Dispatch from the UK: KPMG Settles Carillion –- Whiners Are Not Happy

Guest posted today on Francine McKenna's Substack, The Dig -- a pleasure as always.

 

KPMG has settled the £ 1.3 bn claim brought against it by the liquidators of its client Carillion, the UK outsourcing behemoth whose spectacular collapse in January 2018 triggered an outpouring of the too-familiar criticism, “Where were the auditors?”

Five years on, the entire sorry story is playing yet again to the same tired script.

When the long-anticipated claim was officially commenced, in February 2022, the reaction from KPMG’s leadership was the usual attempted bravado and blame-shifting:  

“We believe this claim is without merit and we will robustly defend the case. Responsibility for the failure of Carillion lies solely with the company’s board and management, who set the strategy and ran the business.”

Now has followed the latest and fully predictable statement of capitulation, from UK CEO John Holt on February 13, 2023 --- which could have been drafted in 2018 and sealed in an envelope marked “Open when needed”: 

“I am pleased that we have been able to resolve this claim. Carillion was an extreme and serious corporate failure, and it is important that we all learn the lessons from its collapse.”     

For want of Mr. Holt’s specification of those “lessons,” let us ask what has been learned –- if anything?

To start, what is not disclosed for the public’s learning is the amount of KPMG’s exit price –- the UK firm using the frequent American tactic of costuming its settlement in a shroud of confidentiality (see the trustees’ claims against KPMG in New Century and against Deloitte in Taylor Bean & Whitaker, and MF Global / PwC).    

Next, depressingly, although there are surely specific lessons available from Carillion about improvements in the technical and complicated reporting, accounting and assurance for large, long-term contracts, none have emerged to inform investors and the capital markets. Not least, that is because the accounting profession has never developed a common forum or other means by which such catastrophes can be put to expert analysis, to be shared for the benefit of all concerned, as is widely done across the business spectrum -- e.g., in aviation safety, structural engineering, medical care, and manufacturing processes.  

One thing we do learn is that the expedient Mr. Holt has reduced by one the number of pending litigation threats against the Big Four that, at their worst, are large enough to be life-threatening. That population now includes, at least, Wirecard in Germany and NMC Health in the UK for EY, and for PwC, Evergrande in China and Americanas in Brazil.

With that small comfort, we also are reminded –- not having needed to learn -– that despite the massive volumes of perfervid critical rhetoric, nothing has been done over the last five years to have any substantive impact on the actual operation of Big Audit, the model by which the Big Four audit all but one of the FTSE 100 and 87% of the FTSE 250.

What has been learned instead is that across the entire body of players, there is a complete lack of will to alter the model:

• The large firms themselves display no discomfort with the current structure of their franchise –- their single gesture having been ready agreement to “operational separation” -- the optically appealing if substantively negligible evolution of expanded disclosure of the organizational and operating distance between their assurance and consulting practices.

• The comprehensive and insightful report and recommendations of Sir Donald Brydon’s “Independent Review into the Quality and Effectiveness of Audit” (December 2019), which recognized the necessity of evolving the assurance model and the qualifications of its professionals, failed to achieve any traction but instead sank without a trace.

• The Financial Reporting Council as the UK’s audit regulator has been shifting its furniture around within what Sir John Kingman described in his December 2018 “Independent Review of the Financial Reporting Council” as its “ramshackle house.” But the prospects that Parliament will actually legislate to re-name and re-configure the FRC as a new Audit, Reporting and Governance Authority –- dead-on-arrival through the years of Boris Johnson and the weeks of Liz Truss –- show no signs of life in the early but distracted and pre-occupied government of Rishi Sunak. Meanwhile as long mooted, Jon Thompson, the FRC’s leader through these fallow years, has chosen to swap one poisoned chalice for another by taking the chair at troubled rail link HS2.

None of this has stopped the whiners, whose petulant voices are heard yet again:

• Annop Rehal of the Haines Watts audit firm (14^th in the UK table -- at £ 105 m in revenue, approximately 2% the size of leaders PwC and Deloitte): the “issue of negligence at the top of the market (is) caused by the lack of ‘real competitors to challenge them’.”

• Gavin Hayes of the Chartered Institute for Internal Auditors: “there is no doubt that there are fundamental issues around a lack of competition in the market.”

For this topic, what has not been learned, or at least is not acknowledged, is the sterility of the discussion on auditor choice and competition, as the advocates for enforced re-structuring of the Big Four’s market dominance have yet to face the reality that the smaller firms lack the capacity, scope of expertise, and risk tolerance to make achievable any such aspirations.

Instead, the complexity of large-company audit and the required range of skills and global presence defy the challenge to carve out for the small firms a portion of such engagements –- either by line of business or by geography, and whether on their own or by forced job-sharing. No assemblage of the firms below the Big Four, singly or in the aggregate, has the necessary capability:

• Performance evaluations by the regulator, and the mix of investigative and enforcement actions involving the smaller UK firms, both caution the prospect of degraded audit quality, should actions be taken to force those firms upon the FTSE-indexed environment.

• A significant reminder regarding audit quality, if needed, is that the case has never been seriously advanced –- much less established –- that “smaller is better.” To the contrary, flares of financial and corporate misfeasance are reported around the globe, all involving the smaller firms: the crypto fiasco of FTX, the Gupta companies in the UK, Lex Greensill’s far-flung structure of companies, and the Adani group in India.

Neither the accounting profession itself nor its hand-wringing critics are heard to advance the difficult if realistic and achievable actions by which to re-engineer a model for large-company assurance that is fit for future purpose. The necessary holistic discussion among all the players awaits.  

 

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