Even at the distance of half a decade, the chaotic collapse of Carillion shocks. One of the country’s biggest construction and contracting firms, embedded in schools and hospitals, failed with liabilities of £7bn and just £29m in cash. The company’s pension schemes were underfunded. Almost 3,000 employees lost their jobs and the implosion ricocheted through supply chains. The government had to spend £150m to maintain basic services, such as the cleaning of hospitals.
The detail that astonished everybody was that it took only six months from Carillion’s first profit warning in July 2017 for the entire pack of cards to fall over. That should not be possible at a large quoted company. It was therefore no surprise to hear – finally – formal confirmation that KPMG disgraced itself in its role as Carillion’s long-serving auditor.
Thursday’s verdict from the Financial Reporting Council revealed negligence on the part of KPMG over many years. Carillion “was not subject to rigorous, comprehensive, and reliable audits in the three years leading up to its demise”, said the watchdog. The inadequate 2016 audit was compounded by “breaches of the ethical standards relating to the fundamental principles of objectivity, independence, and integrity”. KMPG has been fined £21m, which is a record. By rights, the sum should be multiples higher.
Yet there is a second failure here. It is the government’s reluctance or basic inability to do what it said it would do and legislate to enforce higher standards in auditing by creating a new regulator. Carillion’s collapse was meant to be a kind of “Enron moment” for the UK – a realisation that deep problems in corporate reporting could no longer be ignored. Investors, employees, suppliers, governments had to be able to trust the numbers.
Two select committees of MPs said Carillion had exposed the big four auditors as a “cosy club incapable of providing the degree of independent challenge needed”. At the end of 2018, the government’s reviewer, Sir John Kingman, said the FRC had taken “an excessively consensual approach to its work” and should be abolished, to be replaced by a new Audit, Reporting and Governance Authority (Arga) with stiffer powers.
The government agreed. A proposal to create Arga was announced in March 2019. It would be a statutory body that could interfere proactively and make direct changes to accounts. Audit reform was mentioned in the Conservatives’ “get Brexit done” election manifesto. A draft bill was eventually published in 2021. The FRC, under new bosses, was told to prepare for the big switch.
Yet the wait for legislation goes on and on. The bill didn’t make it into Queen’s speeches of 2021 or 2022 (Boris Johnson’s advisers thought auditing was “boring”, reported the FT) and nobody thinks it’ll make the cut in next month’s king’s speech. It is still not clear when Arga will arrive.
To be fair to the FRC, a deferred death sentence has been good for it. The watchdog has shown more bite. It has forced through operational separation of the big four’s audit and advisory arms on a voluntary basis. And it has been more aggressive in policing audit quality. Yet Arga and its statutory powers are plainly still needed. Other fundamental issues, such as the chronic lack of competition in audit, won’t be addressed otherwise. Nor can the current regulator hold to account directors who are not members of accounting bodies.
Now remember what happened in the US after it had its actual Enron moment in 2001 – the bankruptcy of a major energy company amid accounting scandal. Within a year, the US passed the Sarbanes-Oxley Act, which created criminal penalties for corporate misreporting and gave regulators new powers.
Or look at the fate of the respective auditors. Enron’s auditors, Arthur Andersen, didn’t survive. In the UK, the Insolvency Service pursued KPMG for £1.3bn over Carillion but reached a settlement this year on terms that were “confidential”. We wait to discover if the sum was large enough to hit the wallets of today’s KMPG partners in the UK (average remuneration: £757,000 last year).
In terms of pure numbers, Carillion was smaller than Enron. Yet, on a comparative basis, the shambles caused by collapse was arguably just as great, and the need for sweeping market-wide improvements in audit just as pressing. Since Carillion failed in January 2018, we’ve had four prime ministers and seven secretaries of state for business, which partly explains the drift. It does not excuse it.
Audit is indeed boring in the sense that it is dry and technical. But Carillion’s pensioners, employees and shareholders know that it matters. Rotten standards inevitably lead to dire outcomes somewhere. The government’s inertia on reform is itself a scandal.
