Thursday, March 27, 2008

Consumers of services provided by auditors are accustomed to clauses in the standard service agreement limiting the auditors’ liability for certain services.  Typically auditors’ standard service agreements provide that the maximum liability of the auditors in respect of services other than “statutory” audit services (described below) shall be limited to a multiple of the fees charged for those non-audit services. 
Boards of management of pension fund organisations are compelled by section 9 of the Pension Funds Act (PF Act) to appoint an auditor to perform certain audit-related functions which are described in section 15 of the PF Act and regulation 12 under that Act.  Those functions include services which constitute statutory audit services as well as services which do not fall within the scope of that expression, and which would be subject to the limitations in the service agreement.
Although the PF Act imposes certain functions upon auditors, it does not in a general sense impose any duty of care on the auditor of a pension fund in excess of the standard of care expected of a registered auditor in terms of the Auditing Profession Act (APA) or under common law.  Section 46(2) of the APA provides that in respect of any opinion expressed or statement made in connection with statutory audit services, an auditor shall incur no liability to his or her clients or to a third party (including members of a client fund) unless the auditor’s conduct can be shown to have been malicious, fraudulent or negligent.  That provision only refers to the audit services defined in paragraph (a) of the definition of “audit” in section 1 of the APA.  The services contemplated in that paragraph (“statutory” audit services) are those which entail the examination of “financial statements … in accordance with prescribed or applicable reporting standards, with the objective of expressing an opinion as to their fairness or their compliance with an identified financial reporting framework including any applicable statutory requirement”.  Statutory audit services (as defined) do not include the services referred to in paragraph (b) of the definition of “audit” in section 1 of the APA, namely “the examination, in accordance with prescribed or applicable reporting standards, [of] financial and other information, prepared in accordance with suitable criteria with the objective of expressing an opinion on the financial and other information”.  In short, statutory audit services comprise those functions classically expected of, and reserved for, registered auditors, the product of which is the audit opinion which appears near the beginning of every set of audited financial statements. 
In the context of the PF Act and its Regulations, statutory audit services include the audit statement (schedule D to regulation 12) and any specific product of the auditor’s functioning in accordance with section 15 of the PF Act.  Arguably though, the functions of auditors under regulation 12’s schedule F (“Statement of Funds and Net Assets”) and schedule I (the analysis of regulation 28 compliance) would not be classed as statutory audit services.  It appears then that several of the statutory functions of an auditor under the PF Act fall within that category of services which are the subject of auditors’ limitation clauses, and those limitation clauses should not be construed, mistakenly, as referring only to some of the more common “add-on” services often provided by auditors, such as forensic services, litigation support, administrative and consulting services. 
As with any draft agreement presented to a pension fund by a prospective or incumbent service provider, it is necessary for the members of the board of management of that fund (the trustees) to interrogate the proposed provisions, since the trustees have the duty, among others, to protect the interests of the members of the fund which they manage, to exercise due care, diligence and good faith in managing the fund, and to ensure that proper control systems are employed by and on behalf of the fund.  Trustees who fail to apply their minds to auditors’ limitation clauses risk being found to have neglected their own statutory duties
Trustees need to tackle this aspect of any negotiation with prospective auditors themselves.  Those who do not, and who look to the law for same form of generic, overarching protection against such provisions, perceiving them to be unlawful, unethical or simply undesirable, will find scant assistance. Our courts have consistently held that they will not protect a contracting party from the consequences of an agreement duly entered into by it merely because the agreement appears to the court to be unreasonable.  However, our courts have in a number of decisions established certain basic principles in relation to clauses limiting liability.  Such clauses are to be interpreted narrowly.  One cannot disclaim liability for fraud or other intentional wrongdoing, nor can one disclaim liability in circumstances in which to do so would contravene any fundamental principle of justice or prejudice the interest of the public.  So-called gross negligence may be disclaimed. 
The responsibility for ensuring the protection of the best interests of the members of a pension fund lies with the trustees, who are expected to understand exactly what services are to be provided by prospective auditors and to understand which of the proposed services are subject to section 46(2) of the APA and which are subject to the limitations in the proposed agreement.  Trustees also need to consider whether (and if so how) agreeing to limitation provisions may impact upon the level or cost of appropriate insurance for the fund and, also whether (and if so how) limitation clauses may affect the contingent liabilities of the pension fund or their valuation. 
A provision such as a limitation clause, which apparently could only operate to the detriment of the fund would need to be motivated and considered in the context of the overall package and quality of services to be provided by the auditor.  Assuming that no auditor would be prepared to provide services other than statutory audit services in the absence of a limitation of liability, it would not be open to the board of a pension fund to refuse to appoint any auditor at all.  In the situation where the trustees are faced with a choice between appointing an auditor who insists upon a limitation clause and an auditor who does not, the board would presumably consider other relevant factors such as the reputation and quality of services and service level arrangements that comprise the full package of proposed rights and obligations in terms of the competing proposals. 
David Geral is a director at Bowman Gilfillan.