It’s not as if each successive banking scandal throws up new insights. The proverbial “innocent bystander” might reasonably suppose that, by now, something would have been learnt from the cyclical repetition of egregious behaviour and the crises it generates. Much of this behaviour is just plain foolish: unbridled credit expansion; lending practices landing banks with mountains of “non-performing” loans, backed ultimately by worthless collateral; acquiring businesses, while blinding themselves to the dross that comes with them, notably overvalued assets, and unquantified liabilities.
But, the auditors?…..surely?
If a bank’s financial statements fail to reflect the dangers posed by the foregoing characteristics, our bystander, growing less innocent by the minute, will point out that the raison d’être of the auditing fraternity’s great and good is to issue independent correctives. Or so you would have thought. But the RBS saga paints a very different picture. It highlights a danger that, if not addressed, will lead to the most dramatic upheaval in the history of corporate auditing.
The RBS story encapsulates it. Selling $32 billion of toxic residential mortgage-backed securities to the two largest mortgage giants in the world brought down not only Freddie Mac and Fannie Mae, but also RBS itself. Today RBS is still 71% state-owned. In July it agreed to pay penalties of $5.5 billion, and faces further criminal penalties of $9 billion for the same acts. Its chief, Ross McEwan, mourns that investors and taxpayers have paid a heavy price for the “poor decisions” of previous management. (Investors whose shares lost over 50% of their value might put it more strongly.)
“Independent” auditing in practice
Corporate auditing is vulnerable to a bias that, unconsciously perhaps, tends to favour the client’s interests. This is an understandable human tendency, but if not firmly overseen internally it could have fundamental consequences for numbers that appear in published reports and accounts. This is exactly why the system, and firms themselves, must be at pains to avoid circumstances that might be considered incautious at best or seriously compromising at worst.
When Fred Goodwin took the helm at RBS in 2000 he appointed Deloitte to replace PwC as the bank’s auditors – which is fair enough in a free commercial market in professional auditing services. But Goodwin was himself a Deloitte partner between 1988 and 1995, and that should have been enough to disqualify the firm from taking office.
But it gets worse: Goodwin was also a protégé of John Connolly, a Deloitte partner who was censured because of his role in the well-publicised Barlow Clowes fraud. The report on Barlow Clowes was damning of Connolly’s professional conduct, ordered him to pay £40,000 in costs, and be officially reprimanded. But did Deloitte discipline him for bringing the firm into disrepute?
In 1998 they elected him senior partner. In 2010, after Connolly claimed, at a House of Lords Hearing, that Deloitte had audited RBS “well”, Lord Lawson spelt it out: “You were auditor of RBS, which went belly-up within a few months of you giving it a clean bill of health.”
Fees and more fees
Then there are the fees. In last month’s issue I identified fee arrangements that are undoubtedly susceptible to compromised independence. Throughout Deloitte’s tenure as RBS auditor, it received millions in fees for “non-audit” work, and in some years such fees exceeded the fees for pure audit work.
Let’s be clear: “non-audit” work is undefined. It is sometimes referred to as “consultancy”, but in reality it can encompass a host of “interpretive” services that impact on what appears in the published accounts. How can the auditor be expected to opine objectively on the outcome of what includes, in part at least, his own input? Is this “independence”, or do we need a new dictionary?
It has been held, judicially, that the statutory “true and fair” accounting requirement, enshrined in statute 70 years ago, is immutable. The attributes of true and fair accounts are easily recognisable and are not subject to “interpretations”. It does not change every time the technical scribblers dream up a new IFRS that adds no value beyond keeping them off the streets. Remember that.
Oh, and PS: Deloitte is being investigated by the FRC over its audits of RBS!