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In a decision released early this year, Mr. Justice Paul Perell of the Ontario Superior Court of Justice refused to certify a proposed $100 million class action against the former auditor of disgraced portfolio management firm, Crystal Wealth Management Systems Ltd. Certification was denied on the basis that the Crystal Wealth’s auditor owed no duty of care to holders of the units of mutual funds managed and sold by Crystal Wealth.
The proposed representative plaintiffs in Whitehouse v. BDO Canada LLP were former holders of units in mutual funds sold by Crystal Wealth – a discretionary portfolio management firm specializing in alternative investment strategies outside traditional stock and bond portfolios. The plaintiffs alleged that Crystal Wealth’s auditor, BDO Canada, had been negligent in issuing clean audit opinions to the Ontario Securities Commission and unitholders from 2007 – 2017 – a period during which it was alleged that the management of Crystal Wealth was misappropriating assets. The plaintiffs alleged that the fraud was discovered when the OSC appointed a Receiver over Crystal Wealth after it did not deliver audited financial statements for 2016. By that time, Crystal Wealth unitholders had lost more than $100 million CAD.
Over the course of its retainer as auditor, BDO had audited each of the mutual funds sold and managed by Crystal Wealth every year and, for 2015, it had issued clean audit opinions for ten of Crystal Wealth’s mutual funds. After Crystal Wealth created five new funds during 2016 and after it failed to file audited financial statements with the OSC for 2016, the OSC had accounting firm Grant Thornton appointed receiver of Crystal Wealth. Grant Thornton reported to the Court that Crystal Wealth had materially overstated the net asset values (NAV) of its mutual funds and had used inter-fund investments to falsely create liquidity to meet demand for investor distributions or redemptions. The evidence of fraud related primarily to Crystal Wealth’s Media Fund – which invested in loans to finance movie productions.
A key factor in whether an action can be certified as a class proceeding under the Class Proceedings Act, 1992 is whether there the pleadings disclose a cause of action. While normally the existence of a cause of action is not the main obstacle to certification, in this case the lack of a cause of action was fatal to certification. In particular, Justice Perell found that it has been well-settled at the highest level in Hercules Managements v. E&Y that an auditor conducting a statutory audit owes no common law duty of care to investors in relation to their personal investment decisions and that “BDO’s relationship to the Class Members with respect to their investment decisions is indistinguishable from the duty of care relationship alleged and analyzed in Hercules.” Unless an auditor is retained for the specific purpose of helping to promote an investment, as in the 2016 case of Excalibur v. Schwartz Levitsky Feldman, it will be plain an obvious that no duty of care exists and a claim cannot succeed.
This case is just the latest in a series of recent decisions, including Lavender v. Miller Bernstein LLP and Livent v. Deloitte & Touche, that have rejected the claim that auditors owe a duty to assist investors in their investment decisions. This decision and these other decisions should provide some comfort to auditors conducting statutory audits that they will not be held liable to investors if that is all they do – at least at common law. Having said that, it cannot be ignored that there are potential statutory sources of auditor liability to primary and secondary market purchasers of securities under Parts XXIII and XXII.1 of the Ontario Securities Act, respectively, and that auditors who assist companies in soliciting investment also run a risk of liability to investors if they are negligent.