The UK’s financial regulators are presiding over widespread corporate failure

The handling of scandals at leading banks show it's time for a regulatory overhaul.

There is something rotten at the heart of the British establishment. Our regulatory system is presiding over corporate failure.  

A common understanding is that the primary role of the regulators is to protect consumers, taxpayers and the public in general from harmful practices. But this is not the case.

Regulators appear more concerned about defending and protecting corporate interests and sweeping things under dusty carpets. And the stench of scandals has become unbearable.

The Financial Conduct Authority (FCA), the banking regulator, is adept at burying reports relating to misdemeanours by bankers. The latest episode relates to frauds at the Reading branch of HBOS.

The Reading scam

The KPMG-audited bank was bailed out in 2008 and became part of the Lloyds Banking Group. In 2017, the bank manager and a number of his associates were convicted of loan fraud going back more than a decade – fraud which funded lavish trips, supery-achts and sex parties. The scam – which pulled money from small and medium businesses – put many individuals and companies into needless bankruptcy.

Anthony Stansfeld, Police and Crime Commissioner for Thames Valley, estimates that £1bn could have been involved:

The fraud was denied by Lloyds Bank for 10 years, in spite of it being apparent that senior members of the bank were aware of it at least as far back as 2008. It resulted in a great number of companies being ruined, and the lives and livelihoods of their owners and those that worked with them being destroyed.

“They were pursued for their personal guarantees, and lost their houses and possessions as the bank and its lawyers pursued them for all they owned. Families were split up, marriages ruined, and suicides resulted.”

A report known as “Project Lord Turnbull” detailing some of the frauds was prepared in 2013 – but the FCA chose of bury it. 

It has just been released by the All Party Parliamentary Group on Fair Business Banking, and contains damning evidence of criminality which ought to lead to criminal charges of senior executives. As the APPG statement says:

“We again call on the Serious Fraud Office (SFO) and the National Crime Agency (NCA) to investigate the alleged criminality of individuals named in the report….

“This exercise must recognise the loss to business and livelihoods for many people as a result of the mistreatment documented in the report and the potential loss to investors who participated in the HBoS and Lloyds rights issues and the subsequent takeover. Any resolution that does not recognise these wider issues will severely undermine confidence in our regulatory and enforcement agencies.

Worrying track record

Previously, a 2013 report by Lawrence Tomlinson showed that banks artificially put viable businesses into administration, receivership and liquidation. It concluded that “some of the banks, RBS in particular, are harming their customers through their decisions and causing their financial downfall.”

In 2014, the FCA prepared a report titled “RBS Group’s treatment of SME customers referred to the Global Restructuring Group (GRG)”, but decided to bury it. In February 2018, the House of Commons Treasury Committee forced its publication and said:

“The findings in the report are disgraceful. The overarching priority at all levels of GRG was not the health and strength of customers, but the generation of income for RBS, through made-up fees, high interest rates, and the acquisition of equity and property”.

The frauds could not have been perpetrated without the complicity of insolvency practitioners. These companies are regulated by law and accountancy professional bodies – yet there have been no prosecutions.

Audit failure

The poverty of auditing practices continues to make headlines. The big four accounting firms – Deloitte, PricewaterhouseCoopers (PwC), KPMG and Ernst & Young – audit 340 of the FTSE 350 companies, and their work  has a bearing on the interests of shareholders, employees, pensioners, supply chain creditors and taxpayers, as Carillion, BHS and other episodes have amply demonstrated.

The parliamentary report on Carillion hammered the poor quality of KPMG audits. It noted that the accounting regulator, the Financial Reporting Council (FRC), was long aware of the shortcomings of KPMG audits, but did nothing about it.

Carillion has cast doubts of the FRC’s own future, and now a government-backed inquiry is considering evidence. In this environment, the FRC has now stated that 25.5% of the audits delivered by the big four accountancy firms are deficient even by the UK standards. 50% of the KPMG’s FTSE 350 audits ‘required more than just limited improvements.’

Such fault rates in the production of auto, medicines or food industries would be followed by fines and closures, but they have become the norm in accounting. There are no fines for persistent low quality of audits and no plans for eradicating the shortcomings. There are no forced closures of the offending offices and no bans to prevent poor firms from securing any further business.

The relaxed regulatory environment encourages poor practices. Just look at what happened at BHS, a company that was audited by PwC and went into liquidation in 2016.

In 2015, BHS was sold for £1 as a going concern with a clean bill of health from auditors. The Financial Reporting Council has now fined PwC £6.5m for audit failures, but its findings have been challenged by Sir Philip Green, former boss of BHS. The court documents contain internal PwC emails which state that the auditor backdated his audit opinion and spent just two hours on the file to conclude that BHS was going concern.

Much of the audit work was delegated to junior team members. Yet neither FRC nor PwC provided such information to the parliamentary committees investigating BHS. Was FRC not aware of the organisational culture at PwC? What has it been doing?

Regulators should solely be dedicated to protecting people from predatory practices. Mechanisms need to be designed to ensure that they cannot bury reports or fob-off the public. A regulatory overhaul is long overdue.

Prem Sikka is Professor of Accounting at University of Sheffield and Emeritus Professor of Accounting at University of Essex. He tweets here.

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