Auditor’s duty

• Society imposes duty to exercise reasonable care and skill in 2 ways:

1. Contractual (include statutory) relationship
2. Special relationship between two parties.
• Au’s Reasonable care & skill expected of a professional
– adherence to regulatory & professional standards in all aspects of audit.
Negligence
– Define: Any conduct that is
• careless /
• unintentional in nature &
• entails a breach of any contractual duty / duty of care in tort owed to another person

– Claim for negligence, plaintiff must prove ALL:

1. Duty of care was owed to the plaintiff by defendant (there was reasonable
foreseeability & proximity)
2. Au negligent (au not exe reasonable care &skill, breach of duty of care)
3. Plaintiff rely on the au
4. Loss or damage suffered by the plaintiff as a result of au’s negligence
5. Causal relationship existed between the breach of duty by the defendant and the
harm suffered by the plaintiff (as a result of relying on au)
– Defence available to au against suits brought by 3rd parties:
1. Duty of care not owed to plaintiff (no reasonable foreseeability & proximity)
-ensure work performed been completed in prof competent manner & in acc with
Aus Au Standard
2. Au not negligent (au exe reasonable care & skill)
3. Plaintiff not rely on au
4. Plaintiff not suffer quantifiable loss as result of au negligence
5. Loss not suffered as result of relying on au (causation)
6. Strong QC sys within audit firm
7. Plaintiff fail to meet standard of care for own protection, which contributed to
bring abt its loss (contributory negligence)

Liability to clients
– arises in both
• contract (from obligations included in the engagement letter) &
• tort of negligence

– Early cases:
– London & General Bank Ltd (1895)

– Kingston Cotton Mill (1896)

– Thomas Gerrard & Son (1967)

Identify legal duties of au’ in Pacific Acceptance case, relationship btwn those duties & au’
standard?

From case Pacific Acceptance (1970), Au’ duties and responsibilities:

 Use reasonable care and skill

 Check and see for themselves
 Be guided by professional standards(ASA) (but not determinative)
 Audit the whole year
 Rely on satisfactory internal controls
 Properly document procedures
 Appropriately supervise and review work of inexperienced staff
 Warn and inform the appropriate level of management
 Take further action where suspicion is aroused
 Structure plans and procedures so discovery of material error/ fraud is reasonably
expected
*au’ legal duties established in Pacific Acceptance case have been incorporated into au
standard.

Contributory negligence:

• where plaintiff fails to exercise the required standard of care, thus contribute to its own
loss.

• Prior to AWA (1995), defence by au’ was unsuccessful. Refer to Pacific Acceptance
(1970).

• AWA: the company suffered losses due to internal control weaknesses over foreign
exchange.

• Au’ liable for failure to report to BOD.

• Company found to contribute to loss by officers failing to report to board of

directors & failing to put in place adequate internal control system.

• Defence of contributory negligence therefore upheld. 支持

Circumstances for au to rely on contributory negligence by client to reduce au liability for

damage?

-AWA case establish that contributory negligence by client can be accept as a reason for
reducing damages attributable to au

-for contributory negligence to apply, must be a failure by plaintiff to meet standard of

are req for own protection, which contributed to own loss.
Liability to 3rd party (au’s liability in relation to persons other than the immediate client)

• It was believed from early cases (e.g. Donoghue v Stevenson (1932)) that the recovery of
losses by third parties from au for negligence (in the absence of fraud) was not possible-
dun hv liability to 3rd party

Early test: special relationships

• A duty is owed to any third party
• to whom the au shows accounts, or

• to whom the au knows the client is going to show accounts, so as to induce

some action.

– Candler (1951) (per dissenting 不同意的 judgement of Lord Denning)

– Hedley Byrne (1963)
Next test: reasonable foreseeability
• A duty is owed to specific third party of whom the auditor was not aware, but who was part
of a class of persons of whom they should have been aware would rely on their audit
opinion:
– Scott Group (1978)

Current test: proximity 距离; 亲近;

• Was there a sufficient degree of proximity between au’ and third party?

• courts examine whether the report by au was meant to induce the 3rd parties to
undertake specific actions:

– Caparo (1990)

– AGC (1992)

– Columbia Coffee (1992) (very wide interpretation, later overturned in Esanda)

– Esanda (1997)

• A general conclusion: hard to show that audits on general purpose financial reports
(GPFR) were ever intended to induce third parties to undertake a specific course of
action. (Auditors would strongly argue that this was never the intention.)

although au’s liability to 3rd parties under the tort of negligence now seems very narrow and
limited to situations where the au induced the 3rd party to rely on the auditor’s report, the au
may also have a potential liability under the Commonwealth Competition and Consumer Act
2010 / the relevant State Fair Trading Act & under the ASIC Act.

Liability to third parties: Competition and Consumer Act 2010, ASIC Act

• Consideration needs to be given to the provisions of the

– Commonwealth Competition and Consumer Act &

 – relevant State Fair Trading Acts:

• Acts prohibit misleading & deceptive conduct.

in issuing inappropriate au’s report, an au might be guilty of misleading/

deceptive conduct

• Under ASIC Act, proceedings for damages to the public interest can be initiated by ASIC.

• 2008, ASIC utilised this power by commencing action against KPMG for $200
million over the collapse of the Westpoint Group.

Criminal liability of auditors

• Offence under s 1308(2) of the Corporations Act 2001 to knowingly make/ authorise
false & misleading statements.

• Penalty: $22,000 and/or 5 years’ imprisonment.

• Criminal actions against auditors are rare.

Limitation of liability

• Prior to CLERP 9, audit firms were required to operate as sole traders / partnerships —
still the dominant form of organisation for audit firms.

• Therefore, au are personally liable for damages arising from failure by either themselves
or their partners to exercise reasonable skill and care.

• Spiralling litigation costs and court-awarded damages.

• Professional indemnity 赔偿 insurance difficult to obtain & prohibitively expensive

(claimed to be about 14 %of audit revenues).
Arguments for limiting auditors’ liability

• Au cannot restrict their obligation & might not be able to resign

• Au generally cannot rely on management representation

• Inequitable 不公平的 position of the au profession compared with other professions and
service providers (other service providers able to restrict their liability)

• Au carry heavier burden than other professionals with respect to amount of damages
assessed

• Harmful effects on reputation; disciplinary actions by ASIC / acc bodies provide sufficient
incentive for au to maintain high standard

• Unlimited liability doesn’t necessarily provide better investor protection, court awards
may exceed au’s capacity to pay

• Audit perform quasi public service role so should be protected, provided they have
acted in good faith
Arguments against limiting auditors’ liability

• Au should accept full responsibility for their work.

• Au only successfully sued when not performing duties competently.

• If there is a limit, the au’s share of liability passes on to the investing public.

• Set precedent 前例 for other professions.

Methods of limiting auditor’s liability

• impose statutory cap on au’s liability

• au incorporate

• Remove joint & several liability, replace with proportionate liability.

Changes to auditor liability

Legislative actions that hv been taken to reduce extent of an au’s liability & explain why these
actions were taken?

-Changes to the Corporations Act 2001 as a result of CLERP 9 allow:

– Statutory cap: Introduction of Professional Standards legislation to provide a statutory
cap to au's liability (A cap of 10 times the au fees, up to a max of $75mil)
– Incorporation: Au to incorporate and form authorised audit companies with adequate
and appropriate professional indemnity insurance. Allow members of audit firm, other
than the au signing the report to have liability limited to capital invested in the firm
– Apportionment between the plaintiff and defendant according to blame (contributory
negligence – AWA case)
– Proportionate liability, if there are two or more defendants: au liable only for the
proportion of loss suffered by plaintiff that was au’s responsibility

-Reform introduced cus it was argued that

– Unlimited liability unfair, au were reluctant to carry out audit-related
engagements that were in pub int, for fear of litigation.
– Unlimited liability and escalating claims result in pub liability insurance for au
become very expensive, sufficient cover impossible to obtain
– Limited liability reforms had edy been introduced in UK, US & Canada