Thursday, 31 January 2019

UK: England and Wales: auditor liability and trading losses

In 2017 the Financial Reporting Council sanctioned Grant Thornton UK LLP and one of its retired partners for misconduct in relation to the audits of AssetCo plc: see here. A negligence claim against Grant Thornton was brought, in which judgment was delivered by the High Court today: see Assetco Plc v Grant Thornton UK LLP [2019] EWHC 150 (Comm).

Damages of approximately £21 million have been awarded and Grant Thornton's claim that it should be relieved from liability under section 1157 of the Companies Act 2006 was strongly rejected, the trial judge (Bryan J.) stating (at para. [1268]): "The breaches consisted of a catalogue of failures over two audit years that were of the utmost gravity and that went to the very heart of an auditor's duties and the 'very thing' GT admits it was responsible for but failed to do".

One of the more controversial issues in the case was the extent to which Grant Thornton should be liable for trading losses.  It is worth, in this regard, quoting directly from the judgment (paras. [961] to [964],[966] emphasis in the original): 
In the present case GT's negligence deprived the decision-makers within AssetCo of the opportunity to "exercise their powers in general meeting to call the directors to book" for the dishonest way in which the business was being run, to "influence future policy and management" in that regard "and to ensure that errors in management" – i.e., that dishonesty – "were corrected". Thus, GT's (admitted) audit failures deprived AssetCo not only of the opportunity to call the directors to book but also to ensure that errors in management were corrected, and the company did not continue to trade, and be run in a "fundamentally dishonest" way. The losses that were suffered were not suffered simply because the company remained in existence and carried on trading, but rather as a result of AssetCo continuing to trade in a particular fashion in reliance on the (negligent) audit.

I therefore conclude and find that the trading losses fell within the scope of GT's duty on the basis that they were sustained through AssetCo's (continued) trading in a fundamentally dishonest manner, in reliance on the negligent audit, in circumstances where if GT had acted in accordance with its duties it would have uncovered most if not all of the instances of Mr Shannon's and Mr Flynn's dishonesty, and AssetCo would (as I have found on the Counterfactuals) have entered into a Scheme of Arrangement, carried out a refinancing, placed the LFEPA and Lincoln Contracts on a sustainable footing, whilst allowing other subsidiaries to "sink or swim" and would have focussed on securing business in Abu Dhabi.

GT's general points about how Caparo [[1990] 2 AC 605] shows that the auditor's duty is not to create financial statements but to review them, and that its duties in terms of any investigation into the company are somewhat limited as compared to the duties on directors themselves, are not in point in circumstances where it is common ground that GT's duty was sufficiently broad that GT should, in the proper exercise of that duty, have uncovered many, if not all, of the instances of management deceit carried out by Messrs Shannon and Flynn, consequent upon which AssetCo would have called the directors to book and ensured that the company did not continue to trade (given that the company was "ostensibly sustainable only on the basis of dishonest representations or unreasonable decisions made or taken by management – Revised List of Issues para 6(1)).

I am also unpersuaded by GT's submission that the effect of the conclusion that I have reached would be that an auditor that fails to identify a particular fraud effectively becomes an insurer of the company for any dishonesty or fraud within the company and trading losses suffered as a result. That is not the effect of my conclusion.

I also reject the suggestion that the consequences of my conclusion are either draconian or unfair to the auditor. On the contrary, I consider it entirely appropriate that GT assumed a responsibility to protect AssetCo against losses suffered as a result of fraudulent trading conducted by the AssetCo management in circumstances where it is agreed that GT should have detected that the business was being conducted fraudulently, and in circumstances where such fraudulent trading would not have continued had GT complied with its auditing duties".

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