The Financial Reporting Council (FRC) announced investigations into two of the big accountancy firms last week. The first was the investigation under the Accountancy Scheme into PwC’s auditing of the financial statements of BHS for the year ended 30 August 2014. The second, under the same scheme, is an investigation into KPMG’s audit of HBOS for the year ended 31 December 2007. These investigations were instituted by the FRC’s Conduct Committee following the completion of the Executive Counsel’s preliminary enquiries announced on 21 January 2016.
The KPMG investigation will examine whether KPMG, during its audit of HBOS:
“considered the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements for the year ended 31 December 2007; and
considered whether there were material uncertainties about the entity’s ability to continue as a going concern that needed to be disclosed in the financial statements.”
The investigation into KPMG has been instituted by the FRC’s conduct committee following preliminary enquiries by the Executive Counsel that began in January following the publication of a 410-page report published by Bank of England’s Prudential Regulatory Authority and the Financial Conduct Authority into the HBOS collapse. A second report, written by Andrew Green QC, was published at the same time. It provided an assessment of the FSA’s enforcement actions in relation to the failure of HBOS.
KPMG was HBOS’s external auditor from the company’s creation, as a merger between Halifax and Bank of Scotland, in 2001 until the end of 2008. The PRA/FCA notes in particular: “The rapid expansion of its balance sheet placed pressure on HBOS’s ability to fund itself. HBOS’s retail funding struggled to keep pace with the Group’s lending growth, with customer deposits growing at an average annual rate of 5% a year during the Review Period, compared with a customer loan growth rate of 10%. As a result, HBOS increasingly accessed wholesale financial markets as a source of funding, raising its wholesale borrowing from £187 billion at the end of 2004 to £282 billion at end-2007.” Lloyd’s subsequently bought HBOS as the banking crisis took hold in 2008.
BHS filed for administration, the same as Chapter 11 in the United States, in April this year. The retailer's debts exceeded £1.3bn and included a pensions deficit of £571m. As recently as 2000, BHS was bought by billionaire Sir Philip Green for £200m, but he sold it last year for just £1 to Retail Acquisitions, a consortium of financiers, lawyers, and accountants. This group failed to raise £160m in new capital to reverse seven years of losses, and administration became inevitable. No buyer has been found for the business.
The disciplinary process under the Accountancy Scheme are:
Decision to investigate
Investigation
Decision whether to bring enforcement proceedings against Member Firm or Member and, if so decided, referral to Disciplinary Tribunal
Tribunal hearing
Determination and imposition of sanction and/or costs orders
Under the Accountancy Scheme, an FRC disciplinary investigation can be initiated either by a referral from the professional accountancy bodies (such as the Institute of Chartered Accountants in England and Wales (ICAEW)) or it may decide to investigate a matter on its own initiative. The Conduct Committee will consider each case identified or referred to it and decide whether or not the criteria for an investigation are met.
The criteria for an investigation are specified in paragraph 5(1) of the Accountancy Scheme, the press release states. “A Member or Member Firm shall be liable to investigation under this Scheme only where, in the opinion of the Conduct Committee the matter raises or appears to raise important issues affecting the public interest in the United Kingdom and there are reasonable grounds to suspect that there may have been Misconduct or it appears that the Member or Member Firm has failed to comply with any of his or its obligations under paragraphs 14(1) or 14(2) of the Scheme.” The actual investigations themselves are conducted by the Executive Counsel and the Enforcement division of the FRC.
The FRC has been able to sanction accountants since November 2013 when the Auditor Regulatory Sanctions Procedure and Guidance was published. This covers all audit firms who are registered with the ICAEW and who are subject to independent monitoring by the FRC’s Audit Quality Review.
The sanctions policy followed amendments to the Companies Act 2006 which required that Recognised Supervisory Bodies (RSB) enable the FRC to determine sanctions. These sanctions can be brought against statutory auditors where they “have not complied with the rules relevant to statutory audit.” At the time, the FRC CEO Stephen Haddrill said:
“… sometimes our inspections reveal shortcomings that we expect the firms to address. The new procedure enables the FRC to require such work to be done and if appropriate a penalty to be applied without reference to the professional bodies. This reinforces our independence and enhances the impact of our audit monitoring activity. Sanctioning poor quality work provides further encouragement for firms to conduct high- quality audits and ultimately enhances trust in the audit profession.”
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