Any columnist writing about financial misdeeds rarely lacks material. Buccaneering chief executives and ineffective auditors are invariably centre-stage – but what of the wise owls making up the panel of non-executive directors? How effective are they as a bulwark against executive opportunism or worse?

I remember one prominent public company CEO, the darling of his shareholders, whose personal regard for the notion of corporate governance was evident in his practice of obtaining from any new board appointee a signed but undated letter of resignation – which he kept locked away in his desk drawer, until needed. There were no complaints. But that was 40 years ago.

Today, the non-executive presence may be part-time, but NEDs do attend board meetings and see all the papers on key strategy issues. Without the approval of an independent audit committee, accounting policies and budgets cannot be passed. Executive directors may believe that negative outcomes are improbable, but NEDs must ask difficult “what if?” questions. Is the company’s acquisition strategy sustainable? Is each target sufficiently cash-generative to service the borrowings needed for its acquisition?

Skewing reported results

Some accounting methods persistently skew reported results. Last month, in the context of its scandalous half-year profit forecast overstatement of £260 million, I referred to Tesco’s bottom-line “add-ons”, euphemistically described as volume discounts and marketing charges for promotional displays. The investigation has been passed to the Serious Fraud Office and criminal prosecutions may follow. The SFO remit is wide and will surely carry implications for the role of NEDs and their effectiveness as independent monitors.

Billions of pounds of fines are currently being levied on banks guilty of market rigging, product misselling and other forms of customer abuse. Such is the flood of money paid to regulators that they risk becoming more profitable than the entities they supervise – a delightful conflict of interest!

Why have these exemplars of financial probity been proved impotent?

Every one of the four-dozen banks that either flunked the latest EU stress tests, or just managed to squeak through, have an audit committee. Why have these exemplars of financial probity been proved impotent? In our fractional-reserve banking arena, dominated by near-zero borrowing costs and a lemming-like rush for credit-creation, perhaps it’s no wonder that the banks themselves are clueless regarding their own solvency.

Exemption misconceptions

The rot began in 1982 when accountancy experts told a UK Parliamentary Committee that the law exempted accounts of banks from giving a true and fair view because they were permitted to hold hidden reserves. Successive banking crises have highlighted the falsity of that argument. The Companies Act 1947, the first to adopt the true and fair standard, is explicit: banks’ exemption from separate disclosure of reserves does not grant exemption from the true and fair standard. Yet those perceived exemptions led in turn to the discredited “realised loss” valuation model that, in abandoning the principle of prudence, failed the true and fair test and obscured a vast quantum of actual losses. If even auditors were taken in by the charade, the non-execs had no chance.

Hopefully the banks’ stress examiners are more diligent than those who tested the convergence criteria for EU membership in 1997 under the banner of “Stability and Growth Pact”. National accounting fiction became an art form, applicants competing with each other in inventiveness: revaluing gold reserves, putting spurious values on nationalised industries and “delaying” expenditures already incurred.

Despite all the trickery, not one country met the five selection criteria. Even Germany failed the prescribed ‘Deficit-to-GDP’ ratio for three years running. Yet the Pact’s sanctions were never implemented, the sinning members being granted a “self-flagellation” option that, unsurprisingly, they chose not to inflict. By 2005 the criteria had been so watered down that the Pact was nothing more than a charter for deficits.

After “harmonising” the accounting framework for two decades, the only change is that massaging numbers has been given legitimacy. The latest EU rules allow countries to include in GDP their estimates (there being no hard data) of the “economic value” of black market activity, illegal drug sales and prostitution. Even Tesco would blush.