Civil Litigation

Appeal court judgment good news for auditors

By Staff

A recent decision by the Ontario Court of Appeal makes it more difficult for auditors and other professionals to be sued by individuals who were not their clients, says Toronto commercial litigator William Pepall.

The decision overturned a summary judgment ruling that found the auditors of a securities dealer liable for millions of dollars lost by the firm’s customers when it went under.

“It’s an important decision, particularly for the auditors of retail stock brokerage firms,” says Pepall, a partner with Lerners LLP. “It suggests that while auditors may owe duties to the company that engaged them, they do not necessarily owe a duty of care to the customers of that company for failures in the performance of the audit.”

According to the decision, the stock dealer admitted to making untrue statements in regulatory documents, filed with the Ontario Securities Commission (OSC), that are designed to maintain segregation between investor assets and a minimum level of risk-adjusted capital. It was also alleged that the auditor breached its duty of care by "failing to properly review and confirm the accuracy" of documents, says the OCA decision.

Customers of the dealer launched a class action in 2005 following the company’s suspension by the OSC and eventual collapse, which resulted in the loss of at least $10 million in investor assets.

As part of its action, the class claimed the auditor owed it a duty of care — one they claimed was breached when the auditor failed to properly audit the Form 9 Reports filed with the OSC, explains Pepall.

A Superior Court judge granted the class summary judgment after concluding the auditors were indeed liable.

However, the appeal court found the motions judge erred in his duty-of-care analysis, citing a recent decision by the Supreme Court of Canada (SCC) that clarified the framework to be used for establishing a prima facie duty of care.

Pepall says the key finding of the SCC judgment, restated by the Court of Appeal, is that “foreseeability and proximity are distinct and separate tests.”

“Just because a consequence was foreseeable, does not mean there was a sufficient or proximate connection between plaintiff and defendant," he tells

"The scope of the defendant's undertaking is critical to the proximity analysis. In this case, there was no proximate relationship between the auditors and the third-party customers. When the court did its proximity analysis, it concluded there was no duty to the investors on the part of the auditor.”

The unanimous appeal court panel found that the motion judge’s finding of a relationship of proximity between the parties was “unsupportable on the evidence,” noting that the improperly audited forms were filed confidentially with the OSC and would not have been reviewed or available to the Class.

“The Auditor made no representations to members of the Class, most of whom never even knew of the Auditor’s existence or its involvement,” the appeal panel wrote. “The limited scope of the Auditor’s undertaking and lack of direct connection between the Auditor and the Class militate against finding proximity in this case.”

Pepall says he can understand the motion judge’s sympathy for the investors since it’s likely the OSC would have stepped in earlier if there had been properly audited forms. But he says the appeal court made the right call in overturning the judgment.

“It was interesting that the appeal court twice noted that the OSC reports were filed confidentially and I wonder whether the result may have been different if they were public documents,” he adds.

Still, Pepall says it’s likely that auditors will face further attempts in future to broaden the scope of their duty of care beyond their direct clients.

“Auditors have always been — and probably will always be — concerned about potential liability to users of their financial statements, which can include shareholders, creditors, lenders, regulators, and others they have no contract with,” he says. “The proximity analysis is always going to be rooted in the nature of the mandate or specific work undertaken by the professional.”

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