The construction & services giant collapsed even as KPMG signed off on its financial statements; now they deny any responsibility.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
The Big Four accountancy firms — PricewaterhouseCoopers, Ernst & Young, KPMG, and Deloitte — reported combined annual revenues of $134 billion in 2017. In the global audit arena, they are virtually unassailable. In the US, the Big Four audit 497 of the S&P 500 companies. In the UK, they audit 99 of the FTSE 100 companies. In Spain there’s not a single firm listed on the IBEX 35 whose accounts are not audited by one of the Big Four.
But what are the Big Four firms actually good for?
Given the oligopolistic structure of the global audit industry as well as the potential conflicts of interest that can arise between the auditors’ myriad roles, this is a vital question — and one that is finally being asked by British lawmakers following the epic crash-and-burn of the services and construction giant Carillion.
In recent years, the external and internal auditors of Carillion, KPMG and Deloitte, pocketed a combined £40 million for their services. Yet they abjectly failed to discover, and warn investors of, the company’s precarious condition that caused it to collapse in spectacular fashion in January. Many other market players, including major investors, pension covenant assessors, and hedge funds shorting Carillion stocks on the markets — some with access to the accounts, others without — saw warning signs long before its demise. So, why didn’t the auditors make sure that the company discloses those problem to investors?
Carillion’s external auditor, Dutch-seated KPMG, signed off on its accounts without fail to the very bitter end, even though it was clear that Carillion had wafer-thin profit margins and was dangerously overloaded with debt, including some £2.6 billion worth of pension liabilities, and that between 2012 and 2016 it ran up debts and sold assets just to continue paying out dividends to shareholders.
Yet, in Carillion’s last ever annual report, KPMG approved Carillion’s viability statement, certifying it as strong enough to survive for “at least three more years.” It didn’t even last three months.
Even now, the auditor refuses to acknowledge any responsibility. “Clearly with what happened, things are very sad,” said Peter Meehan, the KPMG audit partner who handled the firm, in response to grilling by the UK’s Work and Pensions Select Committees last week. “I have pondered long and hard over this. I think me and my team all did the best we could and I stand by the decision we gave on the 31 December 16 accounts.”
This version of events clashes wildly with another provided last week by a former Carillion executive who claims that big financial problems were readily apparent by mid-2016. But instead of coming clean, the firm’s management, seemingly with the help of its auditors, chose to “placate the City” by failing to disclose the problems. “Anyone in the business knew there were major problems, even middle managers,” the former Carillion executive told The Guardian.
If middle managers knew, then it’s safe to assume that the auditors did too, but the chances of them being held to account are thin. The problem, according to Prem Sikka, a professor of accounting, is that the Big Four, the self-anointed guardians of fiduciary responsibility and probity at the world’s biggest companies and banks, “owe a ‘duty of care’ to the company and not to any individual employee, creditor, pension scheme member, saver or shareholder”:
[R]ather than serving the public interest, they prioritize the interests of their own members. Despite corporate scandals involving all of the Big Four accounting firms (Deloitte, PwC, EY and KPMG), none has been broken up, and hardly any firms are shut down or barred from securing new business.
It wasn’t just the auditors that were asleep at the wheel; so, too, was The Pensions Regulator (TPR), which sat idly by as Carillion steadfastly refused to pour enough funds into its 13 final salary pension plans. Documents published by the committee show the plans’ trustees requested TPR to intervene in 2010 and again in 2013, having repeatedly failed to secure the level of contributions they believed were necessary, or to agree a deficit recovery plan, but to no avail.
The trustees also suspected that Carillion’s finance director at the time, Richard Adam, viewed the pension payments as a “waste of money,” as minutes from a meeting between trustees and the regulator in 2013 show. Directors much preferred to pay out “mega dividends” to shareholders, said Frank Field, a veteran Labour MP and head of the the Work and Pensions Select Committees. “They were shoveling money out to themselves, they were shoveling it to shareholders, why didn’t you [the pension regulators] get them to shovel it to pensioners?” he asked.
In a classic example of closing the barn door after the horse has bolted, TPR launched an “anti-avoidance” inquiry three days after Carillion went bust — or as Field put it: “started its arduous process of chasing money down from Carillion a few days after it was formally announced there was no money left.”
Although the UK’s pensions “lifeboat” – the Pension Protection Fund (PPF) – is supposed to be financially strong enough to absorb Carillion’s pension plans “with relative ease,” pension payouts are still likely to be cut by up to 15% due to the company’s failure. As financial regulators and auditors continue to fail spectacularly at their jobs, corporate collapses like Carillion are likely to occur with increasing frequency, Frank Field eloquently warned:
“We imagined that regulators regulate, and auditors audit. I suppose the employees, suppliers and pensioners of Carillion, and the public, did likewise. We were told this morning, however, that these highly paid individuals are mere spectators – commentators at best, certainly not referees — at the mercy of reckless and self-interested directors.
“I fear it is not only Carillion that is built on sand: it is our whole system of corporate accountability.”
This has dark implications for all stakeholders: In the absence of corporate accountability and the massive expansion of leverage and balance-sheet trickery, Enron-like collapses and scandals are likely to become a more and more common feature of the economic landscape. Unlike with Enron, however, no one goes to jail anymore and none of the Big Four auditors, which are now deemed too-big-to replace, pay more than a token price for their failings and digressions. By Don Quijones.
What happens if cases like this prove to be the rule rather than the exception? Read… On Closer Inspection, Debt of Bankrupt Spanish Construction Firm Grows Four-Fold
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