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The decisions of two recent court cases are of particular interest to auditors
In Hercules Management Ltd. v. Ernst & Young, the Supreme Court of Canada addressed the auditor's duty of care. The Court set out a general framework for approaching the duty of care question in negligence cases (either for economic loss or personal injury). The two-part test to be applied by Canadian courts is: (a) does the defendant owe a prima facie duty of care to the plaintiff and, if so, (b) are there policy reasons for negating that duty of care? In applying the first test to auditors, Mr. Justice La Forest concluded that auditors can reasonably foresee reliance on their reports by many different people, including shareholders, creditors, investors, etc. However, he added that "in the general run of auditors' cases, concerns over indeterminate liability will serve to negate a prima facie duty of care". The policy considerations are pragmatic -- open-ended and unpredictable liability would give rise to "socially undesirable consequences", including increasing costs of insurance and litigation, reduced availability of audit services, and potential decreased vigilance by third parties.
Based on this reasoning, in a statutory audit, the auditor would owe a duty of care to the shareholders as a group because the audit report is made for the specific purpose of guiding "the shareholders, as a group, in supervising or overseeing management." If a shareholder chooses to rely on the report in making personal investment decisions, he or she does so at their own peril. In cases in which the audit report was prepared with a wider audience in mind, such as for inclusion in a prospectus, the policy considerations would be different. "In cases where the defendant knows the identity of the plaintiff (or of a class of plaintiffs) and where the defendant's statements are used for the specific purpose or transaction for which they were made, policy
considerations surrounding indeterminate liability will not be of any concern since the scope of liability can readily be circumscribed." See Privity letters project description.
The Supreme Court of Canada has denied Deloitte & Touche's application to appeal the decision of the Court of Appeal of British Columbia in the case of Kripps v. Touche Ross. In the BC Court of Appeal ruling, the majority concluded that auditors can be found liable for negligent misrepresentation if the auditor signs an unqualified auditor's report on financial statements which comply with GAAP but the auditor knows or ought to know are misleading.
Because of the very particular circumstances of this case, it is unlikely that the ruling will "open the floodgates" for lawsuits against auditors. As well, the BC Court of Appeal observed that the "standard practice" of a profession can be held to fall below the standard of care only if the 'standard practice fails to adopt obvious and reasonable precautions which are readily apparent to the ordinary finder of fact'. The Accounting Standards Board continually improves and adapts its Recommendations with changing conditions. In addition, GAAP itself embodies the concept of fair presentation. For example, any information required for fair presentation is required to be presented in the financial statements (see paragraph 1500.05 of the CICA Handbook - Accounting), whether or not required by a specific CICA Handbook Accounting Recommendation. For these reasons, GAAP remains the appropriate framework to apply in assessing the fair presentation of a entity's financial position, results of operations and changes in financial position.
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