The Times has published revelations suggesting conflicts of interest and regulatory capture at the UK Endorsement Board, the new public interest body set up to vet international accounting standards for use in the UK: Standards board ‘looks like a cabal’.
The article details leaked emails showing members of the UKEB apparently seeking to use secretly a barrister Martin Moore QC, considered to be conflicted due to his ties to the audit industry, and conducting substantive discussions behind closed doors - whereas all meetings by the UKEB should be held in public and fully reported. It points to the heavy involvement of former audit industry executives and others with past commercial links to the audit industry on the Board.
The Local Authority Pension Fund Forum (LAPFF) has repeatedly raised concerns about problems at the UKEB, setting out compelling evidence of a failure to follow due process and a flawed standard approval process. LAPFF has now written to Sir Jon Thompson, Chief Executive at the Financial Reporting Council (FRC), under whose auspices the UKEB operates, to ask him to investigate. Baroness Sharon Bowles has raised numerous questions on the topic in the House of Lords.
This matter of regulatory capture of accounting and audit regulation is not new.
Sarasin & Partners, working alongside other long-term investors, led efforts calling for the FRC to be reconstituted in 2017, when we published a collective investor paper “Investors require a robustly independent audit regulator”. This helped to catalyse the Kingman Review of the FRC, and recommendations for the FRC to be disbanded and replaced by a new public body, the Audit, Reporting and Governance Authority (ARGA). Sir John Kingman’s report provided detailed evidence of ineffectual governance and excessive audit industry influence over its regulator.
It is deeply worrying that following a long process aimed at addressing this failure, we see the spectre of regulatory capture cropping up again at the UKEB. This matters because the UKEB is the body set up post-Brexit to ensure that the UK accounting standards approved for use in the UK underpin, rather than undermine, vital capital protection rules under Company Law.
We have long pointed to flaws in the accounting profession’s application of the law that has failed to ensure that companies fully disclose the true and prudent level of capital they have. Specifically, accounts should distinguish reserves potentially available for distribution and those not – to prevent companies from depleting capital in such a way that runs the risk of insolvency. We’ve seen repeatedly – whether in the financial crisis or more recent company failures such as Carillion - how hidden losses and liabilities and overstated profits can end in disaster for shareholders, staff, local communities and the public.
These flaws with the implementation of the current accounting regime have not just been called out by investors. In 2013 and 2015 George Bompas QC provided two compelling legal opinions in which he roundly dismisses the Government’s failure to implement Company Law protections.
What is striking is that the legal advice the FRC relied on at the time was provided by Martin Moore QC. This is the very same QC the UKEB is apparently seeking to work with behind the scenes, according to the internal emails outlined in the Times.
Yet Bompas could not have been more scathing about Moore’s advice, which he described as “defective”. Bompas further points out that Moore’s claims that there is “no legal requirement for a company to distinguish in its balance sheet between distributable and non-distributable profits”, and thus the determination of distributable reserves as required under the Law, rely on Guidance from the audit industry itself, rather than an independent legal view. Bompas is unequivocal is his assessment of Moore: “The difficulty with this proposition is that it is simply not what was provided for by the Companies Act 1980, or by the replacement Companies legislation…”.
Bompas concludes: “In the circumstances, so long as UK companies legislation relating to company distributions remains as it is at present, it seems to me to be difficult to assert that [IFRS] accounts which fail to enable a determination of what is or is not available for distribution by reference to amounts stated in them can give a true and fair view of a company’s assets and liabilities, financial position and profits or losses, as they will fail to meet one of the central purposes for which the accounts are required.”
Bompas' conclusions require action. The accounting profession needs to correct their current practices to comply with capital maintenance requirements. His opinions have, as far as we know, never been rejected by the Government. And yet UKEB appears to continue to rely on Moore QC for its all-important job of checking accounting standards meet the legal standard.
Against this backdrop, the government White Paper on Restoring Trust in Audit and Corporate Governance was a breath of fresh air. It acknowledged that there is currently no implementation of capital maintenance rules and proposed steps towards addressing these failures. We now await action.
In the meantime, these latest revelations at the UKEB suggest the audit industry is busy re-exerting control over the levers of accounting regulation. This needs to stop.
We call on the government to launch an immediate independent investigation into 1) how the UKEB was constituted, 2) how conflict of interests were managed (or not), and 3) whether the principles the UKEB has been asked to use in approving accounting standards are consistent with UK Company Law, as so clearly set out by Bompas over seven years ago.
It is time we rooted out regulatory capture from our accounting and audit system. It is time we implement the capital protection rules provided by The Companies Act to safeguard investors and the public.