PwC, Barclays auditor since 1896 will be replaced by KPMG in 2017, pre-empting EU rules designed to foster competition in the accounting market, forcing companies to switch auditor every 20 years.
At the London Borough of Newham, PwC is currently acting as independent ‘arbiter’ or adjudicator of the public interest, in the case of £563 million of Lender Option, Borrower Option (LOBO) loans, mis-sold by banks to Newham council. The leading lender with £250m of LOBOs is Barclays.
Next door at the London Borough of Tower Hamlets, KPMG who assume the Barclays audit from PwC in 2017 have the responsibility to decide in the ‘public interest’ if a High Court challenge will be allowed, with regard to Tower Hamlets LOBO loans. The lenders at Tower Hamlets are Barclays and RBS.
Revolving Door Between Big Four Accountancy Firms and UK Government
Cases such as PwC’s Newham vs Barclays conundrum in East London are useful to highlight inherent conflicts of interest, and the revolving door merry-go-round that typifies the Big four accountancy firm audit business. (Source FT)
Infamous revolving door cases include:
Dave Hartnett, the former head of HMRC who signed “sweetheart deals” with Vodafone and Goldman Sachs, then left the tax man to take up jobs with Deloitte and HSBC.
Ian Barlow, an ex-KPMG partner who gave advice to property tycoons behind London’s most expensive luxury flats is now the Chair of HMRC.
Margaret Cole, the ex head of enforcement of The FSA became General Counsel of PwC shortly after the PwC investigation into RBS found no evidence to take enforcement action against anyone in that bank.
A string of high profile audit failures from Enron to HBOS, from RBS to Tesco suggest that rotating auditors might be a good idea to prevent complacency amongst audit teams.
Conflicts of Interest Between Audit, Advisory and Consulting at ‘Big Four’
Whist rotating audit firms makes sense to keep accountants on their toes, in the UK audit business, there are major structural problems requiring even greater regulatory attention. Chief of which, is the inherent conflict of interest between the audit, advisory and consulting roles within ‘big four’ accountancy firms.
In 2001, corporate structure in accountancy shifted from the traditional “partnership model” where partners were ‘jointly and severally liable’ for audit failures and resulting losses, to the “limited liability partnership or LLP, where such failures and losses are largely borne by shareholders.
The resulting change in the culture and risk appetite within accountancy firms has been immense.
The Offshore Link to Enron’s 2001 Collapse
In 2001, Enron collapsed due to audit failures involving the use of offshore tax structures (enabled by among other banks the UK’s NatWest) and complex derivatives, to mask indebtedness and bring forward enormous, but increasingly illusory trading profits.
As the scam unravelled, Enron’s share price plummeted from $90 in 2000 to $1 by November 2001. Investors in Enron lost billions, and the public anger which resulted forced the administration of President George W Bush to pass the Sarbanes-Oxley Act, enshrining auditor independence by forbidding US accounting firms from engaging in consultancy and advisory work for firms they are auditing.
Enron’s auditor, Arthur Andersen, was found guilty in a United States District Court of illegally destroying documents relevant to the SEC investigation, voiding its license to audit public companies, effectively forcing closure of the firm.
Arthur Andersen and the Emergence of ‘Deferred Prosecution Agreements’
US Professor William K Black, a former US prosecutor during the 1980’s Savings and Loans scandal, notes that Arthur Andersen only went bust after the US Department of Justice offered the firm three “Deferred Prosecution Agreements” (DPA) which would have allowed the firm to settle out of court, by paying a fine.
Arthur Andersen refused to accept the DPA, and as a result, went bust, but DPA’s are now the standard tool of regulators in the USA, and increasingly in vogue here in the the UK. DPA’s are problematic because they allow the firm to pay a small fine for committing fraud (saving regulators court expenses) whilst keeping the details of criminality out of the public glare.
Unlike the US, in Britain, there are no such restrictions on accountancy firms conducting highly paid consultancy work for audit clients, generating huge additional fees which provide create incentives to gloss over potential problems with the accounts.
Now that the risk of failure is borne by shareholders not partners, and big 4 firms can settle claims out of court using DPA agreements, and with the absence of competition in the market for auditing large corporates, there’s little incentive for improving accounting practices.
In August 2015, Harriet Agnew wrote in the FT of the increasing concerns that UK audit quality is under threat from the boom in consultancy work at big 4 accounting firms, leading to conflicts of interest.
The professional ethos that underpinned the audit profession until about the mid 1980s has become a distant memory. Berkshire Hathaway vice chairman Charlie Munger has accused the accountants of “selling out,” telling Stanford University Professor Joseph A Grundfest that: “They have sold out and they do not even realise that they’ve sold out … Compared to what could reasonably be with intelligence and honour, the accounting profession is a sewer.”
A former partner of a UK big four accounting firm was quoted as saying: “There’s nothing they can’t do for a fee and nothing they won’t do.”
In this context, it’s important to understand the impact of the Enron scandal and Sarbanes-Oxley Act on the City of London. The US accounting scandals, rather than improving UK practice, actually provided impetus to lower UK standards and attract American business to the ‘light touch’ City of London, a process known as “regulatory arbitrage.”
The City of London and the “Competition in [Regulatory] Laxity”
According to Bill Black, the UK Financial Services Authority (FSA) responded to the Enron scandal by deliberately creating a “competition in laxity” to see “who could have the absolute weakest regulation.” Under the aegis of UK chancellor Gordon Brown, the Treasury embarked on a regulatory race to the bottom, with a view to attracting business to London.
Brooksley Born, the former Chair of the US CFTC who attempted to regulate derivatives use stated; “as soon as the FSA was created [2001], senior leaders of the FSA began coming to the United States industry conferences and saying you should leave America and do your deals, and relocate in the City of London, because we will give you weaker regulation.”
These individuals include current RBS chairman and former FSA chairman Sir Howard Davies.
FT data illustrates the dramatic results of such policies, with PwC UK now earning more money from advisory services (+188% growth 2004-2014) than core audit work (+40%).
Accounting Age reported in July 2015 that PwC will cease to be Barclays auditor from December 2016, to be replaced by KPMG – a firm still under fire for its disastrous auditing of HBOS and the Cooperative Bank, as well as for inadequate auditing of numerous other banks around the world including Countrywide, Wachovia, TierOne Bank Nebraska, Banca Monte Dei Paschi di Siena and Stanbic IBTC in Nigeria.
In some instances KPMG has already paid regulatory fines and settled out of court with investors in these institutions, and four of its partners have been charged with criminal offences related to bank auditing, two in the US and two in Bulgaria
PwC has also been under FRC regulators glare for failures over Tesco’s accounts, and various irregularities at Barclays. It has also been hauled over the coals for its auditing of collapsed and fraudulent banks such as Anglo Irish Bank and Iceland’s Landsbanki.
Across at Europe’s biggest bank – HSBC, accountant PwC will now assume audit duties after KPMG failed to retain HSBC’s confidence, ending 24 years signing off accounts tainted by Mexican money laundering, the promotion and facilitation of tax fraud and tax evasion and terrorist financing scandals.
“Bad Apples”? – It’s the System – Stupid
At this point, it’s worth clarifying that by no means am I suggesting all accountants are bent, and all accounting firms are inherently corrupt.
It was former PwC accountant Antoine Deltour who blew the whistle on the LuxLeaks scandal, at great personal risk and cost to himself. Like Edward Snowden, financial whistleblowers deserve our respect and admiration, and far greater protection and financial security than the present UK legal and regulatory system allows.
Paul Moore, is a former KPMG partner and head of Group Regulatory Risk at HBOS, who blew the whistle on risky lending practices at the bank, and was immediately sacked by CEO Sir James Crosby. HBOS collapsed at great cost to UK taxpayers just 2 years later.
It’s clear from such cases we have significant work to do to ensure that the framework and regulatory architecture of the accountancy sector is fit-for-purpose, and both allows, and rewards accounting staff to do the right thing, without fear of retribution.
The UK Local Audit Government Context
Following the near collapse of the Cooperative Bank in November 2013, competition in local government corporate banking was restricted to just 4 banks, RBS, Lloyds, Barclays, and HSBC.
In local government accounting, choice is little better. Take your pick from EY, PwC, KPMG and Deloitte, with Grant Thornton and BDO thrown in for good measure.
As part of a package of 2010 austerity measures announced by DCLG Minister Eric Pickles, the Audit Commission an independent body which audited local government, NHS Trusts and Housing Associations was closed in April 2015.
What I recently learnt via research from The Bureau of Investigative Journalism, is that the Audit Commission was closed after record donations and lobbying from the Big Four auditing firms – who donated around £1m to the conservatives pre-2010 Election. (Source TBIJ 2012)
Organisations who supported Eric Pickles 2010 decision to close the Audit Commission are reproduced below (Source: Abolishing the Audit Commission – Aston University. K.Tonkiss and C.Skelcher)
Drill down further into the role of Treasury Management Advisers, who help steer local government funds around financial markets, and the choices are even more limited.
Outsourcing giant CAPITA with 70% market share, or the small but fiercely independent outfit Arlingclose, with 30% share.
Conflicts of Interest, Regulatory Blind Spots and Shooting Fish In A Barrel
Currently, local government finance is completely unregulated by the Financial Conduct Authority, the Bank of England and the Prudential Regulatory Authority.
Public sector organisations, struggling with austerity cuts, are like wounded fish in a barrel, defenceless, and easily picked off by the voracious too big to fail sharks circling intently in the City of London.
Taxpayers ought to pay more attention. When City financial firms tear strips off the public sector, it’s the UK taxpayer that ends up footing the bill.
Institutional corruption in firms transacting with UK local government is rife, and NGO’s supposedly monitoring misconduct are funded by the perpetrators and their apologists.
Transparency International – Ernst and Young and PwC
Take the NGO Transparency International (TI) who monitor the global corruption index.
In 2013, Transparency International, whose objective is “fighting corruption worldwide” released a report ‘CORRUPTION IN UK LOCAL GOVERNMENT: THE MOUNTING RISKS’
The TI report cites the closure of the UK’s Audit Commission amid ongoing austerity cuts to local government funding, critically reducing audit and scrutiny functions, and the rise in outsourcing, as contributing factors to growing local government corruption risk.
Notably, the TI report does not mention the Big Four accountancy role lobbying for closure of the Audit Commission, nor does it mention corruption risks emanating from the financial sector, despite LIBOR rigging by UK banks (affecting UK local government finances), being all over the UK media, in the year leading up to the report publication.
A look at the TI UK end of year financial accounts for the years 2010-2014 reveals that Transparency International received £1 million+ in donations from PwC and Ernst & Young (now called EY) in the period the decision to close the Audit Commission took place.
Of the big 4 UK banks in 2016, EY now audit RBS, whilst PwC audit Lloyds, ‘shadowed’ by EY. Curiously, EY, despite making the bulk of donations to TI, was not auditing any of the big 4 UK banks as at 2012, making the size and intended purpose of its 2008-16 UK donations relative to its competitors all the more intriguing.
Ironically, Eric Pickles, the very man who oversaw the cuts to local government funding and closure of the Audit Commission, which Transparency International cite as major corruption risk drivers, now works alongside TI as the UK’s “Anti-Corruption Champion.”
Whilst Minister responsible for DCLG, I emailed Eric Pickles on numerous occassions 2012-2014 outlining the impact of LIBOR rigging fraud on UK local government. Not once did I receive a reply.
How Corrupt Is Britain?
David Whyte, a professor in the Sociology, Social Policy and Criminology Department at the University of Liverpool, warns of a ‘national myth’ that Britain is not corrupt, stating there is “widespread institutional corruption from politics to policing.”
Whyte critiques Transparency International’s corruption index, which he states is simply based around “subjective accounts and interviews with experts and other public figures,” arguing that to solely link corruption to the handing over of “brown envelopes” is simplistic and naive.
Whyte thinks people are complacent in the UK about corruption and points to the deficient world bank definition of corruption: “abuse of public office for private gain” which only captures individual bribery – but not institutional corruption, for the benefit of corporates.
Institutional corruption which is: “much more insidious, much more hidden, and much more extensive” than individual bribery.
David Whyte notes that much of the UK’s corruption problems stem from the failure to adequately define the “public interest” – perhaps best characterised by disgraced HSBC banker Rona Fairhead, now running the BBC Trust.
Newham Council LOBO Loans to Pit PwC against Barclays?
Nowhere in local government are the conflicts of interest and failure to determine the public interest more readily apparent than at the London Borough of Newham, where PwC, assume the role of auditor for both Barclays bank, and Newham Council.
Newham Council between 2002 and 2010 amassed £563 million in bank borrowing, including LOBO loans from Barclays (£238m) and RBS (£150m). Some Olympic legacy!
On Friday 26 February 2016, local resident Rachel Collinson registered an objection to PwC, asking for a declaration to the High Court, that taking out the LOBO loans was irrational and illegal.
PwC now must act as an independent arbiter of the “public interest” in deciding whether to refer the Newham LOBO loan borrowing to the High Court for a judgement.
The Newham LOBO loans have already cost local rate payers at least £10 million in added interest charges, and could run for another 60 years, costing an annual premium of up to £7m.
Stephen Sheen, a former local government auditor, now Director of Ichabod’s Industries had this to say in a recent interview with the Room 151 blog in: “LOBOs and confessions of an ex-auditor”
“The arguments that authorities that took out lender option borrower options (LOBO) loans are better off than if they had borrowed from the PWLB are somewhat disingenuous. The big numbers being thrown around by the critics do have relevance, but not necessarily to illuminate the evils inherent in LOBOs. Instead, the billions of pounds count the cost of committing to fixed interest rate borrowing generally.”
In terms of deciding upon the ‘public interest’ in this case, it’s worth comparing and contrasting the fees paid by each of these institutions to PwC for audit and advisory work each year.
PwC was paid £44,000,000.00 in 2013/14 by Barclays for its audit and non-audit work.
By comparison, PwC earned just £357,339.00 for auditing Newham’s accounts in 2013/14, less than 1% of what PwC earns from auditing and consulting fees at Barclays.
None of this information should suggest that PwC’s judgement will come down one way or the other, but there are some broader market consequences for PwC’s decision for Barclays that the auditor will no doubt be contemplating.
According to FOIA requests by Debt Resistance UK, Barclays are the no.1 issuer of LOBO loans to UK local authorities, with £3-4bn of LOBO loans thought to be issued [note chart depicts analysis of 455 of 1000 contracts] meaning potential implications for Barclays of PwC’s decision extend far beyond Newham Council.
Factor in Barclays lending to UK social housing (also commonly in the form of LOBOs) and the figure for loans originated by Barclays increases by a further £12bn.
Back at Newham Council, there is no doubt that PWC’s Newham Audit team, lead by Julian Rickett have some incredibly difficult decisions to make over the coming month.
In 1989, a similar council objection process ultimately lead to the Hazell [often referred to as Goldman Sachs] vs Hammersmith and Fulham case tried in the High Court and ultimately the House of Lords, ensnaring local government in costly law-suits for a decade, as dramatised in Duncan Campbell Smiths: “Closing the Swaps Shop”.
With this legal precedent in mind, do PwC ignore the public interest case, borne out by £1880+ bank debt per Newham resident, with 80p of every pound raised in Newham Council Tax going towards servicing debt? and with Newham Council facing breakage costs in excess of £1.2billion to exit the LOBO contracts?
Or do PwC refer the matter to the high court, and risk the ire of Barclays, whilst London silks decide their fate..?
Either way, the official line on sound financial management and an Olympic afterglow and ‘legacy’ in Newham looks set for a bumpy ride over the coming weeks…
Acknowledgements: The author would like to thank Prem Sikka, Ian Fraser, Atul Shah and Paul Moore who contributed to this article, providing invaluable insight, and background information.