Challenges mount for SMSF Auditors: A Tough Year Turns Tougher Ahead

It is a tough year for SMSF Auditors (and it is only going to get tougher)

And like all big legislative changes, as we see the compliance workload increase, so will the associated costs to audit and advise an SMSF increase too.

Two recent legal cases, Cam & Bear and Ryan Wealth Holdings, not only highlight the growing risks to SMSF Auditors, they're also warnings to professional advisers, planners, accountants and lawyers.

Read in this article

This is an important article for everyone who is a member of an SMSF, and our SMSF auditor colleagues.

What does your SMSF auditor need to see each year?

SMSF auditors are a vital piece of the complex puzzle that is SMSF.

An auditor ensures the appropriate annual audit evidence is obtained to;

• verify an SMSF has a compliant investment strategy, (Regulation 4.09 SIS Regs), and
• verify an SMSF considers the whole of the circumstances of the fund including risk, return, liquidity, diversification, and any insurance needs.

Each year we prepare documented 4.09 SIS Reg compliant Investment Strategies to ensure our SMSF clients meet these requirements.

As the market for SMSF auditors becomes more crowded, for some SMSF trustees, finding the lowest-cost auditor is the priority and the cost of the audit is seen as an annoyance. But for SMSF members, the auditor provides the necessary arms-length verification of the compliance of an SMSF to the rules, and the existence and value of the very assets that a fund may invest in.

What happens when an Auditor gets it wrong?

Here are two recent legal cases, Cam & Bear and Ryan Wealth Holdings, where the SMSF auditor failed the SMSF members - with catastrophic financial outcomes for all.

The facts of the matter in Cam & Bear

In May 2018, the New South Wales Court of Appeal gave its judgment in the case of Cam & Bear Pty Ltd v McGoldrick [2018] NSWCA 110.

• A ‘busy’ medical practitioner, Dr Bear, and his wife Ms Campbell ran their own SMSF (Fund) from 1985.
• They relied extensively on their accountant and friend Mr Lewis (Accountant) for advice on the management of the Fund.
• Dr Bear and Ms Campbell were both directors of the Fund’s corporate trustee, Cam & Bear Pty Ltd (Trustee).
• Dr Bear provided regular contributions to the SMSF. This was via cheques payable to Lewis Securities.

The evidence suggested that Dr Bear trusted the Accountant implicitly. He should not have.

• Dr Bear believed that from 1996 to 2008 his SMSF is invested in cash and shares.
• Dr Bear’s auditor has a similar view. And provide unqualified audit reports, accordingly.
• They stated that the financial statements 'fairly reflected the financial position' of the Fund.
• The auditor did not have any direct communication with Dr Bear.
• On 22 September 2008, Dr Bear directed Mr Lewis to withdraw some cash from the SMSF.
• Mr Lewis was reluctant to do so. And then conveniently Lewis Securities goes into voluntary administration. There is no money.

What the court said in Cam & Bear Pty Ltd v McGoldrick

Regardless of Dr Bear’s lack of financial sophistication, he should have considered the prudence of giving large amounts of money to Mr Lewis. Dr Bear is silly. He should have been smarter.

However, the auditor’s negligence is the main cause of the SMSF’s loss.

Accordingly, the loss was apportioned.

• 10% to Dr Bear’s SMSF, and the remaining
• 90% is appointed to the SMSF’s auditor.

The auditor owed a duty of care to the SMSF.

• This was to exercise reasonable care, skill and diligence.
• This was to ensure the audited financial report presented a fair description of the Fund's circumstances.

The financial statements did not give a fair representation of the affairs of the SMSF. Therefore, it was incumbent upon the auditor to either qualify the report or bring to the SMSF trustee’s attention to the problem.

How might such an approach to SMSF auditor liability, impact the industry?

• The Accountant prepared the Fund’s financial statements and provided them to the Auditor for audit.
• The Auditor charged $350 per audit.
• For this audit fee, the Auditor was held 90% responsible for the Fund’s loss, despite the actions of the Accountant, and the failure of Dr Bear and Ms Campbell to meet their own duties.

Similarly, in Ryan Wealth Holdings Pty Ltd v Baumgartner [2018] NSWSC 1502, the Court held the SMSF auditor failed to detect and report to the Trustee irregularities that had existed over a number of years.

The facts of the matter in Ryan Wealth Holdings

In 2018, the New South Wales Supreme Court gave its judgment in the case of Ryan Wealth Holdings Pty Ltd v Baumgartner [2018] NSWSC 1502

The Ryan Holdings Retirement Fund was established and over time lodged three financial returns. These were for FYE 07, 08 and 09.

• The Fund invests in loans to various entities and investments in unit trusts.
• Sadly, the professional adviser has a personal interest in some of these investments. 

The SMSF financial statements document these as ‘mortgage loans’.

• But there are no mortgage loans.
• The information provided to the SMSF auditor contained no evidence of any mortgages.
• There is no registration of any encumbrances over any of the assets.
• The auditor fails to try and find evidence of a mortgage.

In all 3 financial years, the auditor gave the SMSF unqualified audits. By the time the SMSF found out that there were no such securities, it was too late.

The SMSF trustee argued, that the auditor failed to check on the mortgages and therefore, they went undetected.

What the court said in Ryan Wealth Holdings Pty Ltd v Baumgartner 

The Court stated the auditor failed to exercise reasonable care and skill:

• to ensure the investments are valued at net market value, and
• failed to exercise judgment in assessing the reasonableness of the disclosed values.

Pro Tip: The auditor has a duty to report to the SMSF about the obvious conflict of interest of the professional adviser and the high level of risk associated with the loans and investments.

The Court assessed damages of $2,260,140 and looked at the chances of the unsecured loans being paid back.

Responsibility for the loss is apportioned as follows:

• 10% to the SMSF,
• 90% to the auditor

The SMSF audit firm has been ordered to pay damages to the SMSF for investment losses incurred from a series of unsecured loans resulting from the auditor’s failure to detect irregularities in the fund over a number of years

In recent news

A new class action led by victims of the late fraudster Melissa Caddick, who ran a $30 million dollar Ponzi scheme for her clients (who were primarily family and friends), are now suing the SMSF auditors who allegedly failed in their jobs to detect fraudulent activities.

• Twenty-four (24) victims, along with their Melbourne-based law firm, are suing the SMSF auditors for failing to pick up that the assets Caddick invested in, never actually existed, when viewing the annual financial reports.
• Documents filed with the Federal Court of Australia in Sydney on October 27th alleged the auditors engaged in a breach of contract, negligence and misleading or deceptive conduct or representations.
• The auditors all provided audit reports that in effect, gave the SMSF a clean bill of health.

The outcome of this case will be interesting as SMSF auditors will be expected to have yet another additional layer of scrutiny and liability applied to them, and we expect the cost of auditing an SMSF properly will necessarily increase.

Pro Tip: Best practice is to check the property register to confirm the assets exist and are not unknowing securing registered loans or other encumbrances.

What does the future hold?

Perhaps the next target of the litigation firms is an SMSF trust deed that is produced by a marketing company, using an out-of-date solicitors template.

Many auditors are feeling anxious about ‘fake’ SMSF Deeds

Did you know there are non-law firms preparing SMSF Deeds and variations?

This is probably illegal but when push comes to shove, they argue they are 'merely reselling an SMSF Deed' they originally purchased from a lawyer some time ago. Sadly, the original law firm's Professional Indemnity Insurance does not cover these ‘resold’ legalese documents. SMSF trustees, fund members, accountants, auditors and clients are exposed.

• Buyer Beware: Downloading a document from a non-law firm website merely resells a lawyer’s template; and therefore, there is no law firm Professional Indemnity insurance on the document or to inform you of needed legal updates. (On reputable sites you can read that in their fine print.).

Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses.  He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn.  Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.