The following article was published in the UK press on 1 December 2017.
“HBOS AUDIT REVELATION RAISES HEAT ON REGULATOR
THE TIMES – 1st December 2017 – UK – Patrick Hosking, Financial Editor.
A leading accounting firm gave HBOS a clean bill of health just seven months before it collapsed because it was reassured by the number of stock market pundits with “buy” ratings on the bank.
The extraordinary revelation was made by the Financial Reporting Council, which regulates auditors, in a report defending its controversial decision to clear KPMG of wrongdoing in its 2008 audit of the bank.
HBOS, which owned the Halifax and Bank of Scotland franchises, failed the same year and had to be bailed out with £20 billion of taxpayers’ money and a rescue bid by Lloyds TSB. More than £52 billion of HBOS-originated loans later went bad and were never repaid.The FRC yesterday admitted some failings in its handling of its oversight of the HBOS audit by KPMG, the bank’s accountant, but stood by its decision in September to clear the firm, arguing the test for misconduct was too high to take enforcement action against it.
That statement brought a sceptical response from the Treasury select committee, which said it would be investigating the regulator further in the new year. Critics of the FRC, who say that it has been “captured” by the industry it is supposed to regulate, called the report a whitewash.
The 66-page report gives the first details of how the auditor came to judge HBOS to be “a going concern” and to approve its annual report as giving a “true and fair” picture of its financial health in February 2008.
The “going concern” seal of approval was awarded to the bank despite the wholesale funding markets freezing the previous summer, the collapse of Northern Rock and widespread anxiety in financial markets.
The regulator found that KPMG had identified liquidity risk as an issue in its “going concern” assessment of HBOS, but that there were three factors that helped mitigate the overall level of risk. One of these was the number of market analysts claiming to see HBOS in a positive light. “Contemporaneous analysts’ reports indicated a positive outlook for HBOS, with the majority of analysts presenting a Hold (43 per cent) or Buy (43 per cent) recommendation through to January 2008,” the regulator quoted KPMG as saying.Accounting experts expressed astonishment that auditors, who have unparallelled access to all the figures in a company, should give weight to the opinions of outsiders, who don’t, and that the FRC should see it as helping to exonerate the firm of incompetence.
Most analysts’ share tips are treated with great scepticism because they are designed to generate trade rather than necessarily give an objective view of a company’s prospects. “Sell” recommendations are extremely rare.“This is an incredible line,” Tim Bush, head of governance at the investment consultants PIRC and a strong critic of the FRC, said. “It’s circular. The auditors sign off on the basis that sell-side analysts have believed the numbers the auditors are signing. Why bother with auditors on that basis if the market is doing their job for them?”
KPMG said yesterday that analysts’ reports could help auditors to exercise professional scepticism. “Analysts reports formed part — but certainly not all — of such information read at the time of our HBOS audits,” a spokesman said.
The senior KPMG audit partner for HBOS at the time was Guy Bainbridge. He is still a partner at the firm and went on to be responsible for auditing HSBC before the bank switched to rival accountancy firm PWC.The FRC admitted it was not fast enough in investigating the audit in the years immediately after the collapse of HBOS. Stephen Haddrill, chief executive of the regulator, said: “We should have adopted a more proactive approach to our early inquiries in relation to HBOS.” It was “not right” that the FRC had decided to leave preliminary inquiries to the main financial regulator at the time, the Financial Services Authority, he added. The FRC only decided to investigate the affair in 2016 after intense pressure from MPs on the Treasury select committee.
In a letter to Nicky Morgan, chairwoman of the committee, who had demanded to know why KPMG was cleared of wrongdoing, Mr Haddrill said that there was no realistic prospect that an independent tribunal would make an adverse finding of misconduct against KPMG. “A tribunal would need to find that no reasonable auditor or audit firm would have acted in the way that KPMG did, and this was not the case in relation to HBOS,” he said.
Mr Haddrill defended the FRC’s processes against conflict of interest. The regulator is staffed with many former partners of the Big Four and had 11 current and former KPMG partners on its committees when it cleared KPMG.Ms Morgan said the FRC was right to acknowledge its past failings but made plain she was not fully satisfied. “We will be calling the FRC to give evidence in the new year to discuss whether their conclusions go far enough,” she said.
Mr Haddrill said that KPMG was “not above criticism” and that there were “questions about the adequacy of the nature and extent of some of the audit procedures” but declined to explain what these were because of confidentiality issues. “