ATO market value guidelines say that valuation of such entities for SMSF annual reporting should be consistent with established accounting valuation principles. Any accountant will tell you that a fee for a private company/trust valuation is between $2K to $10K.
I don’t see how a SMSF auditor could even address such an issue when asking a $400 fee, or less!
Financial qualifications don’t have to be reported to the ATO, only Compliance qualifications.The fact that more financial qualifications are not made is just sheer laziness or the pressure self imposed by quoting ridiculously low one size fits all audit fees.
p.s. SMSF Software providers take note. Perhaps a tick box at the chart of accounts level that will insert a financial qualification(s) in the audit report on that investment would help!
I fully agree with Ms Firth and have already advised my accountant clients that this is what to expect for all future audits where the fund has invested in unlisted entities etc.