This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

Brexit, HBOS, Globo and the FRC

Is it not heartening that the Brexit divorce bill, and other terms, have been settled? The exact cost is unclear but it could be up to £40 billion – a lot of money you may say! However, the fact that the key negotiators, Mrs May, Barnier et al, all looked somewhat glum about the deal when announced perhaps tells us that it was a compromise in which both sides had to concede ground. Or perhaps they were just tired. The terms of any future arrangements including trade deals still need to be worked out so it’s a long way from being concluded.

Now that £40 billion figure, sounds a lot, even if it is spread over some years (it is just over £10bn in year 1 and then reducing). Hard line brexiteers will be unhappy. But it’s all relative. For example the annual UK Defence Budget is over £35 billion and rising (say, about £400bn over 10 years). In addition, I have just read the Financial Reporting Council’s report on the HBOS audit and you can see there on page 7 that HBOS had to write off £63.3 billion in loan losses. That was only one smaller sized UK bank. According to the Bank of England, the financial crisis that affected HBOS and other financial institutions caused £7.3 trillion of losses in total in the UK.

The report from the Financial Reporting Council (FRC) on the audit of HBOS is a quite tedious and turgid document. To remind you, HBOS was a bank that almost went bust after making imprudent commercial property loans financed by short term debt. When Lehman’s collapsed and debt became difficult to raise, HBOS had to be supported by the Government and then bailed out by a merger with Lloyds TSB. The latter’s shareholders are currently pursuing a claim against the company and its directors over that event.

The reason the audit of HBOS was examined by the FRC was because the company obtained an unqualified audit report suggesting that it was a “going concern” when it soon turned out to be otherwise. These events date back to 2008 – that’s 9 years ago which shows the speed with which the FRC typically operated.

One interesting comment made in the FRC report is that it suggests on page 11 that liquidity support from central banks may be considered “a normal funding source…..and therefore reliance on such support does not mean that the bank is not a going concern…..”. As banks with a positive balance sheet are usually assumed to be eligible for “lending of last resort” from the Bank of England that might mean that HBOS would be considered to be a going concern even if it ran out of cash (which is the reason most banks go bust, not because of defective balance sheets – Northern Rock is a good example).

The report also refers on page 29 to “market expectations” at the time. Market participants did not expect the financial crisis to get worse which affected the auditor’s views. So now we know one of the reasons why the FRC let the auditors of HBOS (KPMG) off the hook!

As I mentioned in a blog post a couple of weeks ago , I attended a meeting with the FRC organised by ShareSoc/UKSA. One of the issues raised was the lack of feedback from the FRC on the progress of investigations. I followed up with one of the speakers after the meeting, specifically about the case of Globo. I asked what was the status on the investigation of the audit of their accounts by Grant Thornton. As readers may know, Globo was a company that went into administration in 2015 after it was revealed that the revenue of the company was probably fictitious (see https://www.sharesoc.org/campaigns/globo/ for details). The report of the administrators made it clear that the cash on the balance sheet of Globo plc seemed to have disappeared, bringing into doubt the preceding audit report on that ground alone let alone the revenue recognition issue.

The FRC announced an investigation in December 2015, i.e. two years ago. What have the FRC been doing, when will the investigation likely conclude, are there any preliminary conclusions, etc, etc? All of these questions are very relevant as the answers might provide the basis for legal action by shareholders against the auditors and others. After several email exchanges with FRC staff, the only answer I managed to elicit is that the investigation is on-going. It has not even been turned into a “Formal Complaint”.

The reason more information could not be supplied is that it might prejudice “the overarching requirement for fairness”. My response was “I really do suggest that the FRC needs to reconsider its policies in this area. You have too much emphasis on treating those who have been complained about (i.e. auditors) fairly, while those who have complained are treated unfairly. This rather suggests, as we already knew, that the FRC is dominated by auditors who are the people it is supposed to be regulating”.

The FRC’s Publication Policy document (para. 3) states that “Transparency contributes to public confidence in independent disciplinary arrangements….” but then proceeds to spell out all the restrictions it imposes that thwart it.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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