‘Big Four’ auditors admit they misrepresented bank solvency pre-crisis

November 27th, 2010 (updated March 27th, 2011)

I was shocked by the testimony given by the heads of the “Big Four” accountancy firms — PricewaterhouseCoopers (PwC), Deloitte, KPMG and Ernst & Young — to the House of Lords economic affairs committee on Tuesday, November 23rd 2010 (full video above and transcript of evidence).

One of the “Big Four” accountants’ more startling admissions was that they thought it was perfectly acceptable to dupe investors about banking clients’ solvency (via what with the benefit of hindsight were wholly misleading “going concern” statements), after a quiet ‘fireside chat’ with the British government about the possibility of future bailouts.

The “big four” audit firms seem to have decided that, just because the government told them it might bail out the banks if such a thing became necessary, they should give the banks unqualified audits and pretend that the banks had sufficient working capital to survive unaided for the next 12 months (!!)

If the admissions made by these auditors to the House of Lords committee prove anything, it is that the “big four” accountancy firms have now lost all credibility. By their behaviour ahead of the crisis, it’s clear they were more interested in self-preservation and giving what were transparently insolvent institutions a veneer of solvency than in conveying timely, accurate and reliable information to the markets.

Their astounding admissions to the House of Lords committee removes any vestige of credibility that the ‘Big Four’ auditors once had. It presumably also leaves them wide open to multi-billion pound law suits from the thousands of investors that they misled. It might also hammer the final nail in the coffin of the fundamentally flawed system of corporate governance and audit that we have in the UK.

The former Chancellor of the Exchequer, Lord Lawson, summed up the auditors’ admissions by saying:

“You noticed that they were on very thin ice, but you were completely relaxed, as you knew that they would be supported by the taxpayer.”

The people grilled about their audit firms’ absence of integrity were John Connolly, chief executive of Deloitte; John Griffith-Jones, chairman of KPMG; Ian Powell, chairman of PwC; and Scott Halliday managing partner of Ernst & Young.

I can’t quite decide who came across as the least trustworthy of this bunch of charlatans — but the one who springs to mind is John Connolly.

Remember Connolly was one of several auditors who was officially censured by “self-regulatory” body the Joint Disciplinary Scheme over their role in the 1988 Barlow Clowes fraud. Barlow Clowes cost the UK government £150m in compensation to thousands of mainly elderly savers after the fraudulent investment group collapsed in 1988.  In 1995 the JDS said that it had found:

“the professional efficiency, conduct and competence of Mr Connolly fell below the standard which should be displayed by, and may be properly expected of, a chartered accountant who is the second partner on work done and services provided as reporting accountants.”

Bizarrely the firm for which Connolly then worked, Touche Ross (which later became Deloitte), did not fire Connolly or invite him to resign following the JDS ruling, as one might have expected had the firm had any integrity. No. They elected him managing partner of the firm (!!!)

“That horrified me”, said a person familiar with the matter. “At the time other audit firms like Coopers & Lybrand displayed much greater moral backbone when partners were censured.”

The questioning in the House of Lords session, especially when compared to what we’ve seen at some of the Congressional  hearings in the US, may have been a bit on the tame side. But it was effective. Lord Levene asked a reasonably good question when he asked:

“Would you agree that by about the middle of 2007 — we’re talking about the banks now — the writing was sufficiently on the wall about global financial crisis for auditors to have sounded serious notes of caution when they reported on the 2008 financial statements? Was this a failure of the audit? And, if there are lessons to learned from that, what changes are going to be made in the future?

In response, the auditors sought to persuade their noble lords that there had been no audit failure (!!!) and that no changes were required (!!!).

Connolly, who was paid an astonishing £5.1m in 2009 prefaced his remarks by saying that: “I do believe auditors performed well in the highly complex circumstances of the financial crisis. Er, we did draw the attention of regulators and government to ‘going concern’ issues on high impact clients.” Que??

Connolly then added:

“I don’t think there was [a failure of audit]. The environment was such that the complexity of the financial environment at that time caused there to be a hugely intensive effort from auditors, recognizing the onerous nature of their role, and as a consequence of that we dealt with very significant complex audits and had very important decisions to make around our audits.”

What platitudinous bullshit! What Connolly seems to have neglected to mention was that, unfortunately for UK taxpayers, the decisions that Deloitte made between securing the Royal Bank of Scotland audit (apparently without a tender) from his old mucker Fred Goodwin in February 2000 and the time of the bank’s collapse in October 2008, were not the right ones!!

Here’s a little aside about the shortcomings of Connolly. He is understood to have been behind the “whitewash” investigation into the theft of £1.5m from Ritz Design Group PLC by its own chairman and chief executive Michael Bancroft) and finance director (Tony Cartwright) in 1991.

His leniency on this occasion appears to have enabled Bancroft and Cartwright to go on to participate in the later ‘heist’ of circa £1 billion from Halifax Bank of Scotland, Bank of Scotland Corporate Reading branch, a sordid episode which caused some 200 UK-based SMEs to go to the wall, and which is the subject of one of the UK’s largest ever fraud inquiries.

Had Connolly been a little bit more rigourous with his Ritz Design Group investigation in the early 1990s, Bancroft and Cartwright might have gone to jail at the time. Had Touche Ross and/or Connoly done a proper investigation instead of what appears to have been a ‘deal’/’whitewash’, whereby Bancroft and Cartwright were excused as long as they repaid the money, one might imagine that the two directors would, at the very least, have been “struck-off” as directors by the Department for Trade and Industry. Bank of Scotland then might have been less inclined to force scores of its own SME customers to welcome a couple of known embezzlers onto their boards.

Back to the House of Lords session. In response to a question, Connolly claimed that “independent” inspectors have stated that UK bank audits for 2007 and 2008 were “of a high quality”. It’s simply astonishing that Connolly had the effrontery to repeat this farcical claim. Remember that many of the banks concerned were effectively bust a few months later!

Connolly told the peers that there had been no cases where financial statements had to be restated “which would have been required if the financial statements had been incorrect.” This may be true, but then one has to remember that self-regulation has turned out to be an abject failure in the UK market, that “regulatory capture” persists despite the crash of 2008 and that even supposedly “independent” regulators have been largely infiltrated by ‘fifth columnists’ of a corrupt accountancy profession.

Connolly then went on to say:-

“The management of the banks, first of all, who make the initial decision as to whether they conclude they are still a going concern, had to take into account all circumstances and we had to take into account all circumstances, including the likely availability of support, in concluding that they were a going concern. And we had to take into account all the available evidence in reaching that conclusion.

“One of the vitally important issues we all faced was ‘how did we deal with the ‘going concern’ question?’ And all four of the people here had detailed discussions, instigated by the ‘big four’, with Lord Myners — because of the circumstances we were in, it was recognized that the banks would only be ‘going concerns’ if there was support forthcoming.

[Editorial note: Connolly used the word “support” frequently in his testimony. By “support” I think he means the expectation that the taxpayer would pick up the tab for the utter recklessness, probable fraudulence and sometimes criminal activities of the bankers, i.e. that horrendous losses caused by their greed-fuelled binge could be “socialised” while they continued to award themselves obscene pay and bonuses and continued to allow incompetent and corrupt auditors to live in the style to which they had grown accustomed]

“I think it was a proper and appropriate act from the four firms to seek to understand the likelihood of support being forthcoming and I can only say that had we concluded — and that management of the banks had concluded — that there was not going to be support then a different audit opinion would have been given.”

To this Lord Lawson, the former Chancellor of the Exchequer, exclaimed:

“That is absolutely astonishing. Absolutely astonishing. It seems to me that you’re saying that you noticed they were on very thin ice, but that you were completely relaxed about it, because you knew they would be supported, in other words that the taxpayer would support them. So there was no problem.”

Lawson also accused Connolly of being “extraordinarily self-satisfied … You were the auditor of RBS, which went belly up within a few months of [you] giving it a clean bill of health.” I didn’t always agree with Lawson when he was chancellor, but with this I couldn’t agree more…

The Labour peer, Lord David Lipsey reminded the auditors that their duty is supposed to provide a “true and fair view” of the state of client’s balance sheet — not to become an arm of the government nor to set about “misleading markets and investors”.

“Your duty is to report to investors the true state of the company. You were giving a statement that was deliberately timed to mislead the company and mislead markets and investors about the true state of those banks and that seems to be a very strange thing for an auditor to do.”

But Connolly continued to spout more of the same far-fetched disingenuousness, including this:-

“What we were very aware of [was that] the consequences of reaching the conclusion that a bank was actually going to go belly up were huge, the impact that could have had, and the requirement of the auditor is to satisfy itself first of all starts with management that that will not occur.”

What utter crap!!

Quizzed by Lord Forsyth, formerly Michael Forsyth, on the nature of the talks that the auditors had with the government, Connolly said: “We had conversations that sought to understand the likelihood of ‘support’ being forthcoming.”

Connolly, prompted by PwC’s Iain Powell, informed the Lords that initial discussions with the UK government took place in December 2008, and that these were followed by further talks in January 2009.

This is decidedly odd. The auditors seem to be as confused about dates as they were about the viability of their clients. By December 2008, almost 100% of the UK population, unless they happened to be living under a stone, was aware that the government of Gordon Brown had misguidedly bailed out failed banks including Northern Rock, HBOS, Lloyds TSB and Royal Bank of Scotland. (They were presumably also aware that Barclays and HSBC only continued to survive thanks to the Bank of England’s special liquidity scheme).

Soon after Connolly’s extraordinary claim, PwC’s Powell sought to ‘row back’ on the date Connolly had provided, saying that talks between the auditors and the government about possible bail outs had, erm,  in fact, commenced in December 2007 (i.e. ten months before Lord Myners became a minister and a year before Powell had claimed).

Powell went on to provide his take of what had happened. The PwC boss claimed that the wholesale funding markets had closed in the “second half of 2007” and that, after that, the audit firms were actively assessing the availability of liquidity. He said:-

“Personally I wasn’t at that meetings although my firm was represented.  Erm, the reason the banks got into real difficulty was the closure of the wholesale money markets and the closure of the wholesale money markets in the second half of 2007 created real difficulty for many banks.

“As the auditors, one of the things that we have to do, we have to look forward and it’s the same whether it’s a bank or any other type of firm, we have to look at the liquidity that’s available. And one of the key questions around the banks in signing off the audit opinion at the year end 31 December 2007 was, is there adequate liquidity available to this bank to enable us to form a view that the bank is a going concern and we can sign off a going concern audit?

“And the .. em.. discussions that have been referred to were around, is there adequate liquidity or is there likely to be liquidity provided to these banks to survive? And that was the depth of the discussion as I understand it at the end of – er – in December 2007 and in 2008 based on the assessment that we took as the four large audit firms.

“Based on the assessment of the availability of liquidity we then had to go away and form a view, and our audit partners had to form a view as to whether or not we could sign off a clean going concern on those banks. And that is the process we went through in order to form that opinion.

It does seem very, very  strange that these leading auditors are unable to even agree on when the government first tapped them on the shoulder and indicated it would bail out bust banks (causing them to decide there’d be no harm in signing off mendacious going concern statements).

In conclusion I’d just like to say that, with the possible exception of UKFI’s Robin Budenberg’s pathetic performance in front of the House of Commons economic affairs committee in March 2010, I have never witnessed a less persuasive group of platitudinous bullshitters attempting to post-rationalise past failures than this bunch of tossers.

• For previous articles from ianfraser.org on the audit profession including “Are the Big Four a waste of space?” click here
• Hat tip to Yves Smith (Naked Capitalism) and Francine McKenna (Re: The Auditors) for alerting me to this story.
• See also my earlier post – The curious incident of the regulator in the night time – from February 2009 about misleading bank audits and “going concern” statements.

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Posted by Ian Fraser on Mar 27 2010. Filed under Blog. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry