Winning the blame game: assumption of responsibility test saves auditors from market loss claim

Background

Mortgage providers MBS instructed Grant Thornton to audit their accounts between1997 and 2012. In 2006, MBS began a policy of entering into long 50 year interest rate swaps with a view to offsetting interest rate risks associated with lifetime mortgages (under which no payments were made or equity released until owners entered into a care home or died). Grant Thornton did not advise on the swaps themselves but did advise that the impact of the volatility of the swaps on MBS’s balance sheet could be mitigated by a practice known as “hedge accounting” whereby opposing hedged securities are treated as one. This approach continued but, as a result of the dramatic fall in interest rates following the 2008 financial crisis, MBS eventually suffered substantial losses under the swaps.

In 2013, MBS subsequently discovered that hedge accounting was not permitted under applicable regulations, meaning that the effects of the practice had to be reversed. As a result, MBS’s profit from 2011 became a loss and net assets were substantially reduced. MBS’s regulatory capital position was also significantly affected. Following these changes, MBS was forced to close out the swaps and sell its book of UK lifetime mortgages. It sought to recover losses of £48.5 million from Grant Thornton, based upon its total cost of breaking the swaps and other associated losses.

Grant Thornton admitted that it had negligently advised MBS that its hedge accounting policy complied with all relevant standards and had therefore negligently conducted audits for years ending 2006 to 2011. However, the extent of the losses recoverable from Grant Thornton remained in dispute. MBS sought to recover the full £48.5 million on the basis that it would not have entered into the life mortgage business and swaps after April 2006, and would at that time have closed down its existing swaps.

In contrast, Grant Thornton argued that:

• MBS’s losses were not within the scope of its duty of care (applying the decisions in SAAMCO and Hughes-Holland);
• Even if the correct advice had been given, MBS would have still effected the same mortgage business (albeit hedged by a different form of swap), resulting in the same losses; and
• Even if they were found liable, any damages should be discounted by 70 to 80 per cent due to MBS’s contributory negligence in failing to take reasonable care of its own interests.

Decision

In reaching his decision, Teare J held that:

1. Although MBS’s decision to close the swaps had been caused, both as a matter of fact and in law, by the defendant’s negligent advice and that MBS’s losses were foreseeable, Grant Thornton had not assumed responsibility for such losses and therefore they were not recoverable;
2. Grant Thornton was, however, liable for other smaller heads of loss, including various penalties in relation to the termination of the swaps; and
3. MBS had themselves been negligent in buying the 50 year swaps (which far exceeded the duration of the lifetime mortgages), justifying a contributory negligence deduction of 25 per cent.

The result of the above was that damages awarded by the court to MBS were limited to just £315 (a fraction of the total £48.5 million claimed). In coming to this decision, Teare J commented that it would be a striking conclusion if an accountant who advises a client as to the manner in which its business activities may be treated in its accounts has assumed responsibility for the financial consequences of those business activities.

Comment

This decision should provide some reassurance (for now at least) to accountants and their insurers by illustrating the fact that, whilst losses may be foreseeable and advice crucial, this will not in itself mean that an adviser has assumed responsibility for any resulting losses. This decision also reinforces the court’s wider reluctance to attribute blame to accountants for losses which result from general commercial decisions.

Perhaps less helpful is the obvious difficulty faced by the judge in applying SAAMCO and in assessing whether particular losses fell within the scope of the accountants’ duty of care. These uncertainties may make this an appropriate case for an appeal and it is thought that MBS is considering its options.