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Supreme Court rules Grant Thornton must pay £13.4m over negligent advice

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A long-running court battle between Grant Thornton and Manchester Building Society has ended with the challenger firm liable for significant damages after senior judges clarified what counts as “negligent” advice.

24th Jun 2021
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The Supreme Court has backed a £32.7m damages claim against Grant Thornton over suspect advice given to a client, in a ruling which experts say may leave other auditors open to litigation.

The long-running civil case, brought by Manchester Building Society in 2013, hinged on what counted as “advice” versus simple “information”.

Grant Thornton audited the books of the mutual building society until 2012, but after advising the use of “hedge accounting” an error in the treatment of interest rate swaps meant the client had to break an agreement early, incurring costs of almost £33m.

For six years the case traversed the lower courts before the Supreme Court judgment handed down on 18 June sided with Manchester Building Society and ruled that it is entitled to claim £13.4m from Grant Thornton for negligence. The sum is less than half the total amount the society originally lost, which the court said was down to its own contributory failings in the matter.

The challenger firm said it was “disappointed” by the judgment, which overturned earlier rulings in the High Court and Court of Appeal.

“We always accepted that our audits of the Society for the 2006-2011 years fell below the high standards that we strive for and regret the errors in the Society’s financial statements that arose from hedge accounting; which our audit team identified and brought to the attention of the Society and the Prudential Regulation Authority in 2013,” a spokesman for Grant Thornton UK LLP said.

Scope of duty

Hedge accounting is used to reduce the volatility of the mark-to-market value of swaps in accounts, and from 2006, Grant Thornton advised the society that its accounts could be prepared using the method to give a true and fair view of its financial position.

This allowed the society, under tightly specified circumstances, to adjust the carrying value of the lifetime mortgages to offset any changes in the value of the swaps.

Grant Thornton advised that the combination of swaps and mortgages passed the stringent tests applicable to the use of hedge accounting, and repeated this same incorrect advice in each annual audit, the court found.

Following the global financial crisis of 2008, a fall in interest rates, meant the mark-to-market value of the swaps became negative.

The misstated accounts hid both volatility in the society’s capital position and the eventual severe mismatch between the negative value of the swaps and the value of the mortgages which the swaps were supposed to hedge.

In 2013, when Grant Thornton realised its error, the society had to restate its accounts, showing substantially reduced assets and insufficient regulatory capital. To remedy the situation, the society closed out the interest rate swap contracts early for a multi-million-pound loss, and had to source emergency funding.

Information or advice?

Such was the complexity of the case, three different courts took three very different views of both the scope of duty test that applies in cases of professional negligence, and the proper outcome.

Grant Thornton admitted negligence but defended its liability on the basis that the swap break costs did not fall within its scope of duty when it gave the advice and undertook the audits

Whilst the Commercial Court awarded damages to Manchester Building Society, both it and the Court of Appeal found in favour of Grant Thornton in relation to the swap break costs, albeit on differing grounds.

The Court of Appeal weighed if “information” or “advice” had been provided by the auditor, and consequently if it would be liable for “all the foreseeable consequences of entering into the transaction”.

Ultimately, the appeal judges felt it was an information case, to which the society appealed, and eventually the case was heard in October 2020 by a panel of the Supreme Court. The seven judges unanimously determined that the losses suffered by Manchester Building Society were within the scope of Grant Thornton’s duty.

“The very thing”

Future cases of negligent advice will concern “what risk the duty was supposed to guard against and then whether the loss suffered represented the fruition of that risk”, experts told AccountingWEB.

“If one is looking for a bite-size take away from this judgment it is that, in practical terms, the scope of duty test has become the question; ‘Is this loss the very thing that the professional advice was supposed to guard against?,” said Anthony Taylor, litigation partner at Squire Patton Boggs who represented Manchester Building Society. “The judgment has significantly reformulated the legal test for the scope of duty of care owed by professional advisers to their clients.”

The case was twinned with an unrelated claim also concerning scope of duty in a professional negligence context. In that case, a doctor negligently advised a patient that she was not at risk of passing on haemophilia to any child she might have.

“The legal test for scope of duty in professional negligence had become narrow and difficult to navigate,” said Taylor. “The over emphasis on the counterfactual test had introduced both uncertainty and undue barriers to recovery in cases involving complex facts.” He said the simplification of the test provided by the court in this judgment was “very welcome”.

Audit firms in the crosshairs

The case is likely to have ramifications for auditors who provide advice to clients who later lose money.

“Claimants who have suffered loss as a result of negligent advice are likely to turn to this judgment as providing both a more generous and more common-sense test for scope of duty,” said Taylor. “Professionals giving advice should pay heed to the ‘purpose of duty’ question and make sure that their terms of engagement are absolutely clear on the agreed purpose of the advice being sought.”

The decision will fuel further scrutiny of the audit word during a difficult time for the top firms, said Paul Brehony, partner and specialist insolvency disputes expert at Signature Litigation. “It demonstrates that where an auditor is held liable for a company's losses, significant damages can follow,” Brehony said. “Going forward, we can expect an uptick in corporate failures as pandemic support measures are eventually withdrawn. Audit firms are deep-pocketed targets and large claims for negligence and potential wrongdoing seem inevitable at this time."

Professional advisers are under growing scrutiny and should pay attention to the judgment, added Janine Alexander, financial services partner at Collyer Bristow LLP.

‘This case forms part of an intensifying focus on the duties owed by accountants, and in particular, auditors when scrutinising the finances of large enterprises - a reminder that the courts and regulators expect more from them than a box ticking approach,” Alexander said.

The Financial Reporting Council (FRC) probed the matter in 2013, and the regulator took action against Grant Thornton in 2015, fining the firm just under £1m.

While the FRC did not wish to comment on this case, the thinking inside the regulator is understood to be that the outcome won’t have particularly wide-ranging implications given the unique set of circumstances involved.

Replies (12)

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By SteveHa
25th Jun 2021 08:58

And I wonder why the big firms don't separate their general accountancy/tax work from their audit work. With the multitude audit failures in recent years, the reputational damage must be huge.

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By paul.benny
25th Jun 2021 11:36

Actually, they have to do so now. Auditors of Public Interest Entities (PIEs) are not permitted to provide most other services to the same client. The definition of a PIE includes listed companies, insurers and credit institutions.

So today, GT would not have been permitted to provide advice on the accounting treatment of hedge transactions. That said, they would still have to form an opinion on the acceptability MBS accounting treatment.

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By Duggimon
25th Jun 2021 09:50

You know, it's almost as if the accounting practices in the mortgage industry were too complex, and the big audit firms were too complicit in disguising the problems.

I'm starting to think these sorts of practices might have had something to do with the global financial collapse in 2008...

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Replying to Duggimon:
By Nick Graves
25th Jun 2021 12:21

Duggimon wrote:

You know, it's almost as if the accounting practices in the mortgage industry were too complex, and the big audit firms were too complicit in disguising the problems.

I'm starting to think these sorts of practices might have had something to do with the global financial collapse in 2008...

You'll be telling me next that the entire fiat monetary system is nothing but a giant Ponzi scheme fraud. Oh, hang on...

Actually, I'd have thought it would make the audit report pretty damned straightforward "given the complexity of derivative FIs, we have NFI what's going on and are therefore incapable of expressing an opinion".

Audit fee £100....

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By AndrewV12
25th Jun 2021 09:53

Firstly Shame on me for not know who the Manchester Building society are.

Secondly, what the hell is a Building society getting involved in the following ;-

Hedge accounting is used to reduce the volatility of the mark-to-market value of swaps in accounts, and from 2006, Grant Thornton advised the society that its accounts could be prepared using the method to give a true and fair view of its financial position.

This allowed the society, under tightly specified circumstances, to adjust the carrying value of the lifetime mortgages to offset any changes in the value of the swaps.

Thirdly, what the hell is a building Society getting involved in taking advice from Grant Thornton, they should be experienced enough by now.

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By lh3f9764bg1g
25th Jun 2021 10:19

If any of the rest of us (i.e. the little guys) were to have done this . . . . . . . . . .

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By Justin Bryant
25th Jun 2021 10:56

I reckon GT's PII premiums must be pretty high these days (and this decision is bound to increase them for all generally, all else being equal). I'm sure the legal costs of this defeat for GT (or rather their insurer) alone would be well over £1m.

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By rezasamii
25th Jun 2021 11:44

Commiseration for GT. Very good firm and I use them for adhoc consultancy works. As an auditor, it is good to see a case going all the way to the Judge rather settled out of court. This way at least we may learn more about the concept of negligence and events leading to payouts.

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By dwgw
25th Jun 2021 11:46

“Going forward, we can expect an uptick ..."

Anyone impressed by the language? Why do people talk like this?

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By Arcadia
25th Jun 2021 17:33

Still don't get it. Why would GT's advice on how to account for something impact the Society's decision to enter into the swaps? If the market value fell then how is that GT's fault ? No-one seems to be saying GT provided advice on entering into the swaps, just whether were eligible for hedge accounting (when they were not). Who advised on buying the swaps? The bank manager selling them maybe?

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Replying to Arcadia:
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By DJKL
25th Jun 2021 22:10

I think in part it is that the accounting may have disguised the exposure position leading to the society not making decisions earlier re their "real" position and suffering loss as a result.

It is in some degree similar to RBOS and Ambro, where the bankers in RBOS did not appear to have really understood what it was they were buying when purchasing Ambro.

Bank balance sheets frankly remind of the Schleswig Holstein Question (except unlike Palmerston I never understood), they are so opaque they are now a sector, together with insurers, where I will just not buy shares as I just do not understand their accounts and I am frankly not sure how many people , including analysts and auditors, really do understand what they are shown.

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Replying to Arcadia:
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By Ian Bee
28th Jun 2021 11:32

Thank you for raising this as it occurred to me when reading the article to begin with.

You would expect the building society to have created models outlining the cash flows of the swaps and the risks involved when interest rates rise or fall which would not change depending on the year end position.

Year end accounting is merely to show the position at the balance sheet date according to relevant accounting standards. However the regulations of a building society require levels of capital to be maintained based on year end accounts. It is not completely clear to me but if the capital was overstated using an incorrect method, the resulting loss when corrected may be what forced the society to break the swaps, thereby realising the loss.

By analogy I can remember when pension liabilities were put on the company balance sheet. It created havoc at the time, which still affect commercial decisions, even though the underlying cash flows have not changed at all.

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