Showing posts with label PwC. Show all posts
Showing posts with label PwC. Show all posts
Tuesday 28 March 2023
Saturday 4 July 2020
After Wirecard: is it time to audit the auditors?
The industry’s failure to spot holes in the accounts of several collapsed companies has led to clamour for reform writes Jonathan Ford and Tabby Kinder in The FT
At the end of 2003, the Italian dairy company Parmalat descended into bankruptcy in an eye-catchingly abrupt manner. A routine bank reconciliation revealed that €3.9bn of cash which Parmalat was supposed to have at Bank of America did not actually exist.
At the end of 2003, the Italian dairy company Parmalat descended into bankruptcy in an eye-catchingly abrupt manner. A routine bank reconciliation revealed that €3.9bn of cash which Parmalat was supposed to have at Bank of America did not actually exist.
The scam that emerged duly blew apart one of Italy’s best-known entrepreneurial companies, and sent its founder, Calisto Tanzi, to prison for fraud. Dubbed Europe’s Enron, it humiliated two large auditing firms, Deloitte and Grant Thornton, and ended up costing the former $149m in damages.
Yet it rested on an apparently simple deception: the reconciliation letter on which the auditors were relying had been forged.
There were shades of Parmalat’s collapse again last week when, nearly two decades later, another fast-growing European entrepreneurial company blew up in strikingly similar circumstances.
After years of public questions about the reliability of its accounts, primarily from the FT, the German electronic payments giant, Wirecard, was forced to admit to a massive hole in its balance sheet.
Rattled by the failure of an independent probe by KPMG to verify transactions underpinning “the lion’s share” of its reported profits between 2016 and 2018, and unable to publish its results due to issues eventually raised by its longstanding auditors EY, Wirecard finally capitulated. It announced that purported €1.9bn cash balances at banks in the Philippines probably did “not exist” and parted company with its chief executive Markus Braun. Evidence relied on by EY had been bogus.
It remains unclear exactly how the crucial confirmation slipped through the cracks. According to one EY partner: “The general view internally is that confirming historic cash balances is auditing 101, and [that] ordinary auditing processes were followed, including third party verification, in which case the fraud was sophisticated in its use of false documents.”
Others, however, take a less charitable view of such slip-ups, especially when, as with both Wirecard and Parmalat, they were preceded by so many questions about the reliability of the figures.
“The integrity of the cash account [which records cash and should reconcile to all the other items in the accounts] is totally central to the whole system of double-entry bookkeeping,” says Karthik Ramanna, professor of business and public policy at Oxford’s Blavatnik School of Government. “If there is no integrity to the cash account, then the whole system is just a joke.”
Shareholder support
Wirecard’s collapse is the latest in a wave of accounting scandals that has swept through the corporate world, including UK outsourcing group Carillion and Abu Dhabi-based hospital group NMC Health, as well as alleged frauds at the mini-bond firm London Capital & Finance (LCF) and the café chain Patisserie Valerie.
Many fear a further surge as the Covid-19 lockdown washes away those companies with weakened balance sheets or business models in the coming months.
Questions about “softball” auditing have dogged many recent high-profile insolvencies. Carillion’s enthusiasm for buying companies with few tangible assets for high prices led it to build up £1.5bn of goodwill on its balance sheet. Despite vast losses at some of those subsidiaries, it had written down the value of just £134m of that goodwill when the whole edifice caved in.
Similar questions hang over LCF, where close reading of the notes in the last accounts it published show how the estimated fair value of its liabilities far exceeded that of its assets in 2017, making it technically insolvent roughly 18 months before it collapsed taking with it more than £200m of savers’ cash. Yet EY gave the accounts a clean bill of health.
Such cases have raised concerns about the independence of auditors, and their willingness to challenge the wishes of management at the client, who are often driven by their own desire for self-enrichment or survival.
“It’s so important if you want to keep the relationship to have a rapport with the finance director,” says a financier who once worked at a Big Four auditing firm. “It is basically sometimes easier to swallow what you are told.”
It is a problem that has deepened with the adoption of modern accounting standards. Over the past three decades, these have progressively dismantled the traditional system of historical cost accounting with its emphasis on the verifiability of evidence and using prudent judgment, replacing it with one based on the idea that the primary purpose of accounts is to present information that is “useful to users”.
This process has allowed managers to pull forward anticipated profits and unrealised gains, and write them up as today’s surpluses. Many company bonus schemes depend on the delivery of the “right” accounting numbers.
In theory, shareholders are supposed to provide a check on the influence of self-interested bosses. They choose the auditors and set the terms of the engagement. But in practice, investors tend not to assert themselves in the relationship. Scandals rarely lead to the ejection of auditors.
So after UK telecoms group BT announced a £530m writedown in 2017 because of accounting misstatements at its Italian business, the auditors, PwC, were not sanctioned by investors. Far from it, the firm was reappointed with more than 75 per cent support. And when EY came up for re-election at Wirecard in the summer of 2018, despite rumblings about the numbers, it was voted back by more than 99 per cent.
Tight budgets and timetables
It is not only an auditor’s desire for an easy life that can drain audits of that all important culture of challenge. There are practical issues too. Tight budgets and timetables limit the scope for investigation.
Audit fees in Europe are far below those in the US. Audits of Russell 3000 index companies in the US cost 0.39 per cent of company turnover on average. Those in Europe average just 0.13 per cent, while for German companies it is a feeble 0.09 per cent.
With fees low, auditing teams are often stretched thin, with only limited support from a partner out of a desire to limit costs and maximise the number of audits done. Audit is traditionally the junior partner in a big accountancy firm, with around four-fifths of the Big Four’s profits coming from the non-audit consultancy side.
Take the last audit of BHS under the ownership of Philip Green, who sold the failing UK retailer to a little known entrepreneur, Dominic Chappell, in 2015. The chain subsequently collapsed the following year.
The PwC partner, Steve Denison, recorded only two hours of work auditing the financial statements. The number two, an auditor with just one year’s post-qualification experience, recorded 29.25 hours, and the more junior team members 114.6 hours. Mr Denison was later fined for misconduct and effectively banned by the audit regulator.
According to Tim Bush, head of governance and financial analysis at the Pensions & Investment Research Consultants, a shareholder advisory group, this reliance on juniors tends to result in “box checking” rather than an investigative approach to audit processes. “Audit teams are less likely to have a feel for the company’s business model,” he says.
This in turn can open the door to abuse. Scams often hinge on faith in some implausible business activity. Parmalat’s €3.9bn cash pile, for instance, was supposed to have come from selling milk powder to Cuba. But an analysis of the volumes claimed suggested that if the company’s numbers were accurate, each of the island’s inhabitants would have needed to be consuming 60 gallons a year.
As the author Richard Brooks noted in his book The Bean Counters: “It shouldn’t have been difficult for a half-competent audit firm to spot.”
No ‘golden age’
The academic Prem Sikka rejects the idea that auditing has gone downhill in the past few decades. “Go back into history and you will find there was never a golden age,” he says.
He argues that most of the weaknesses are of longstanding vintage, and are down to a lack of accountability. “On the audit side, there is no transparency. You have no idea as a reader of accounts how much time the auditors spent on the task and whether that was reasonable,” says the professor of accounting at the University of Sheffield.
While there are signs that the UK regulator is getting tougher, it is down to shareholders to provide stronger governance, Prof Sikka says. If they won’t do it, the government should consider setting up a state agency to commission audits of firms and set fees. “It wouldn’t have to be everyone. You could just do large companies and banks.”
Britain has recently been through a comprehensive review of audit, including how it is regulated and competition in the market, plus a review by the businessman Donald Brydon of its purpose. This devoted many pages to establishing it as a distinct new profession and coming up with new statements to include in already groaning company reports.
Far from creating new tasks, many observers think that audit should reconnect with its original purpose. This is to assure investors that companies’ capital is not being abused by over-optimistic or fraudulent managers. “At their heart, audits are about protecting capital, and thereby ensuring responsible stewardship of capital,” says Natasha Landell-Mills, head of stewardship at the asset manager Sarasin & Partners.
Yet modern accounting practice has made audits more complicated while watering down the legal requirement to exercise the judgment needed to ensure the numbers are “true and fair”. Despite the endless mushrooming of numbers, it is no easier to know if the capital is really present and can thus justify the payment of dividends and bonuses.
Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales says auditors need a “renewed focus on internal controls, going concern and fraud. The vast majority of business failures are not the fault of the auditor, but when audit quality is a contributory factor, the problem generally involves these three fundamental areas.”
Mr Bush thinks a radical simplification is in order. “Without clarity there is never going to be proper accountability,” he says. “What we have is a recipe for weak auditing, and ever more Wirecards and Parmalats. In the extreme it facilitates Ponzi schemes. Stay on that route and it won’t be long before you come unstuck.”
Tuesday 29 May 2018
The financial scandal no one is talking about
Accountancy used to be boring – and safe. But today it’s neither. Have the ‘big four’ firms become too cosy with the system they’re supposed to be keeping in check?
By Richard Brooks in The Guardian
In the summer of 2015, seven years after the financial crisis and with no end in sight to the ensuing economic stagnation for millions of citizens, I visited a new club. Nestled among the hedge-fund managers on Grosvenor Street in Mayfair, Number Twenty had recently been opened by accountancy firm KPMG. It was, said the firm’s then UK chairman Simon Collins in the fluent corporate-speak favoured by today’s top accountants, “a West End space” for clients “to meet, mingle and touch down”. The cost of the 15-year lease on the five-storey building was undisclosed, but would have been many tens of millions of pounds. It was evidently a price worth paying to look after the right people.
Inside, Number Twenty is patrolled by a small army of attractive, sharply uniformed serving staff. On one floor are dining rooms and cabinets stocked with fine wines. On another, a cocktail bar leads out on to a roof terrace. Gazing down on the refreshed executives are neo-pop art portraits of the men whose initials form today’s KPMG: Piet Klynveld (an early 20th-century Amsterdam accountant), William Barclay Peat and James Marwick (Victorian Scottish accountants) and Reinhard Goerdeler (a German concentration-camp survivor who built his country’s leading accountancy firm).
KPMG’s founders had made their names forging a worldwide profession charged with accounting for business. They had been the watchdogs of capitalism who had exposed its excesses. Their 21st-century successors, by contrast, had been found badly wanting. They had allowed a series of US subprime mortgage companies to fuel the financial crisis from which the world was still reeling.
“What do they say about hubris and nemesis?” pondered the unconvinced insider who had taken me into the club. There was certainly hubris at Number Twenty. But by shaping the world in which they operate, the accountants have ensured that they are unlikely to face their own downfall. As the world stumbles from one crisis to the next, its economy precarious and its core financial markets inadequately reformed, it won’t be the accountants who pay the price of their failure to hold capitalism to account. It will once again be the millions who lose their jobs and their livelihoods. Such is the triumph of the bean counters.
The demise of sound accounting became a critical cause of the early 21st-century financial crisis. Auditing limited companies, made mandatory in Britain around a hundred years earlier, was intended as a check on the so-called “principal/agent problem” inherent in the corporate form of business. As Adam Smith once pointed out, “managers of other people’s money” could not be trusted to be as prudent with it as they were with their own. When late-20th-century bankers began gambling with eye-watering amounts of other people’s money, good accounting became more important than ever. But the bean counters now had more commercial priorities and – with limited liability of their own – less fear for the consequences of failure. “Negligence and profusion,” as Smith foretold, duly ensued.
After the fall of Lehman Brothers brought economies to their knees in 2008, it was apparent that Ernst & Young’s audits of that bank had been all but worthless. Similar failures on the other side of the Atlantic proved that balance sheets everywhere were full of dross signed off as gold. The chairman of HBOS, arguably Britain’s most dubious lender of the boom years, explained to a subsequent parliamentary enquiry: “I met alone with the auditors – the two main partners – at least once a year, and, in our meeting, they could air anything that they found difficult. Although we had interesting discussions – they were very helpful about the business – there were never any issues raised.”
KPMG abandons controversial lending of researchers to MPs
Conscious of their extreme good fortune and desperate to protect it, the accountants sometimes like to protest the harshness of their business conditions. “The environment that we are dealing with today is challenging – whether it’s the global economy, the geopolitical issues, or the stiff competition,” claimed PwC’s global chairman Dennis Nally in 2015, as he revealed what was then the highest-ever income for an accounting firm: $35bn. The following year the number edged up – as it did for the other three big four firms despite the stiff competition – to $36bn. Although they are too shy to say how much profit their worldwide income translates into, figures from countries where they are required to disclose it suggest PwC’s would have been approaching $10bn.
Among the challenges PwC faced, said Nally, was the “compulsory rotation” of auditors in Europe, a new game of accountancy musical chairs in which the big four exchange clients every 10 years or so. This is what passes for competition at the top of world accountancy. Some companies have been audited by the same firms for more than a century: KPMG counts General Electric as a 109-year-old client; PwC stepped down from the Barclays audit in 2016 after a 120-year stint.
As professionals, accountants are generally trusted to self-regulate – with predictably self-indulgent outcomes. Where a degree of independent oversight does exist, such as from the regulator established in the US following the Enron scandal and the other major scandal of the time, WorldCom – in which the now-defunct firm Arthur Andersen was accused of conspiring with the companies to game accountancy rules and presenting inflated profits to the market – powers are circumscribed. When it comes to setting the critical rules of accounting itself – how industry and finance are audited – the big four are equally dominant. Their alumni control the international and national standard-setters, ensuring that the rules of the game suit the major accountancy firms and their clients.
The long reach of the bean counters extends into the heart of governments. In Britain, the big four’s consultants counsel ministers and officials on everything from healthcare to nuclear power. Although their advice is always labelled “independent”, it invariably suits a raft of corporate clients with direct interests in it. And, unsurprisingly, most of the consultants’ prescriptions – such as marketisation of public services – entail yet more demand for their services in the years ahead. Mix in the routine recruitment of senior public officials through a revolving door out of government, and the big four have become a solvent dissolving the boundary between public and private interests.
There are other reasons for governments to cosset the big four. The disappearance of one of the four major firms – for example through the loss of licences following a criminal conviction, as happened to Arthur Andersen & Co in 2002 – presents an unacceptable threat to auditing. So, in what one former big-four partner described to the FT as a “Faustian relationship” between government and the profession, the firms escape official scrutiny even at low points such as the aftermath of the financial crisis. They are too few to fail.
The major accountancy firms also avoid the level of public scrutiny that their importance warrants. Major scandals in which they are implicated invariably come with more colourful villains for the media to spotlight. When, for example, the Paradise Papers hit the headlines in November 2017, the big news was that racing driver Lewis Hamilton had avoided VAT on buying a private jet. The more important fact that one of the world’s largest accountancy firms and a supposed watchdog of capitalism, EY, had designed the scheme for him and others, including several oligarchs, went largely unnoticed. Moreover, covering every area of business and public service, the big four firms have become the reporter’s friends. They can be relied on to explain complex regulatory and economic developments as “independent” experts and provide easy copy on difficult subjects.
Left to prosper with minimal competition or accountability, the bean counters have become extremely comfortable. Partners in the big four charge their time at several hundred pounds per hour, but make their real money from selling the services of their staff. The result is sports-star-level incomes for men and women employing no special talent and taking no personal or entrepreneurial risk. In the UK, partners’ profit shares progress from around £300,000 to incomes that at the top have reached £5m a year. Figures in the US are undeclared, because the firms are registered in Delaware and don’t have to publish accounts, but are thought to be similar. (In 2016, when I asked a senior partner at Deloitte what justified these riches, he sheepishly admitted that it was “a difficult question”.)
Targeting growth like any multinational corporation, despite their professional status, the big four continue to expand much faster than the world they serve. In their oldest markets, the UK and US, the firms are growing at more than twice the rate of those countries’ economies. By 2016, across 150 countries, the big four employed 890,000 people, which was more than the five most valuable companies in the world combined.
The big four are supremely talented at turning any change into an opportunity to earn more fees. For the past decade, all the firms’ real-terms global growth has come from selling more consulting services. Advising on post-crisis financial regulation has more than made up for the minor setback of 2008. KPMG starred in the ultimate “nothing succeeds like failure” story. Although – more than any other firm – it had missed the devaluation of subprime mortgages that led to a world banking collapse, before long it was brought in by the European Central Bank for a “major role in the asset quality review process” of most of the banks that now needed to be “stress-tested”.
The big four now style themselves as all-encompassing purveyors of “professional services”, offering the answers on everything from complying with regulations to IT systems, mergers and acquisitions and corporate strategy. The result is that, worldwide, they now make less than half of their income from auditing and related “assurance” services. They are consultancy firms with auditing sidelines, rather than the other way round.
The big firms’ senior partners, aware of the foundations on which their fortunes are built, nevertheless insist that auditing and getting the numbers right remains their core business. “I would trade any advisory relationship to save us from doing a bad audit,” KPMG’s UK head Simon Collins told the FT in 2015. “Our life hangs by the thread of whether we do a good-quality audit or not.” The evidence suggests otherwise. With so many inadequate audits sitting on the record alongside near-unremitting growth, it is clear that in a market with very few firms to choose from, poor performance is not a matter of life or death.
By Richard Brooks in The Guardian
In the summer of 2015, seven years after the financial crisis and with no end in sight to the ensuing economic stagnation for millions of citizens, I visited a new club. Nestled among the hedge-fund managers on Grosvenor Street in Mayfair, Number Twenty had recently been opened by accountancy firm KPMG. It was, said the firm’s then UK chairman Simon Collins in the fluent corporate-speak favoured by today’s top accountants, “a West End space” for clients “to meet, mingle and touch down”. The cost of the 15-year lease on the five-storey building was undisclosed, but would have been many tens of millions of pounds. It was evidently a price worth paying to look after the right people.
Inside, Number Twenty is patrolled by a small army of attractive, sharply uniformed serving staff. On one floor are dining rooms and cabinets stocked with fine wines. On another, a cocktail bar leads out on to a roof terrace. Gazing down on the refreshed executives are neo-pop art portraits of the men whose initials form today’s KPMG: Piet Klynveld (an early 20th-century Amsterdam accountant), William Barclay Peat and James Marwick (Victorian Scottish accountants) and Reinhard Goerdeler (a German concentration-camp survivor who built his country’s leading accountancy firm).
KPMG’s founders had made their names forging a worldwide profession charged with accounting for business. They had been the watchdogs of capitalism who had exposed its excesses. Their 21st-century successors, by contrast, had been found badly wanting. They had allowed a series of US subprime mortgage companies to fuel the financial crisis from which the world was still reeling.
“What do they say about hubris and nemesis?” pondered the unconvinced insider who had taken me into the club. There was certainly hubris at Number Twenty. But by shaping the world in which they operate, the accountants have ensured that they are unlikely to face their own downfall. As the world stumbles from one crisis to the next, its economy precarious and its core financial markets inadequately reformed, it won’t be the accountants who pay the price of their failure to hold capitalism to account. It will once again be the millions who lose their jobs and their livelihoods. Such is the triumph of the bean counters.
The demise of sound accounting became a critical cause of the early 21st-century financial crisis. Auditing limited companies, made mandatory in Britain around a hundred years earlier, was intended as a check on the so-called “principal/agent problem” inherent in the corporate form of business. As Adam Smith once pointed out, “managers of other people’s money” could not be trusted to be as prudent with it as they were with their own. When late-20th-century bankers began gambling with eye-watering amounts of other people’s money, good accounting became more important than ever. But the bean counters now had more commercial priorities and – with limited liability of their own – less fear for the consequences of failure. “Negligence and profusion,” as Smith foretold, duly ensued.
After the fall of Lehman Brothers brought economies to their knees in 2008, it was apparent that Ernst & Young’s audits of that bank had been all but worthless. Similar failures on the other side of the Atlantic proved that balance sheets everywhere were full of dross signed off as gold. The chairman of HBOS, arguably Britain’s most dubious lender of the boom years, explained to a subsequent parliamentary enquiry: “I met alone with the auditors – the two main partners – at least once a year, and, in our meeting, they could air anything that they found difficult. Although we had interesting discussions – they were very helpful about the business – there were never any issues raised.”
A new ticker about the Lehman Brothers collapse in New York in 2008. Photograph: Alamy
This insouciance typified the state auditing had reached. Subsequent investigations showed that rank-and-file auditors at KPMG had indeed questioned how much the bank was setting aside for losses. But such unhelpful matters were not something for the senior partners to bother about when their firm was pocketing handsome consulting income – £45m on top of its £56m audit fees over about seven years – and the junior bean counters’ concerns were not followed up by their superiors.
Half a century earlier, economist JK Galbraith had ended his landmark history of the 1929 Great Crash by warning of the reluctance of “men of business” to speak up “if it means disturbance of orderly business and convenience in the present”. (In this, he thought, “at least equally with communism, lies the threat to capitalism”.) Galbraith could have been prophesying accountancy a few decades later, now led by men of business rather than watchdogs of business.
Another American writer of the same period caught the likely cause of the bean counters’ blindness to looming danger even more starkly. “It is difficult to get a man to understand something”, wrote Upton Sinclair, “when his salary depends upon his not understanding it.”
For centuries, accounting itself was a fairly rudimentary process of enabling the powerful and the landed to keep tabs on those managing their estates. But over time, that narrow task was transformed by commerce. In the process it has spawned a multi-billion-dollar industry and lifestyles for its leading practitioners that could hardly be more at odds with the image of a humble number-cruncher.
Just four major global firms – Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young (EY) and KPMG – audit 97% of US public companies and all the UK’s top 100 corporations, verifying that their accounts present a trustworthy and fair view of their business to investors, customers and workers. They are the only players large enough to check the numbers for these multinational organisations, and thus enjoy effective cartel status. Not that anything as improper as price-fixing would go on – with so few major players, there’s no need. “Everyone knows what everyone else’s rates are,” one of their recent former accountants told me with a smile. There are no serious rivals to undercut them. What’s more, since audits are a legal requirement almost everywhere, this is a state-guaranteed cartel.
Despite the economic risks posed by misleading accounting, the bean counters perform their duties with relative impunity. The big firms have persuaded governments that litigation against them is an existential threat to the economy. The unparalleled advantages of a guaranteed market with huge upside and strictly limited downside are the pillars on which the big four’s multi-billion-dollar businesses are built. They are free to make profit without fearing serious consequences of their abuses, whether it is the exploitation of tax laws, slanted consultancy advice or overlooking financial crime.
This insouciance typified the state auditing had reached. Subsequent investigations showed that rank-and-file auditors at KPMG had indeed questioned how much the bank was setting aside for losses. But such unhelpful matters were not something for the senior partners to bother about when their firm was pocketing handsome consulting income – £45m on top of its £56m audit fees over about seven years – and the junior bean counters’ concerns were not followed up by their superiors.
Half a century earlier, economist JK Galbraith had ended his landmark history of the 1929 Great Crash by warning of the reluctance of “men of business” to speak up “if it means disturbance of orderly business and convenience in the present”. (In this, he thought, “at least equally with communism, lies the threat to capitalism”.) Galbraith could have been prophesying accountancy a few decades later, now led by men of business rather than watchdogs of business.
Another American writer of the same period caught the likely cause of the bean counters’ blindness to looming danger even more starkly. “It is difficult to get a man to understand something”, wrote Upton Sinclair, “when his salary depends upon his not understanding it.”
For centuries, accounting itself was a fairly rudimentary process of enabling the powerful and the landed to keep tabs on those managing their estates. But over time, that narrow task was transformed by commerce. In the process it has spawned a multi-billion-dollar industry and lifestyles for its leading practitioners that could hardly be more at odds with the image of a humble number-cruncher.
Just four major global firms – Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young (EY) and KPMG – audit 97% of US public companies and all the UK’s top 100 corporations, verifying that their accounts present a trustworthy and fair view of their business to investors, customers and workers. They are the only players large enough to check the numbers for these multinational organisations, and thus enjoy effective cartel status. Not that anything as improper as price-fixing would go on – with so few major players, there’s no need. “Everyone knows what everyone else’s rates are,” one of their recent former accountants told me with a smile. There are no serious rivals to undercut them. What’s more, since audits are a legal requirement almost everywhere, this is a state-guaranteed cartel.
Despite the economic risks posed by misleading accounting, the bean counters perform their duties with relative impunity. The big firms have persuaded governments that litigation against them is an existential threat to the economy. The unparalleled advantages of a guaranteed market with huge upside and strictly limited downside are the pillars on which the big four’s multi-billion-dollar businesses are built. They are free to make profit without fearing serious consequences of their abuses, whether it is the exploitation of tax laws, slanted consultancy advice or overlooking financial crime.
KPMG abandons controversial lending of researchers to MPs
Conscious of their extreme good fortune and desperate to protect it, the accountants sometimes like to protest the harshness of their business conditions. “The environment that we are dealing with today is challenging – whether it’s the global economy, the geopolitical issues, or the stiff competition,” claimed PwC’s global chairman Dennis Nally in 2015, as he revealed what was then the highest-ever income for an accounting firm: $35bn. The following year the number edged up – as it did for the other three big four firms despite the stiff competition – to $36bn. Although they are too shy to say how much profit their worldwide income translates into, figures from countries where they are required to disclose it suggest PwC’s would have been approaching $10bn.
Among the challenges PwC faced, said Nally, was the “compulsory rotation” of auditors in Europe, a new game of accountancy musical chairs in which the big four exchange clients every 10 years or so. This is what passes for competition at the top of world accountancy. Some companies have been audited by the same firms for more than a century: KPMG counts General Electric as a 109-year-old client; PwC stepped down from the Barclays audit in 2016 after a 120-year stint.
As professionals, accountants are generally trusted to self-regulate – with predictably self-indulgent outcomes. Where a degree of independent oversight does exist, such as from the regulator established in the US following the Enron scandal and the other major scandal of the time, WorldCom – in which the now-defunct firm Arthur Andersen was accused of conspiring with the companies to game accountancy rules and presenting inflated profits to the market – powers are circumscribed. When it comes to setting the critical rules of accounting itself – how industry and finance are audited – the big four are equally dominant. Their alumni control the international and national standard-setters, ensuring that the rules of the game suit the major accountancy firms and their clients.
The long reach of the bean counters extends into the heart of governments. In Britain, the big four’s consultants counsel ministers and officials on everything from healthcare to nuclear power. Although their advice is always labelled “independent”, it invariably suits a raft of corporate clients with direct interests in it. And, unsurprisingly, most of the consultants’ prescriptions – such as marketisation of public services – entail yet more demand for their services in the years ahead. Mix in the routine recruitment of senior public officials through a revolving door out of government, and the big four have become a solvent dissolving the boundary between public and private interests.
There are other reasons for governments to cosset the big four. The disappearance of one of the four major firms – for example through the loss of licences following a criminal conviction, as happened to Arthur Andersen & Co in 2002 – presents an unacceptable threat to auditing. So, in what one former big-four partner described to the FT as a “Faustian relationship” between government and the profession, the firms escape official scrutiny even at low points such as the aftermath of the financial crisis. They are too few to fail.
The major accountancy firms also avoid the level of public scrutiny that their importance warrants. Major scandals in which they are implicated invariably come with more colourful villains for the media to spotlight. When, for example, the Paradise Papers hit the headlines in November 2017, the big news was that racing driver Lewis Hamilton had avoided VAT on buying a private jet. The more important fact that one of the world’s largest accountancy firms and a supposed watchdog of capitalism, EY, had designed the scheme for him and others, including several oligarchs, went largely unnoticed. Moreover, covering every area of business and public service, the big four firms have become the reporter’s friends. They can be relied on to explain complex regulatory and economic developments as “independent” experts and provide easy copy on difficult subjects.
Left to prosper with minimal competition or accountability, the bean counters have become extremely comfortable. Partners in the big four charge their time at several hundred pounds per hour, but make their real money from selling the services of their staff. The result is sports-star-level incomes for men and women employing no special talent and taking no personal or entrepreneurial risk. In the UK, partners’ profit shares progress from around £300,000 to incomes that at the top have reached £5m a year. Figures in the US are undeclared, because the firms are registered in Delaware and don’t have to publish accounts, but are thought to be similar. (In 2016, when I asked a senior partner at Deloitte what justified these riches, he sheepishly admitted that it was “a difficult question”.)
Targeting growth like any multinational corporation, despite their professional status, the big four continue to expand much faster than the world they serve. In their oldest markets, the UK and US, the firms are growing at more than twice the rate of those countries’ economies. By 2016, across 150 countries, the big four employed 890,000 people, which was more than the five most valuable companies in the world combined.
The big four are supremely talented at turning any change into an opportunity to earn more fees. For the past decade, all the firms’ real-terms global growth has come from selling more consulting services. Advising on post-crisis financial regulation has more than made up for the minor setback of 2008. KPMG starred in the ultimate “nothing succeeds like failure” story. Although – more than any other firm – it had missed the devaluation of subprime mortgages that led to a world banking collapse, before long it was brought in by the European Central Bank for a “major role in the asset quality review process” of most of the banks that now needed to be “stress-tested”.
The big four now style themselves as all-encompassing purveyors of “professional services”, offering the answers on everything from complying with regulations to IT systems, mergers and acquisitions and corporate strategy. The result is that, worldwide, they now make less than half of their income from auditing and related “assurance” services. They are consultancy firms with auditing sidelines, rather than the other way round.
The big firms’ senior partners, aware of the foundations on which their fortunes are built, nevertheless insist that auditing and getting the numbers right remains their core business. “I would trade any advisory relationship to save us from doing a bad audit,” KPMG’s UK head Simon Collins told the FT in 2015. “Our life hangs by the thread of whether we do a good-quality audit or not.” The evidence suggests otherwise. With so many inadequate audits sitting on the record alongside near-unremitting growth, it is clear that in a market with very few firms to choose from, poor performance is not a matter of life or death.
The ‘big four’ accountancy firms. Composite: Getty / Alamy / Reuters
These days, EY’s motto is “Building a better working world” (having ditched “Quality in everything we do” as part of a rebrand following its implication in the 2008 collapse of Lehman Brothers). Yet there is vanishingly little evidence that the world is any better for the consultancy advice that now provides most of the big four’s income. Still, all spew out reams of “thought leadership” to create more work. A snapshot of KPMG’s offerings in 2017 throws up: “Price is not as important as you think”; “Four ways incumbents can partner with disruptors”; and “Customer centricity”. EY adds insights such as “Positioning communities of practice for success”, while PwC can help big finance with “Banking’s biggest hurdle: its own strategy”.
The appeal of all this hot air to executives is often based on no more than fear of missing out and the comfort of believing they’re keeping up with business trends. Unsurprisingly, while their companies effectively outsource strategic thinking to the big four and other consultancy firms, productivity flatlines in the economies they command.
The commercial imperatives behind the consultancy big sell are explicit in the firms’ own targets. KPMG UK’s first two “key performance indicators”, for example, are “revenue growth” and “improving profit margin”, followed by measures of staff and customer satisfaction (which won’t be won by giving them a hard time). Exposing false accounting, fraud, tax evasion and risks to economies – everything that society might actually want from its accountants – do not feature.
Few graduate employees at the big four arrive with a passion for rooting out financial irregularity and making capitalism safe. They are motivated by good income prospects even for moderate performers, plus maybe a vague interest in the world of business. Many want to keep their options open, noticing the prevalence of qualified accountants at the top of the corporate world; nearly a quarter of chief executives of the FTSE100 largest UK companies are chartered accountants.
When it comes to integrity and honesty, there is nothing unusual about this breed. They have a similar range of susceptibility to social, psychological and financial pressures as any other group. It would be tempting to infer from tales such as that of the senior KPMG audit partner caught in a Californian car park in 2013 trading inside information in return for a Rolex watch and thousands of dollars in cash that accountancy is a dishonest profession. But such blatant corruption is exceptional. The real problem is that the profession’s unique privileges and conflicts distil ordinary human foibles into less criminal but equally corrosive practice.
A newly qualified accountant in a major firm will generally slip into a career of what the academic Matthew Gill has called “technocratism”, applying standards lawfully but to the advantage of clients, not breaking the rules but not making a stand for truth and objectivity either. Progression to the partner ranks requires “fitting in” above all else. With serious financial incentives to get to the top, the major firms end up run by the more materially rather than ethically motivated bean counters. In the UK in 2017, none of the senior partners of the big firms had built their careers in what should be the firms’ core business of auditing. Worldwide, two of the big four were led by men who were not even qualified accountants.
The core accountancy task of auditing can seem dull next to sexier alternatives, and many a bean counter yearns for excitement that the traditional role doesn’t offer. As long ago as 1969, Monty Python captured this frustration in a sketch featuring Michael Palin as an accountant and John Cleese as his careers adviser. “Our experts describe you as an appallingly dull fellow, unimaginative, timid, lacking in initiative, spineless, easily dominated, no sense of humour, tedious company and irredeemably drab and awful,” Cleese tells Palin. “And whereas in most professions these would be considerable drawbacks, in chartered accountancy they’re a positive boon.” Palin’s character, alas, wants to become a lion tamer.
The bean counter’s quest for something more exciting can be seen running through modern scandals like Enron and some of the racy early-21st-century bank accounting. One ex-big four accountant told me that if there was a single thing that would improve his profession, it would be to “make it boring again”.
Where once they were outsiders scrutinising the commercial world, the big four are now insiders burrowing ever deeper into it. All mimic the famous alumni system of the past century’s pre-eminent management consultancy, McKinsey, ensuring that when their own consultants and bean counters move on, they stay close to the old firm and bring it more work. The threat of an already too-close relationship with business becoming even more intimate is ignored. In 2016, EY’s “global brand and external communications leader” waxed biblical on the point: “You think about the right hand of greatness; actually the alumni could be the right hand of our greatness.”
These days, EY’s motto is “Building a better working world” (having ditched “Quality in everything we do” as part of a rebrand following its implication in the 2008 collapse of Lehman Brothers). Yet there is vanishingly little evidence that the world is any better for the consultancy advice that now provides most of the big four’s income. Still, all spew out reams of “thought leadership” to create more work. A snapshot of KPMG’s offerings in 2017 throws up: “Price is not as important as you think”; “Four ways incumbents can partner with disruptors”; and “Customer centricity”. EY adds insights such as “Positioning communities of practice for success”, while PwC can help big finance with “Banking’s biggest hurdle: its own strategy”.
The appeal of all this hot air to executives is often based on no more than fear of missing out and the comfort of believing they’re keeping up with business trends. Unsurprisingly, while their companies effectively outsource strategic thinking to the big four and other consultancy firms, productivity flatlines in the economies they command.
The commercial imperatives behind the consultancy big sell are explicit in the firms’ own targets. KPMG UK’s first two “key performance indicators”, for example, are “revenue growth” and “improving profit margin”, followed by measures of staff and customer satisfaction (which won’t be won by giving them a hard time). Exposing false accounting, fraud, tax evasion and risks to economies – everything that society might actually want from its accountants – do not feature.
Few graduate employees at the big four arrive with a passion for rooting out financial irregularity and making capitalism safe. They are motivated by good income prospects even for moderate performers, plus maybe a vague interest in the world of business. Many want to keep their options open, noticing the prevalence of qualified accountants at the top of the corporate world; nearly a quarter of chief executives of the FTSE100 largest UK companies are chartered accountants.
When it comes to integrity and honesty, there is nothing unusual about this breed. They have a similar range of susceptibility to social, psychological and financial pressures as any other group. It would be tempting to infer from tales such as that of the senior KPMG audit partner caught in a Californian car park in 2013 trading inside information in return for a Rolex watch and thousands of dollars in cash that accountancy is a dishonest profession. But such blatant corruption is exceptional. The real problem is that the profession’s unique privileges and conflicts distil ordinary human foibles into less criminal but equally corrosive practice.
A newly qualified accountant in a major firm will generally slip into a career of what the academic Matthew Gill has called “technocratism”, applying standards lawfully but to the advantage of clients, not breaking the rules but not making a stand for truth and objectivity either. Progression to the partner ranks requires “fitting in” above all else. With serious financial incentives to get to the top, the major firms end up run by the more materially rather than ethically motivated bean counters. In the UK in 2017, none of the senior partners of the big firms had built their careers in what should be the firms’ core business of auditing. Worldwide, two of the big four were led by men who were not even qualified accountants.
The core accountancy task of auditing can seem dull next to sexier alternatives, and many a bean counter yearns for excitement that the traditional role doesn’t offer. As long ago as 1969, Monty Python captured this frustration in a sketch featuring Michael Palin as an accountant and John Cleese as his careers adviser. “Our experts describe you as an appallingly dull fellow, unimaginative, timid, lacking in initiative, spineless, easily dominated, no sense of humour, tedious company and irredeemably drab and awful,” Cleese tells Palin. “And whereas in most professions these would be considerable drawbacks, in chartered accountancy they’re a positive boon.” Palin’s character, alas, wants to become a lion tamer.
The bean counter’s quest for something more exciting can be seen running through modern scandals like Enron and some of the racy early-21st-century bank accounting. One ex-big four accountant told me that if there was a single thing that would improve his profession, it would be to “make it boring again”.
Where once they were outsiders scrutinising the commercial world, the big four are now insiders burrowing ever deeper into it. All mimic the famous alumni system of the past century’s pre-eminent management consultancy, McKinsey, ensuring that when their own consultants and bean counters move on, they stay close to the old firm and bring it more work. The threat of an already too-close relationship with business becoming even more intimate is ignored. In 2016, EY’s “global brand and external communications leader” waxed biblical on the point: “You think about the right hand of greatness; actually the alumni could be the right hand of our greatness.”
The top bean counter’s self-image is no longer a modest one. “Whether serving as a steward of the proper functioning of global financial markets in the role of auditor, or solving client or societal challenges, we ask our professionals to think big about the impact they make through their work at Deloitte,” say the firm’s leaders in their “Global Impact Report”. The appreciation of the profound importance of their core auditing role does not, alas, translate into a sharp focus on the task. EY’s worldwide boss, Mark Weinberger, personifies how the top bean counters see their place in the world. He co-chairs a Russian investment committee with prime minister and Putin placeman Dmitry Medvedev; does something similar in Shanghai; sat on Donald Trump’s strategy forum until it disbanded in 2017 when the US president went fully toxic by appeasing neo-Nazis; and revels in the status of “Global Agenda Trustee” for the World Economic Forum in Davos.
The price of seats at all the top tables is a calamitous failure to account. In decades to come, without drastic reform, it will only become more expensive. If the supposed watchdogs overlook new threats, the fallout could be as cataclysmic as the last financial crisis threatened to be. Bean counting is too important to be left to today’s bean counters.
The price of seats at all the top tables is a calamitous failure to account. In decades to come, without drastic reform, it will only become more expensive. If the supposed watchdogs overlook new threats, the fallout could be as cataclysmic as the last financial crisis threatened to be. Bean counting is too important to be left to today’s bean counters.
Thursday 12 May 2016
Receptionist 'sent home from work without pay for refusing to wear high heels'
Siobhan Fenton in The Independent
A woman has been sent home from work for refusing to wear high heels, it has been reported.
Temp worker Nicola Thorp says she arrived for her first day in a new role at the London offices of accountancy firm PwC wearing flat shoes. She says she was told to change into high heels with a height of 2 to 4 inches.
Ms Thorp claims she was laughed at when she challenged the policy and sent home without pay when she refused to wear heels.
Ms Thorp told The BBC that she was shocked when she arrived at work for her first day and was told about the policy: “I said ‘If you can give me a reason as to why wearing flats would impair me to do my job today, then fair enough’, but they couldn’t. I was expected to do a nine-hour shift on my feet escorting clients to meeting rooms. I said ‘I just won’t be able to do that in heels’.”
She says she asked whether men were also expected to wear high heels and was laughed at for raising the objection. She said: “I was a bit scared about speaking up about it in case there was backlash. But I realised I needed to put a voice to this as it is a much bigger issue. Aside from the debilitating factor, it’s a sexism issue. I think companies shouldn’t be forcing that on their female employees.”
Ms Thorp has launched a petition calling for the law to be changed to stop employers from being able to insist that a woman wear high heels as part of their work. It has amassed more than 20,000 signatures of support.
PwC have stated that the dress code is not their policy but that of a third party recruitment firm Portico which they use to employ staff. A spokesperson told The BBC: “PwC outsources its front of house and reception services to a third party supplier. We first became aware of this matter on 10 May, some five months after the issue arose. The dress code is not a PwC policy.”
A Portico spokesperson said: “In line with industry standard practice, we have personal appearance guidelines across many of our corporate locations. These policies ensure staff are dressed consistently and include recommendations for appropriate style of footwear for the role. We have taken on board the comments regarding footwear and will be reviewing our guidelines in consultation with our clients and team members.”
A woman has been sent home from work for refusing to wear high heels, it has been reported.
Temp worker Nicola Thorp says she arrived for her first day in a new role at the London offices of accountancy firm PwC wearing flat shoes. She says she was told to change into high heels with a height of 2 to 4 inches.
Ms Thorp claims she was laughed at when she challenged the policy and sent home without pay when she refused to wear heels.
Ms Thorp told The BBC that she was shocked when she arrived at work for her first day and was told about the policy: “I said ‘If you can give me a reason as to why wearing flats would impair me to do my job today, then fair enough’, but they couldn’t. I was expected to do a nine-hour shift on my feet escorting clients to meeting rooms. I said ‘I just won’t be able to do that in heels’.”
She says she asked whether men were also expected to wear high heels and was laughed at for raising the objection. She said: “I was a bit scared about speaking up about it in case there was backlash. But I realised I needed to put a voice to this as it is a much bigger issue. Aside from the debilitating factor, it’s a sexism issue. I think companies shouldn’t be forcing that on their female employees.”
Ms Thorp has launched a petition calling for the law to be changed to stop employers from being able to insist that a woman wear high heels as part of their work. It has amassed more than 20,000 signatures of support.
PwC have stated that the dress code is not their policy but that of a third party recruitment firm Portico which they use to employ staff. A spokesperson told The BBC: “PwC outsources its front of house and reception services to a third party supplier. We first became aware of this matter on 10 May, some five months after the issue arose. The dress code is not a PwC policy.”
A Portico spokesperson said: “In line with industry standard practice, we have personal appearance guidelines across many of our corporate locations. These policies ensure staff are dressed consistently and include recommendations for appropriate style of footwear for the role. We have taken on board the comments regarding footwear and will be reviewing our guidelines in consultation with our clients and team members.”
Friday 13 February 2015
As HSBC shows, we’ve been timid and pathetic in dealing with tax dodgers
Prem Sikka in The Guardian
The parliamentary hearing on HSBC, chaired by Margaret Hodge this week has further exposed the cosy arrangements between big business and those who are supposed to be collecting its taxes. Revelations of organised tax avoidance and even evasion don’t lead to any investigations, prosecutions and fines, it appears. And Lin Homer, the chief executive of HMRC, faced angry questioning from MPs who accused her department of failing to serve taxpayers’ interests.
While the UK dithers, other countries, notably the US, are taking meaningful action against the tax avoidance industry. In 2013 Ernst & Young was fined $123m for its past misdemeanours after admitting “wrongful conduct” over the sale of tax avoidance schemes. Some staff also received prison sentences. In 2005 KPMG was fined $456m after it admitted to a fraud that generated at least $11bn in phoney tax losses for clients. A number of the firm’s former senior personnel were jailed.
And US regulators have targeted lawyers: a former Jenkens & Gilchrist employee received an eight-year sentence and a $190m fine for promoting fraudulent tax avoidance schemes. Another was jailed for 15 years.
There have been other massive fines for tax-dodging schemes: Credit Suisse was made to pay $2.6bn; UBS $780m, and Deutsche Bank $554m. All these illustrate how the US, the supposed home of deregulation and light-touch regulation, deals with organised tax avoidance. Periodic hearings by its Senate committees have led to action by the tax authorities and the department of justice. One programme rewards individuals who expose tax problems at their workplace. Whistleblowers can receive up to 30% of the tax proceeds resulting from their information. In 2013 122 whistleblowers shared awards totalling $53m.
Britain’s efforts to recoup taxes are pathetic by comparison. As Hodge said to Homer yesterday: “One of my feelings of anger with you is that you sit there waiting for people to come. You don’t go out and police in the way other authorities are doing.”
No doubt all those addicted to tax avoidance, in whatever country, are able to game the rules and play cat-and-mouse with the tax authorities. These practices are deeply embedded in contemporary entrepreneurial culture. That’s why strong measures are needed to counter them.
But Britain lacks effective institutions and the political will to deal with the tax-avoidance industry. Hodge’s public accounts committee hearings have not been followed up with action by any government department.
The UK has a fragmented regulatory system. HMRC, the Serious Fraud Office, the Treasury, the Crown Prosecution Service, the Department of Justice, professional bodies and others are all keen to pass the buck. The overlapping structures result in duplication and waste. With an annual budget of about £35m, the SFO is incapable of fighting banks and giant law and accountancy firms.
Tax courts and tribunals have often declared avoidance schemes to be unlawful, but this has not been followed by investigations, fines or prosecutions. Despite winning some cases, HMRC has not even sought to recover legal costs from any of the parties.
One reason for HMRC’s timidity is the lack of personnel and resources. The economic case for investment to check tax avoidance is unanswerable: evidence suggests that for every £1 spent in 2013/14 by HMRC’s large business service – which deals with the UK’s largest and most complex businesses – an additional £97 was recovered. The local compliance unit, which handles smaller businesses and wealthy individuals, collected an additional £18 for every £1 spent the same year.
But it seems the government is not listening. It has cut HMRC funding, badly denting its efforts to expose wrongdoing. This leads to false economies, such as the HMRC relying on professional bodies to deal with the tax avoidance schemes promoted by big accountancy firms. This has to stop. No such firm has ever been disciplined or fined for peddling abusive tax avoidance schemes, even after the courts declared them unlawful.
We’ve heard ministers announce proposals, but these are rarely fully implemented. For example, in April 2013 the government introduced rules to ban companies and individuals who took part in failed tax avoidance schemes from being awarded government contracts. In practice, no such business has been barred.
This week’s revelations in the Guardian and the House of Commons show how flawed is our policing of tax dodgers. It’s clear these abuses will continue until, like others countries, we send out a tough signal that tax evaders will be caught – and punished severely.
Tuesday 9 December 2014
PriceWaterhouseCoopers chief Kevin Nicholson denies lying over tax deals
Nicholson stands by previous testimony to MPs, as accountants are accused of mass-marketing tax avoidance schemes
The head of tax at one of the UK’s top accounting groups was accused of lying to parliament about his firm’s role in devising controversial tax deals for clients in Luxembourg.
Kevin Nicholson, PwC UK’s head of tax, who worked as an HM Revenue and Customs tax inspector in the early 1990s, was in front of the Commons public accounts committee for the second time in two years, following last month’s revelations of aggressive tax avoidance by PwC clients published by the Guardian and more than 20 other international news outlets.
In a series of fractious exchanges on Monday, the committee’s chair, the Labour MP Margaret Hodge, said: “We’ve asked you to come back to see us because we’ve reflected on the evidence that you gave us on 31 January 2013, and tried to relate that to the revelations around the Luxembourg leaks that have been in the press. I think I have a very simple question for you: did you lie when you gave evidence to us?”
Nicholson responded: “I didn’t lie and stand by what I said.”
Hodge’s anger stemmed from Nicholson’s previous evidence that PwC did not “mass market” tax products or sell tax avoidance “schemes” to clients, when set against the new evidence of 548 letters – relating to 343 companies – showing how PwC wrote to Luxembourg tax authorities to agree on how their clients structured their businesses for tax purposes.
“It’s very hard for me to understand that this is anything other than a mass-marketed tax avoidance scheme,” Hodge said. “I think there are three ways in which you lied and I think what you are doing is selling tax avoidance on an industrial scale.”
Nicholson again denied that the tax services sold by PwC were mass-marketed schemes and said that around 80 of the Luxembourg rulings related to UK companies, which were all distinct and had been disclosed to HMRC.
He said: “At the heart of the Luxembourg economy now is an economy that is based around businesses going there to finance [and] to hold investments. The tax structure, the system that they have created, facilitates that happening, along with all the other infrastructure. I’m not here to change the Lux tax regime. If you want to change the Lux tax regime, the politicians could change the Lux tax regime.”
Last month’s analyses of the way multinational companies establish businesses in Luxembourg were based on a leaked cache of hundreds of tax rulings secured by PwC Luxembourg that showed major companies – including drugs group Shire Pharmaceuticals and vacuum cleaner firm Dyson – using complex webs of internal loans and interest payments, which have greatly reduced tax bills.
The exposure of these arrangements – signed off by the grand duchy and all perfectly legal – have triggered an emergency debate in the European parliament focusing on the track record of the new European commission president, Jean-Claude Juncker, who had dominated Luxembourg politics as prime minister between 1995 and 2013. Juncker has sought to brush aside criticisms, insisting: “I am not the architect of the Luxembourg model because this model doesn’t exist.” However, Hodge added: “Since I have uncovered all this, I have questions about if Mr Juncker is fit to be the president of the European commission. I think if this had been around during the period of his appointment, it might well be a different decision.”
Appearing alongside Nicholson was Shire’s head of tax, Fearghus Carruthers, who explained how the group had two full-time employees in Luxembourg, who earn a total of €135,000 (£106,200) a year and handle intra-company loans of around $10bn (£6.4bn).
Hodge said: “It is stretching our credulity in suggesting to us that these two employees, who are also directors of umpteen other companies, are seriously the guys taking the decisions on loans totalling $10bn. Let me put this to you, Mr Carruthers, because it is a very serious matter, because if the decisions in substance aren’t taken in Luxembourg, this isn’t just avoidance; for me, it’s fraud.”
Carruthers responded: “Madam chair, I can assure you that the decision-making in respect of that Luxembourg company is made in Luxembourg.”
The executive was also repeatedly asked to explain the commercial rationale behind Shire establishing companies in Luxembourg and his answers included: “The commercial purpose is to allow us to have a treasury operation in Luxembourg which finances our activities”; and “the commercial purpose is for us to reinvest our cash appropriately and efficiently.”
When asked what Shire could do more efficiently in Luxembourg, Carruthers said: “It is not necessarily a question of comparative efficiency, we could have this lending in and lending out in all sorts of other jurisdictions. It’s just a good location.”
Well-known buyout firms such as Blackstone and Carlyle also appeared in the leaked documents, and Luxembourg investment vehicles are commonplace in such investment firms. A 2008 joint venture between private equity group Apax Partners and Guardian Media Group, which owns the Guardian, used a Luxembourg structure after it invested in the magazine and events group Emap, now called Top Right.
When the leaked documents were published, a GMG spokesman said: “We partnered with a private equity company which regularly used such structures. A Luxembourg entity was used because Apax already had that structure in place. The fact that the parent company is a Luxembourg company does not give rise to any UK corporation tax savings for GMG.”
Last year, PwC made revenues of £2.81bn, of which £714m came from its tax advisory practice. PwC Luxembourg had turnover of €276m for the year to June 2013, up more than 12% on the previous 12 months. Tax advice accounted for 29% of revenues, up from 24% two years ago. The Luxembourg partnership employs about 2,300 staff – equivalent to one in every 240 people resident in the small country. New offices for the fast-growing practice were officially opened last week at a ceremony attended by the duchy’s prime minister, Xavier Bettel.
Tuesday 30 September 2014
Awkward questions for Tesco should be answered by its accountants too
Auditors are vital to the financial markets. But when they miss a catastrophe in the offing, they’re not doing their job
So the supermarket that shoved horsemeat in its burgers now admits to sprinkling horse manure on its balance sheet. That quip has been doing the rounds since Tesco confessed last week to exaggerating its profits by £250m, and it strikes at the heart of the scandal. Just as a meat patty is manufactured, so too are a set of accounts. Neither falls from the sky, or gets slung together by a solitary bloke at twilight. They are instead a huge co-production of staff, auxiliaries and quality controllers, and they reflect the culture of the environment in which they are assembled.
Conversely, whoppers as large as the one Tesco has been caught telling won’t suddenly have popped out of the mouths of a mere handful of managers. Profits forecast for the biggest of FTSE 100 retailers will have been chalked up by advisers working to standard company practice, sweated over by executives and signed off at top levels of the company. Yet the result, according to new chief executive, Dave Lewis, is the kind of accounting he hasn’t seen during 27 years in business.
The horsemeat disgrace exposed a systemic dysfunction in capitalism: the abuse of suppliers by all-powerful supermarkets resulting in dinners that families couldn’t trust. Last week’s accounting scandal opens the door on another systemic breakdown: how one of those same giant businesses, struggling to pep up a flagging stock price, produced numbers that the business world couldn’t believe.
For understandable reasons, the press has largely spun this as the latest episode in the downfall of Tesco. Who wouldn’t tell that story? It’s simpler, starker and focuses on a high-street institution – what could be more satisfying than a tale of hubris at one Britain’s last remaining world-leading companies, especially if it allows a moist recollection of former Tesco boss Terry Leahy, one of the country’s dwindling number of business people of international repute.
But then awkward questions arise that force us to pull back the frame. The one that foxes me: where were Tesco’s auditors in all this? PwC is one of the Big Four accountancy firms who between them carry out around 90% of all audits for FTSE 350 companies. The £2.7bn-turnover partnership went over Tesco’s accounts for the 12 months to February this year, and gave the supermarket chain a clean audit in May. Just a few weeks later, on 29 August, Tesco executives issued their now infamous forecast – the one that exaggerated their likely profits by 25%.
You can imagine that in the course of a not-so-balmy summer, one of Europe’s biggest businesses suddenly went off its collective trolley and put out a confected set of figures – which, let me emphasise, were not checked over by its auditors. But consider this: back in May, PwC plainly was not entirely comfortable with the numbers it was signing off for Tesco. It went so far as to note its concern over commercial income – the fees paid by suppliers for Tesco giving their products prominence within their stores, and the income overstated in August by the supermarket chain.
On page 66 of the annual report, the auditors note that “commercial income is material to the income statement and amounts accrued at the year end are judgmental. We focused on this area because of the judgment required in accounting for the commercial income deals and the risk of manipulation of these balances.” In the polite, formulaic world of company reporting, this is a warning klaxon. And yet the auditors then went on to list the measures they’d taken to allay their concerns – and to sign off the numbers.
PwC has been Tesco’s auditor for over 30 years. For that service, Tesco paid PwC £10.4m in the last financial year – plus another £3.6m for other consultancy work. Of the 10 directors on the supermarket’s board (leaving aside the chief executive and the chief financial officer, both of whom are relatively new), two are ex-PwC: Mark Armour, a non-executive director, and Ken Hanna, chair of the company’s own audit committee.
Now imagine yourself as a senior executive at Tesco. The business has never been the same since Leahy left. The slump has dampened consumer spirits, some of the company’s foreign adventures now look ill-judged, and Aldi and Lidl are eyeing up your customers. And your remuneration partly depends on the share price – which is listing, badly. How and when to count commercial income is already one of the greyest of grey areas in accounting. Why wouldn’t you be a bit more “aggressive” in your forecasting?
To be clear, we don’t know that anything like this happened – yet it’s exactly to avoid such suspicions arising that we have auditors. This is why the government demands the vast bulk of limited companies (and hospitals and charities) have their accounts audited.
Just as with credit-rating agencies, auditing is a necessary part of the financial markets – but the auditors are paid by the very companies they are judging. Just as with S&P and Moodys, they form a small but powerful “oligopoly” – what was once the Big Eight shrank to the Big Five and, after the Andersen debacle at Enron, to the Big Four. And just as with the credit-raters, the result is often so unsatisfactory as to be useless.
All those banks that collapsed in the crisis were signed off as perfectly sound by PwC and its fellow auditors. But then, as Jeff Skilling, chief exective of Enron, said in 2004: “Show me one fucking transaction that the accountants and the attorneys didn’t sign off on.”
Nor was that a one-off lapse: in May this year, the regulators at the Financial Reporting Council noted that PwC audits, while generally of “a good standard”, were also too accepting of management fudge. As Prem Sikka, professor of accounting at the University of Essex, argues: “If some used car dealer was engaged in a fraction of the shortcomings, warnings and scams that big accountancy firms have been involved in, he would be put out of business.”
For their part, accountants are often aware of their industry’s shortcomings. For his book Accountants’ Truth: Knowledge and Ethics in the Financial World, Matthew Gill interviewed 20 young accountants at the Big Four firms. He found a bunch of men well aware of the boredom of the audit and of the shortcuts they were forced to make.
Some defended what they did. One told him: “I don’t think there’s anything unprofessional in giving views of facts directed by whoever it should be.” Another described his discomfort at working in his firm’s corporate-finance department and supporting what he described as “immoral” and “borderline corrupt” tax wheezes. But rather than voice his qualms, he simply moved department. Whistleblowing was not for him: “I would have felt I would look slightly ridiculous.”
Read that last sentence and recall that the person who blew the whistle this month on Tesco wasn’t the company’s audit committee or ethics committee – and they don’t appear to be from PwC either. As far as we know, the anonymous whistleblower worked for Tesco’s UK finance director, Carl Rogberg, and their report was at first ignored.
When last week’s scandal broke, Tesco chair Sir Richard Broadbent airily opined: “Things are always unnoticed until they are noticed.” He forgot to mention that that goes double if people are paid to turn a blind eye.
Monday 18 March 2013
You think the government is fighting tax avoidance? Think again
George Osborne has pulled off a stunning confidence trick: he has bamboozled people into thinking he is fighting tax dodgers
‘Chancellor George Osborne's new rules – as KPMG makes clear – give “UK-based multinationals an opportunity to significantly reduce their tax rate”.’ Photograph: Carl Court/AFP/Getty Images
Chancellors of the exchequer have never been entirely straight about their tinkering with the tax system. With his penchant for "stealth taxes", Gordon Brown certainly didn't always come clean with the British public. But when it comes to the vexed subject of tax avoidance, his successor George Osborne has taken the deception to a new level and, after three years, pulled off a stunning confidence trick.
"The parties agree that tackling tax avoidance is essential for the new government, and that all efforts will be made to do so," declared the coalition agreement in May 2010. The commitment was a victory for the Lib Dems and for their pre-election shadow chancellor Vince Cable in particular. A year earlier, Cable had responded to the Guardian's Tax Gap series by writing: "Systematic tax avoidance by rich individuals and UK-based companies strikes a particularly ugly note in these straitened times."
Cable's prize was to be a "general anti-avoidance rule", and soon enough one of Britain's leading tax QCs, Graham Aaronson, was dispatched to work up the scheme that Osborne has promised to introduce in this week's budget. But it will be what Aaronson describes as "narrowly focused", and apply only to the "most egregious tax avoidance schemes". For which, read convoluted arrangements involving multiple transactions that circumvent the spirit of the law – of the sort deployed by comedian Jimmy Carr before he saw the light (or the headlights of career death hurtling towards him).
Scheming of this type is, however, a relative minority sport, and is generally defeated by judges increasingly intolerant of tax avoidance anyway. Worse still, the senior tax inspectors' union argues that, by hitting just "egregious" cases, the new law risks "actually facilitating avoidance".
By far the costliest tax avoidance takes the form of the corporate structuring that has repeatedly hit the front pages in the last couple of years, whether through Starbucks' payment of royalties to Amsterdam, Amazon's Luxembourg sales hub or Vodafone's multibillion-pound internal financing arrangements through the same grand duchy. And,as the Lords economic affairs committee pointed out last week: "There is a misconception that Gaar [general anti-abuse rules] will mean the likes of Starbucks and Amazon will be slapped with massive tax bills. This is wrong, and the government need to explain that to the public."
Such corporate manouevrings do not officially constitute tax avoidance even if, on any commonsense view, that is exactly what they are. When a couple of years ago the BBC commissioned a ComRes survey on attitudes to tax avoidance, it defined the practice as "where people or businesses arrange their financial affairs to minimise the amount of tax they pay while remaining within the law". Eighty four percent of people favoured a clampdown on the behaviour, which clearly encompasses multinational's offshore structures.
Yet this is where the great tax trick is played. Outside the official definition of tax avoidance, the offshore schemes of Britain's biggest multinationals have not just escaped any clampdown, they have been rewarded with a rewriting of corporate tax law that makes them more irresistible than ever. Working closely with the companies most affected, in his last two budgets Osborne has relaxed – almost to the point of obsolescence – the so-called controlled foreign companies laws that were introduced by Nigel Lawson in the early 1980s to prevent companies shifting profits into their tax-haven subsidiaries.
From this year offshore financing structures such as Vodafone's, for instance, will be taxed at no more than 5%, while companies' tax-haven branches will be exempt from tax. Incredibly, the British government is subsidising the largest companies to send billions of pounds into the world's tax havens. And in the absence of any opposition from the Labour party – compromised by its own record of offshore tax relaxations and now advised by Vodafone's tax consultant PricewaterhouseCoopers – the new laws have arrived on the statute book unchallenged.
The big four accountancy and tax consulting firms that were hauled before Margaret Hodge's public accounts committee a few weeks ago are probably licking their lips. KPMG touts for business in one of its pamphlets by pointing out: "For every £1m of finance income received in the UK, the finance company regime could save cash tax of £165,000." And even better: "As the new rules have been designed and enacted by the government, this should represent a low-risk tax-saving opportunity." What could be sweeter than state-endorsed tax avoidance?
This surreptitious slashing of corporate tax bills is not something the government is keen to dwell on. Indeed, the rhetoric can be very different. In Davos, David Cameron said that businesses are "setting up ever more complex tax arrangements abroad to squeeze their tax bills right down ... Well, they need to wake up and smell the coffee". Given low corporate tax rates, soon to be 21% and by far the lowest among G8 countries, the PM insists they "should pay that rate of tax rather than avoid it".
But Osborne's new rules – as KPMG makes clear – give "UK based multinationals an opportunity to significantly reduce their tax rate". In other words, using "tax arrangements abroad" the largest multinationals won't pay even the new all-time-low headline tax rates.
Through the "general anti-avoidance rule" and a regular stream of smaller specific anti-avoidance announcements, such as this weekend's move against a national insurance dodge, Osborne will sustain the illusion that tax avoidance is being fought on all fronts, confident that his bamboozled audience will never notice the abject surrender on the most important one of all.
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