Professions
Accountancy

In search of an honest accountancy firm

Burgess COMMENTARY

Peter Burgess

In search of an honest accountancy firm

Were Napoleon Bonaparte alive today, he would surely call Britain a “nation of accountants” rather than a “nation of shopkeepers”. With around 330,000 professionally qualified accountants, the United Kingdom has more accountants than the combined total of lawyers, doctors, surgeons, engineers and architects. This vast social investment has failed to deliver good corporate governance, meaningful company accounts, or worthwhile audits. But it has produced a tide of sleaze and the destruction of tax revenues. Accountancy firms are a ripe case for Ed Miliband’s quest for responsible capitalism.

The world of accounting is dominated by four accounting firms operating through a series of international networks.

These are Deloitte & Touche, PricewaterhouseCoopers, Ernst & Young and KPMG. The firms enjoy the state-guaranteed market of external auditing and insolvency, which also gives them numerous opportunities to sell consultancy services, including tax avoidance. The Big Four firms audit 99 per cent of the FTSE100 companies, 94 per cent of the FTSE250 and 78 per cent of all main market listed companies. They work both sides of the street for the Private Finance Initiative, and have probably collected in about £1 billion in fees by advising government departments and corporations.

The same firms are busy privatising the National Health Service. KPMG are the advisors on the flawed HS2 railway project. Ernst & Young collected its fee for the undervalued Royal Mail privatisation. And who can forget the role of Price Waterhouse (now part of PricewaterhouseCoopers) in busting the 1984-85 miners’ strike?

Such activities have enabled the Big Four firms to generate annual global revenues of around $115 billion (£72 billion), of which some $65 billion (£41 billion) is from non-auditing services. This provides resources to fund political parties, jobs for potential and former ministers, and to thwart effective regulation, or retribution for failure. The firms gave £3.5 million to the Tories before the 2010 general election. In return, the Conservative-led Government dutifully abolished the Audit Commission, providing a £100 million windfall in local authority audits and consultancy. They oiled the wheels of the Labour Party in previous elections and got Limited Liability Partnerships to protect them from the consequences of their own follies. They have provided jobs for the likes of Lord Peter Mandelson, Sir Malcolm Rifkind, Lord Norman Warner and Jacqui Smith.

The compliant culture has nurtured failure on a gigantic scale. In the 2007-08 banking crash, all distressed banks received a clean bill of health from auditors even though savers were queuing outside Northern Rock, and Chancellor Alistair Darling thought that the UK was just two hours away from a financial meltdown.

Banks published opaque accounts, moved assets and liabilities off balance sheet, did not make provision for losses, and recognised profits which had not been made.

Lehman Brothers had a leverage of more than 30 to one. With this leverage, a 3.3 per cent drop in the value of assets would wipe out the entire value of equity and make the bank technically insolvent. Ernst & Young still thought the bank was a going-concern. Bear Stearns had a leverage ratio of more than 35 to one ($395 billion /$11 billion) and could barely absorb a decline of around 3 per cent in its assets. Royal Bank of Scotland (RBS) was even worse and had a leverage ratio of around 2 per cent. Deloitte and Touche provided a clean bill of health to both Bear Stearns and RBS. Accounting firms collected vast fees, taxpayers picked up the bailout bill.

The firms have a long history of failure. The mid-1970s’ secondary banking collapse showed accounting firms to be in cahoots with client companies turning a blind eye to the abuses. The UK bailed out the banks and had to go cap in hand to the International Monetary Fund. In 1984, Johnson Matthey Bank collapsed under the weight of frauds, but still received a clean bill of health. In 1995, Barings Bank collapsed due to frauds, but still received its customary clean bill of health. In July 1991, the fraud-infested Bank of Credit and Commerce International (BCCI) was closed by the Bank of England. Some 1.4 million depositors lost some part of their savings. Unlike the previous banking collapses, no government inspectors have been appointed to investigate the BCCI frauds. A United States Senate investigation led by Senator John Kerry concluded that bank auditors had become “partners, not in crime, but in cover-up”.

This state of affairs exists because the UK has ineffective regulation. In the case of Man Nutzfahrzeuge AG & Anor versus Freightliner Ltd & Anor (2007), the auditing firm admitted negligence, but escaped liability because under the UK’s Companies Act 2006 auditors do not owe a “duty of care” to any individual shareholder, creditor, employee, pension scheme member, or any other stakeholder affected by their negligence. The duty, in general, is to the company, and if by hook or crook a fraud-ridden company survives, auditors escape all repercussions.

In folklore, auditors are supposed to be independent of companies, but the firms are so addicted to profits they have little regard for any rules. The British court case of Iliffe News and Media Ltd & Ors versus Revenue & Customs [2012] UKFTT 696 (TC) showed that auditors Ernst & Young devised a tax avoidance scheme for their audit client and also made profits disappear, so that workers’ demands for a higher wage could be defeated. The company’s board minutes noted that auditors had confirmed this scheme “would significantly lessen the transparency of reported results”.

The UK auditing regulator has stated that PricewaterhouseCoopers’ rewards its partners for selling consultancy services to audit clients, but has failed to ban such practices. In January 2014, KPMG paid the US Securities Exchange Commission (SEC) $8.2 million for violating auditor independence rules. In August 2010, the SEC charged a former Deloitte partner with insider trading in the securities of several of the firm’s audit clients. The partner paid more than $1.1 million to settle the SEC’s charges and in October 2012 received a prison sentence of 21 months. In June 2013, Deloittes was fined for misconduct and violations of law in relation to money laundering advisory work at Standard Chartered Bank. Couldn’t happen in the UK, could it?

The Big Four accountancy firms are the epicentre of a global tax avoidance industry. In March 2013, the US authorities fined Ernst & Young $123 million for “wrongful conduct” in enabling clients to dodge taxes. Some of its former partners and employees received prison sentences. Previously, KPMG paid a fine of $456 million for “criminal wrongdoing” and enabling clients to evade taxes. A number of its former partners and employees also received prison sentences.

In 2013, just before the House of Commons Public Accounts Committee took evidence on the role of large accountancy firms in tax avoidance, it received representation from a former PricewaterhouseCoopers partner saying that the firm would sell a tax avoidance scheme if there was a 25 per cent chance that it would withstand a legal challenge from HM Revenue and Customs – in other words, if there is a 75 per cent chance that what it is doing could be found to be illegal, it would still sell it. This did not persuade HMRC to investigate the industry. Its chairman is a former partner of KPMG. Partners of other big accounting firms also sit of the HMRC board and its various committees.

Despite numerous cases of courts declaring the avoidance schemes concocted by accountancy firms to be unlawful, there is not even one case where the government has prosecuted the firms, or where any professional body has disciplined the firm for unlawful practices.

Insolvency brings misery to many, but a boom to accountancy firms. The Lehman Brothers insolvency will generate around £1 billion in fees for PricewaterhouseCoopers.

The insolvency of BCCI began in 1991 and was finalised some 21 years later in 2012. This generated

$1.7 billion in fees for Deloitte & Touche. The Israel-British Bank entered liquidation in 1974 and the liquidation was finalised in 2009. There is no control over the industry as administrations run for years and the firms milk the assets rather than returning the cash to creditors.

The last Labour administration made theft even easier by inventing “pre-pack” administrations, which allows directors of distressed businesses to buy company assets at knockdown prices before the unsecured creditors even get to know what has happened. The secured creditors, usually banks, get most of what is due to them but others just whistle in the wind. The firms get business from banks and also pass business to banks. Ordinary people are the biggest casualty of this incestuous relationship.

The accounting industry provides a fertile ground for Ed Miliband’s promise to promote responsible capitalism. A start should be made by creating regulatory bodies in which accounting firms have a minority representation so that they cannot easily capture them. Big accounting firms can’t be relied on to do effective audits of banks. That task should be undertaken on a real-time basis by a specifically designated regulator. This will reduce the size and influence of big firms and encourage the rest to compete with them.

Elsewhere, auditors should act exclusively as auditors. That means a complete ban on the sale of consultancy services to audit clients. All auditor files should be publicly available. Producers of toffees and potato crisps have to ensure that their products are fit for use. The same should apply to auditors and they should owe a “duty of care” to all stakeholders. Insolvency practitioners should owe a duty of care to all stakeholders and their files should be publicly available. This would deter prolonged insolvencies.

As accounting firms are busy undermining tax revenues they should not be given any taxpayer-funded contracts. For any contract that they do secure, the National Audit Office should have right to see that taxpayers get value for money. Whenever any of their dodges are declared illegal by the courts, there should be an automatic fine of 10 times the tax that would have been lost and persistent offenders should be shut down.

These reforms might give us a glimpse of an honest big accountancy firm and help Labour to make capitalism, and the accounting industry, responsible at last.