Accountants negligent in review engagement of Ponzi scheme

In a recent ruling, the Alberta Court of King's Bench[1} considers the standard of care expected of an accounting firm performing a Review Engagement following the collapse of a Ponzi scheme.

Facts

Marco Baldasaro is a partner in the Calgary office of McLennan Ross LLP. Graham McLennan, K.C. is a partner in the Edmonton office of of McLennan Ross LLP.

Peers Kristiansen Foster Inc. ("PFK") was an Edmonton investment firm and longtime client of the accounting firm Mowbrey Gil LLP ("Mowbrey Gil"). The Plaintiffs Robert Mewburn ("Robert") and Charity Mewburn ("Charity") were siblings and shareholders/investors in PFK, as well as clients of Mowbrey Gil.

In 2009, Charity came into an inheritance, and was approached by PFK to invest the funds. Before proceeding, Charity spoke with Robert about the investment opportunity.

Robert reviewed PFK's 2008 financial statements, which had been prepared on a Review Engagement basis, and spoke with the Mowbrey Gil partner responsible for their preparation. During the discussion, Robert asked the partner if he had noticed any signs of impropriety. The partner assured Robert he had not.

Based on the financial statements and the partner's assurances, Robert provided a favorable recommendation to Charity. Charity subsequently invested $1,000,000 in PFK. The following year, PFK was discovered to be a Ponzi scheme and assigned itself into bankruptcy. Virtually the entirety of Charity's investment was lost.

The Plaintiffs commenced an action against Mowbrey Gil in relation to the investment. The action alleged, among other things, that Mowbrey Gil was negligent in the preparation of PFK's 2008 financial statements, that the Plaintiffs relied on the 2008 financial statements to their detriment, and that but for Mowbrey Gil's negligence in the preparation of the financial statements, Charity would not have invested the $1,000,000 in PFK.

Mowbrey Gill defended the action by denying that it had been negligent and asserting that it was protected by the disclaimer clause contained in the Review Engagement Report. The disclaimer clause indicated the financial statements had not been prepared in accordance with Canadian generally accepted accounting principles (GAAP) and purported to limit the use of the financial statements to the directors of PFK, the federal and provincial income tax authorities, and the Alberta Treasury Branch.

The Expected Standard of Care

The court's consideration of Mowbrey Gil's negligence focused on whether Mowbrey Gil met the requisite standard of care. Most of PFK's "investments" were in a corporation known as Visionwall Inc., and its subsidiary Visionwall Corporation (collectively, "Visionwall"). Although there were clear signs that Visionwall was in serious trouble and needed additional cash to carry on its regular business activities, Mowbrey Gil neglected to perform any meaningful plausibility analysis of PFK's accounts receivable. Mowbrey Gil defended its conduct on the basis that the financial statements were expressly non-GAAP and consequently, no plausibility analysis was required.

The court rejected this assertion and concluded that Mowbrey Gil was negligent. Citing the CICA Assurance Recommendations (now the CPA Canada Handbook – Assurance), the court concluded that Mowbrey Gil ought to have performed a plausibility analysis and considered whether the investments in Visionwall were likely collectable. Had Mowbrey Gil performed a plausibility analysis, it would likely have concluded that the accounts receivable were doubtful or uncollectable. By failing to do so, Mowbrey Gil failed to meet the standard of care expected of an accounting firm preparing financial statements on a Review Engagement basis.

The Disclaimer Clause

In addition to denying that it was negligent, Mowbrey Gil attempted to defend the claim on the basis of the disclaimer clause in the 2008 financial statements. In essence, Mowbrey Gil asserted that any reliance by the Plaintiffs on the Review Engagement Report was unreasonable and unforeseeable as it had been prepared solely for use by PFK's directors, certain tax authorities, and the Alberta Treasury Branch.

The court rejected this argument noting that:

a. The use of the Review Engagement Report by shareholders had not been expressly precluded by the disclaimer;

b. The engagement letter between PFK and Mowbrey Gil stated that the Review Engagement Report was for the use of PFK and its shareholders/owners to make investment decisions; and

c. Notwithstanding the disclaimer, the Review Engagement Report was specifically addressed to PFK's shareholders (who included the Plaintiffs).

Takeaways

Firstly, the standard of care for a Review Engagement, whether expressly stated to be in accordance with GAAP or not, requires the accounting firm to perform a plausibility analysis. Simply identifying a Review Engagement Report as non-GAAP does not excuse an accountant from this task. Secondly, this decision is a good reminder that courts will be very reluctant to enforce disclaimer clauses unless clearly worded and unambiguously applicable to the precise circumstances under consideration.

Footnote

1. Mewburn v Mowbrey Gil LLP, 2022 ABKB 810

Marco Baldasaro is a partner in the Calgary office of McLennan Ross LLP. Graham McLennan, K.C. is a partner in the Edmonton office of of McLennan Ross LLP.