Corporate Governance II: Officers (Group C) Question 3 John was hired by Grantly Thornbird to perform the audit for Strange

Limited since 1997. Hence, Grantly Thornbird is the appointed auditor of Strange Limited. In preparing a firm’s audit report, it is the auditor’s duty to carry out such investigation as will enable them to form an opinion as to whether: a) Proper books of accounts have been kept by the company and proper returns adequate for their audit have been received from branches not visited by them; and b) The company’s balance sheet and profit and loss account unless framed as a consolidated profit and loss account are in agreement with the books of accounts and returns. If the auditors are of the opinion that any matter set out in (a) or (b) is not the case, that fact must be stated in their report (s141(4)). The report must state whether, in the auditors’ opinion, the company’s balance sheet, profit and loss account and, if relevant, the group accounts, have been properly prepared in accordance with the provisions of the ordinance and whether, in their opinion, those documents provide a true and fair view of the company’s affairs at the end of its financial year and of the company’s profit and loss for its financial year (s141(3)). Auditor’s Duties & Auditor’s Liability for Misstatement in Report The auditor must act honestly and with reasonable care and skill. They will not be considered negligent if they rely on information from the manager or other responsible official of the company unless they have reason to suspect that the information is inaccurate. Auditors may incur liability under three circumstances, namely statutory liability, liabilities under contract and liabilities in tort. Civil Liabilities under Statutes don’t apply in our case as Strange Limited is not in the course of winding up (S.276). Similarly, the case is not a misstatement in prospectus (S.40). In order to establish negligence under tort, three conditions have to be fulfilled: 1) Auditors have a duty of care 2) Breach of duty shown with evidence 3) A loss is suffered by plaintiff as a result of the breach of duty In addition, as a result of the Caparo decision, a public company’s auditor owes duty to company and existing shareholders as a whole and is now unlikely to owe a duty of care to

However. David does not have a direct contract relationship with Grantly Thornbird. Yue Xiu Finance Co. Shareholders on the other may have the objective to maximize their holdings’ value in the firm. There has been a long term business relationship between Grantly Thornbird and Strange Limited. they will not be considered negligent if they rely on information from the manager or other responsible official of the company unless they have reason to suspect that the information is inaccurate. Grantly Thornbird is hired by Strange Limited and owes duty of care to the company. proximity relationship exists as David may be one of the many unidentified investor in the pool of investors. David’s Relationship with Grantly Thornbird & Contract Liability In the case of David. Agency Problem & Criminal Liability However. David did not satisfy the above conditions and therefore cannot directly sue the auditor for his loss of 25% drop in share price unless he could prove the above. creditors. However. Strange Limited is considered as a public company and that David is an investor that relied on Grantly Thornbird’s audited report. one must note that in a private company. Hence. there is no clue or reason to suspect that the management’s information is inaccurate. the degree of foreseeability and proximity of relationship may justify the court in holding that it is just and reasonable to impose a duty of care on shareholders. It is possible that they have unlawful special relationship arises due to agency problem. Grantly Thornbird owes Duty of Care to Strange Limited Given that Grantly Thornbird acted honestly and with reasonable care and skill. Strange Limited appointed Grantly Thornbird as their auditor since 1997 and that Grantly Thornbird . v Dermot Agnew (1996) held that proximity could be established by showing that the defendants knew that the plaintiffs who and why would rely on the audited reports for a particular purpose and intended that the plaintiffs should rely on the reports for that purpose. Directors desire high profit figures as their remuneration is often tied to the company’s profit figure. From the information given. In conclusion. such as the remuneration terms of Grantly Thornbird.anyone other than the company for whom he performs due to the lack of proximity and foreseeability. or potential investors. David should further examine Grantly Thornbird’s relationship with Strange Limited. hence . no duty of care is owed to David from Grantly Thornbird.

. David can sue the auditor under Criminal Liability for his loss by reporting the fraud to the government.they have different interests. The directors of Strange Limited who appointed Grantly Thornbird may have a special agreement where the company pays Strange Limited an attractive sum of compensation in return for unqualified audited report. If such fraud is found with sufficient evidence.

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