Auditors: 'Watchdog OR Bloodhound'? by Janet Morgan, Contributor

Source: Financial Gleaner, October 27, 2000

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IN the famous case Re: Kingston Cotton Mills Co. (1896), Lord Justice Lopes defined an auditor's duty of care as follows:

"It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution which a reasonably careful, cautious auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective, or, as was said to approach his work with suspicion, or with a forgone conclusion that there is something wrong. He is a watchdog, not a bloodhound. He is justified in believing tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest and rely upon their representations, provided he takes reasonable care."

Ironically, since that definitive statement, there has been a gradual metamorphosis in an auditor's duty of care. It is no longer sufficient for an auditor to rest upon the honesty and accuracy of others. He must go further and satisfy himself that accounts upon which he relies have been taken on sound accounting principles. In the later case Fomento (Sterling Area) Ltd. v Selsdon Fountain Pen Co. Ltd. (1958), Lord Denning put it this way:

"To perform his task properly he must come to it with an enquiring mind - not suspicious of dishonesty - but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none."

Interestingly, the 1997 amendments to the Banking Act and the Financial Institutions Act raised the standard from the duty of having an "enquiring mind" to that of having a "suspicious mind". The role of the modern auditor of banks and financial institutions was thereby effectively transformed from that of "watchdog" to "bloodhound".

Under section 19A(1) of both Acts, auditors have a duty to report in writing to the chief executive office, each director and to the Supervisor (defined as the Supervisor of Banks and Financial Institutions appointed under the Bank of Jamaica Act) any "material transactions or conditions" obtaining in a bank or financial institution which in the auditor's opinion amount to:

* changes in accounting policy which have the effect of misrepresenting the financial position;
* transactions or conditions which give rise to potential exposure or exposure which may jeopardise viability;
* transactions or conditions which indicate that internal controls are significantly weak;
* transactions that are irregular and that have a significant or material impact on the financial position;
* transactions or conditions that contravene the Acts or regulations as regards capital adequacy or liquidity requirements;
* transactions or conditions which in the opinion of the auditors ought to be included in such a report.

An auditor is therefore mandated to approach his duties with suspicion and to take an investigative approach to each transaction. We await with interest the Court's interpretation of the words "material conditions or transactions". Hopefully, future judgments will guide auditors by providing greater definition of these concepts.

In the meanwhile, pressing questions which now arise are:

* Should auditors protect themselves by reporting all transactions and conditions, and thereby risk incurring the displeasure and loss of clients?
* Can the directors sue auditors for breach of statutory duty and do these duties take precedence over the common law duty to the company and its members?
* When audited accounts induce investment in a Bank or Financial Institution followed by an alleged breach of statutory duty (which in law cannot be disclaimed), is the auditor liable to pay damages to the investor?

Given the onerous obligations imposed on auditors on pain of imprisonment, fine or both, and their exposure to civil and criminal proceedings, it is a high rope upon which they are called to perform a precarious balancing act. However, the impending Companies Bill should provide a helpful safety net. Recognising auditors' heightened exposure to liability, the Bill provides that a company may not only indemnify its directors and officers, but also any person employed to it as an auditor.

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* Janet Morgan is an attorney-at-law with the firm Dunn, Cox, Orrett & Ashenheim.

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