Risk & Economy » Audit » Auditors ‘in the dock’ over Carillion as report calls for Big Four break-up

Auditors ‘in the dock’ over Carillion as report calls for Big Four break-up

An inquiry report is scathing of Carillion directors and auditors and calls for the audit market to be referred to the Competition and Markets Authority with a view to assessing the break-up of the Big Four.

A final report from the Carillion inquiry carried out by the Work and Pensions Committee and the Business, Energy and Industrial Strategy (BEIS) Committee has been released, with the chair of the BEIS Committee asserting said that auditors should be “in the dock” for the “catastrophic” Carillion collapse.

BEIS chair Rachel Reeves, MP for Leeds West, said that the company’s “delusional” directors’ “colossal failure as managers” had “effectively pressed the self-destruct button on the company”, but that auditors were also “guilty of failing to tackle the crisis” and had failed to “paint a true picture of its crippling financial problems”.

Reeves continued: “The sorry saga of Carillion is further evidence that the Big Four accountancy firms are prioritising their own profits ahead of good governance at the companies they are supposed to be putting under the microscope.”

The fall of Carillion

The committees attributed the rise and “spectacular” fall of Carillion to “recklessness, hubris and greed”, describing the company’s business model as a “relentless dash for cash, driven by acquisitions, rising debt, expansion into new markets and exploitation of suppliers”.

At the time of collapse, Carillion had 43,000 employees – 19,000 of whom were based in the UK. Yet a significant number of individuals were also employed in the company’s supply chains. Since the collapse, 2,000 people have lost their jobs.

The pension liability left by Carillion amounts to £2.6bn with £2bn also owed to 30,000 suppliers, sub-contractors and short-term creditors, all of which are due to suffer heavy losses.

So how did it all go so wrong?

Carillion’s 2016 accounts were published on 1 March 2017 and included a record dividend of £79m. On 10 June, £55m of this dividend was paid out, and large bonuses awarded to senior individuals. Yet just one month later on 10 July, the company issued a profit warning, announcing an £845m write down in the value of its contracts.

A second profit warning was issued in September 2017 with the write down extending to £1,045m. By January 2018, the company was in liquidation with liabilities totalling £7bn and with only £29m in cash.

“The mystery is not that it collapsed,” the report said, “but that it lasted so long.”

Audit failures

The report was scathing of Carillion’s directors. It said that they had presented themselves to the inquiry as “self-pitying victims of a maelstrom of coincidental and unforeseeable mishaps”, but that the problems had begun long before the collapse and stemmed from a “rotten” corporate culture.

But the report also said that internal and external checks and balances designed to prevent failures of the board had all failed. This included those relating to audits.

While KPMG took a £29m pay packet as Carillion’s auditor for 19 years, the inquiry said that it “complacently” signed off “fantastical figures” and that “in failing to exercise professional scepticism towards Carillion’s accounting judgements over the course of its tenure as Carilion’s auditor, KPMG was complicit in them”.

The report was also critical of Deloitte, which it said had failed in its risk management and financial controls role despite being paid £10m, and EY, which provided failed turnaround advice while being paid £10.8m.

These were “lucrative fees”, said the report.

The inquiry also flagged the Financial Reporting Council, which had failed to follow up on concerns identified in 2015, and the Pensions Regulator, which threatened action to enforce pension contributions but never did so.

Break-up of the Big Four

The report said that KPMG’s failures were “not isolated”, but rather “symptomatic of a market which works for the Big Four firms but fails the wider economy”. It cited conflicts of interest as a particular problem with KPMG having been Carillion’s external auditors, Deloitte its internal auditors, and EY with responsibility for getting the company back on track.

The committees said this paved the way for PwC – the least conflicted of the Big Four despite having advised Carillion, its pension schemes and the government on Carillion contracts – to “name its price” to come on board as special managers following the company’s collapse.

Warning that another Carillion-like collapse could happen again and in the near future, the report pushed for a “radically different approach”, recommending that the statutory audit market be referred to the Competition and Markets Authority with a view to considering whether the Big Four should be broken up into more audit firms to promote audit trust and quality.

Reeves said: “KPMG, PwC, Deloitte and EY pocket millions of pounds for their lucrative audit work – even when they fail to warn about corporate disasters like Carillion. It is a parasitical relationship which sees the auditors prosper, regardless of what happens to the companies, employees and investors who rely on their scrutiny. The Competition and Markets Authority must now look at the break-up of the Big Four accountancy firms to help increase competition and deal with conflicts of interest.”

Frank Field, chair of the Work and Pensions Committee and MP for Birkenhead, added: “Same old story. Same old greed. A board of directors too busy stuffing their mouths with gold to show any concern for the welfare of their workforce or their pensioners. They rightly face investigation of their fitness to run a company again. This is a disgraceful example of how much of our capitalism is allowed to operate, waved through by a cosy club of auditors, conflicted at every turn. Government urgently needs to come to parliament with radical reforms to our creaking system of corporate accountability. British industry is too important to be left in the hands of the likes of the shysters at the top of Carillion.”

First published in Financial Director’s sister publication Accountancy Age.

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