Auditors: 'Watchdog OR Bloodhound'? by Janet Morgan, Contributor
Source: Financial Gleaner, October 27, 2000
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.
* Janet Morgan is an attorney-at-law with the firm Dunn, Cox, Orrett & Ashenheim. janet.morgan@dunncox.com