Akintola Williams Memorial lecture (Continuation)

Britain’s accounting watchdog, the Financial Reporting Council, opens a new tab and has sanctioned PwC, along with EY and Oliver Clive & Co, following its investigation into the audits of LCF.

The Serious Fraud Office has an open criminal investigation into the failures at LCF.

Following accounting scandals at retailer BHS and builder Carillion, one review, opening a new tab, said the “gap” between public expectations about auditors’ ability to detect fraud and their responsibility to do so, needed addressing.

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The FCA said PwC was not responsible for “seeking out or fully investigating” suspected fraud, but auditors’ “unique insight” into companies means they have an important role in alerting watch dogs.”

Shivaram Rajgopal, Professor at Columbia Business School:

“Why Don’t We Ask Companies And Auditors To Disclose Their Materiality Standards”?

“In today’s column on Forbes, I ask an innocuous question that I had never thought of asking before. We see so much hand wringing about “materiality” in financial statements whenever new disclosure rules are discussed or when a disclosure case goes to court. Yet, we never seem to ask firms and auditors to simply tell us what materiality standards they used when they prepared and audited a firm’s financial statements.

This is where travel and exposure to foreign settings help. Columbia Business School ran a faculty tour of China in early June that I was lucky to be a part of. One of the businesses we visited during that trip was the Chinese electric vehicle giant BYD. I used to go over the financial statements of any company we visited as a quick way of familiarising myself with the stated narrative and the proof points of that business. It turns out that BYD clearly discloses the numerical thresholds they use in determining materiality standards in their financial statements. We often think of Chinese financial reporting and governance systems as relatively opaque relative to the ones we have in the West. While that is true in many respects, they also innovate along dimensions that we don’t often think about. Will the Financial Accounting Standards Board, the U.S. Securities and Exchange Commission, and the Public Company Accounting Oversight Board (PCAOB) consider asking US managers and auditors to publish their materiality thresholds for individual firms and/or transactions?”

Ernst & Young

“Big four” accounting firms PricewaterhouseCoopers and EY have been fined a combined £9.3m for a series of failures in auditing the accounts of London Capital & Finance, the collapsed mini-bond firm that wiped out the investments of thousands of savers.

It concludes a near-four-year investigation by the Financial Reporting Council (FRC) into how auditors breached their duties while reviewing the firm’s finances in the years leading up to its demise in 2019.

Jamie Symington, the regulator’s deputy executive counsel, said the auditors failed to understand the business and raised the possibility that there could be “material misstatements” in the company’s accounts.

“These breaches are made considerably more serious by the fact that all of the auditors knew they were auditing an expanding business that was engaged in selling unregulated financial products to retail investors and that potential investors might place reliance on the clean audit opinions,” Symington said.

London Capital & Finance (LC&F) collapsed in 2019 after taking about £237 million from 11,600 investors. Its mini-bonds promised stellar returns of up to 8% a year but put only a small amount of cash into safe interest-bearing investments.

The rest was funnelled into speculative property developments, oil exploration in the Faroe Islands, and even a helicopter bought for a company controlled by LC&F. The company collapsed in January 2019. The scandal has led to reprimands for the city regulator, the Financial Conduct Authority, and prompted a criminal investigation by the Serious Fraud Office, which is still open.

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PricewaterhouseCoopers (PwC) and one of its staff members—who were appointed as auditors for the 2016 financial year—admitted to eight breaches, the most serious being a failure to adequately understand the nature of LC&F’s business and internal controls.

That year, the firm issued £9.2 million in bonds and was growing even more rapidly by the time the audit report was signed, the regulator said. However, PwC did not apply “sufficient professional scepticism” while conducting its audit, the FRC said.

EY took over as LC&F’s auditor for the 2017 financial year, after PwC resigned. That year, LC&F ramped up its operations, selling a further £53.4m in bonds. But EY fell short, having also failed to understand and properly scrutinise the business, particularly in light of the risk of fraud. EY and one of its employees have since admitted to six breaches of FRC rules.

PwC and EY have been severely reprimanded for their failings and hit with fines worth £4.9m and £4.4m, respectively. It marks the largest-ever fine issued against EY by the FRC to date and the third largest for PwC.