Can directors rely on external auditor to detect material errors in financial statements?
A recent court case in Australia came to an interesting conclusion. The Australian Securities and Investments Commission (ASIC) sued executives and non-executive members of the board of Centro, alleging that the company wrongly classified more than $2b of debt as non-current and failed to disclose a $2.8b debt guarantee.
The directors argued that they took reasonable steps and relied on the external auditor, who did not detect the errors. ASIC’s position was that “It is the duty of every director to read the financial statements carefully and consider whether what they disclose is consistent with the directors’ own knowledge of the company’s affairs.”
Although the judge found that there was no evidence of dishonesty by the directors, and that they relied on extensive advice, he found against the directors. He commented that the directors failed to apply their minds to the financial statements, otherwise they would have picked up the errors.
I wonder how many boards, and especially audit committee members, would need to intensify their review of the financial statements and questioning of both management and the external auditor to meet the standard in the ASIC argument above. How many rely on the external auditor without (a) questioning the quality of the external audit staff and approach, and (b) applying their own knowledge and understanding of the business and the financial condition of the company before approving the financial statements? Can they rely on the few directors with formal financial experience (financial experts)?
I hope that counsel at corporations around the world will look at this ruling and check to make sure their board is doing enough.
I welcome your comments.