How much credence can shareholders of public companies safely attach to financial statements that carry a “true and fair” imprimatur from their auditors?

Big-4 firms hold the lion’s share of public company audit appointments, yet they are regularly found to have issued “clean” reports on accounts that grossly misrepresent the results and financial position of client companies, causing severe damage to shareholders’ interests.

The main UK regulator is the Financial Reporting Council (FRC). The “Notes to Editors” that accompany its press releases state that the FRC is “the UK’s independent regulator responsible for promoting transparency and integrity in business.” The term “independent” raises the question: “independent of whom?” The FRC website shows that the membership of its board, councils, committees and other divisions includes at least 20 accountants with past Big-4 affiliations.

Personally I don’t believe that members’ historic links to Deloitte, KPMG, EY or PwC necessarily pose an independence threat. Would they seek to persuade an enforcement tribunal to adopt an inappropriately lenient position in a particular case? Considering that in most cases the competence and integrity – the very culture – of a Big-4 firm is in the spotlight, it would be a salutary experience for its senior partners to witness some reputational shredding before their very eyes!

KPMG and HBOS

Whenever we witness conspicuous professional failures, whether concerning false accounting or audit failure or both, the role of the FRC is implicitly raised. After all, it is the FRC that decides whether to bring enforcement proceedings against a firm in the first place. Its recent decision, 10 years after the event, to let KPMG off the HBOS hook was described by the Financial Editor of The Times as “especially bone-headed and provocative”, an opinion that the FRC’s own press release does absolutely nothing to dispel.

Since the core issue is KPMG’s agreement in early 2008 that the December 2007 HBOS accounts should be prepared on a going concern basis, the wording of FRC’s conclusion is astonishingly obtuse: “The evidence of market conditions at that time did not show this decision of HBOS or the auditor’s assessment of it to be unreasonable at the time.”

This use of the double negative by the FRC is singularly unhelpful: Surely “not ……… unreasonable” is the same as, well, “reasonable”? If so, why not say just that? If not, what’s the ever-so-subtle difference? Do FRC press releases expect readers to interpret nuances?

Liquidity? Or Solvency?

It gets worse. The FRC press release declares that KPMG accepted the conclusion reached by HBOS in early 2008 – that market conditions would not worsen, and its 2007 accounts should be prepared on a going concern basis. The FRC adds that the “extreme funding conditions which arose in October 2008 were not anticipated,” suggesting that the whole problem was one of liquidity.

Yet two years ago the Parliamentary Committee for Banking Standards (PCBS) reached a very different conclusion. According to its analysis: “The problems of liquidity were the occasion for the failure of HBOS, not the cause.” And: “The HBOS failure was fundamentally one of solvency.” A 2016 House of Commons Treasury Committee report is explicit in castigating the “inexplicable and inexcusable” delays in the FRC investigation process.

Personally, I find the FRC’s press release to be insulting. Its conclusion is technically flawed, blaming the HBOS collapse on liquidity issues, as if it were simply a matter of bad luck that it ran out of cash when the market was unable to help.

Analysis by the PCBS shows by contrast that the real problem was solvency – masking of which was demonstrably an accounting failure.

The December 2007 accounts declared a profit of £5.5 billion supported, incredibly, by a solvent balance sheet.

Yet only eight months later HBOS went bust with the loss of 50,000 jobs – and over the next four years £52.6 billion of its loans and investments proved to be worthless, at a cost to taxpayers of £21 billion.

This is a case that highlights the ease with which accounting as now practised and supervised by the FRC is capable of churning out utter tripe as plausible information, and then lending it bogus credibility in a formal audit report.

This piece was originally published on Emile Woolf Writes, and was reproduced with permission of the author.

Emile Woolf

Emile Woolf

Emile Woolf is a Renegade Inc. correspondent.

Over 45 years, he has been a teacher, lecturer, best-selling author of professional texts, practising accountant, forensic expert witness and, throughout this period, one of the profession’s most widely read columnists and magazine journalists.

Emile's subject range includes the wider spectrum of economics, taxation and any related developments that have a financial dimension, always seeking to identify the principle that lies behind the dilemma.

Website: http://www.emilewoolfwrites.co.uk/
Emile Woolf

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