Oral evidence: Carillion, HC 769
Oral evidence, 30 January 2018.
Witnesses
Sarah Albon and Stephen Haddrill.
Chair
Thank you very much for coming to give evidence on the collapse of Carillion to our two Select Committees this morning. I will start by asking both of you, the FRC and The Insolvency Service, to provide us briefly with an update of your investigations into Carillion.
Stephen Haddrill
We announced yesterday that we will have a formal investigation into the audit by KPMG of Carillion and we are looking at the three years from 2014 to the present day. We have said that the scope of the investigation will include the going concern matter, the pensions matter and how the contracts were being assessed, and it will look into other matters as well. There is also the question of whether we launch an investigation into what we call members in business, the accountants who were in the company. That is under different regulations and has a different test for launching the investigation, a misconduct test rather than a breach of regulations test. It is going to take us a little bit longer to work through whether there is a proper basis for launching the investigation but we hope to do that very soon.
Chair
What does “very soon” mean, Mr Haddrill?
Stephen Haddrill
I would hope certainly within a matter of a few weeks. We have managed to launch the investigation into the audit very quickly and that would be our intention with that as well.
Chair
How long would you expect your investigations into KPMG and then potentially into the accountants at Carillion to last?
Stephen Haddrill
I fully understand that the public, and in particular those people who have been heavily disadvantaged, lost their jobs and so on, as a result of this, want the most rapid possible conclusion to this investigation and, if it points that way, any prosecution thereafter. I think it would be wrong of me to set a firm timetable on this because, first, the scope of the investigation is very wide, going back a number of years, and, secondly, it is absolutely vital that we do this thoroughly. We have the resources we need. We have expanded the resources of our enforcement team considerably over the last few years and I have made it clear to the executive counsel that if she needs any further resources we will provide them. We are absolutely committed to doing it as fast as possible but if I give a date and then, for reasons of making sure that we are on really solid ground, we cut corners and made mistakes I think that would be intolerable.
Chair
I ask because it is 19 months since the FRC announced that it will investigate PricewaterhouseCoopers’ audit of BHS and we have still had nothing from the FRC. The FRC investigation of audit failures at MG Rover, audited by Deloitte Touche, was announced in August 2005 and the outcome was not finalised until April 2015. Might we have to wait 10 years to get the outcome of this inquiry?
Stephen Haddrill
No, certainly not. The Rover one was deferred while other inquiries were going on. We are starting this one absolutely now and, as I said, we will do it much faster than those timescales.
Chair
When might you expect the work on the audit of BHS to be completed?
Stephen Haddrill
It is very close to completion.
Chair
It might report within two years, might it?
Stephen Haddrill
I think we will see a report faster than that.
Frank Field
One year?
Chair
No, it has already been 19 months.
Stephen Haddrill
I really must not be drawn on things.
Chair
No, Stephen Haddrill, the point of a Committee hearing is for us to try to draw out evidence from you and there is a public interest here. BHS was a huge collapse that cost jobs, people’s pensions and livelihoods. It has been 19 months and there is still no report. We are trying to find out whether there is any chance that the report that you announced yesterday, ahead of coming to our Committees to give evidence, might be published in a timescale that allows learnings to be made and also to have some resolution for people who worked there and receive pensions from Carillion.
Stephen Haddrill
The object of the investigation is to consider whether to bring a prosecution. That is a legal process and it has to be done thoroughly to make sure that a prosecution, if we proceed with it, is on an absolutely firm basis. We have to go through all the rules of the court processes, the rules of disclosure and so on. Very often—and this was the case with some of the other ones you mentioned, the Rover one for example—you can end up with the other side bringing judicial review hearings and so on. We need to be absolutely firm that we have the right basis for taking a case if we decide to do that.
Frank Field
The Prime Minister is waiting for your report on BHS before she decides how and when she might act on the unanimous recommendation of the Commons that Sir Philip Green should lose his knighthood. I know there is lots of things on the Prime Minister’s mind but we are here to help encourage memory. When do you think that will be delivered?
Stephen Haddrill
What we are doing is producing a basis, if the facts support it, for a potential prosecution. We are not delivering a report to the Prime Minister.
Frank Field
No, you are delivering a report but she is waiting on your report before she decides to act on the resolution of the House of Commons that Sir Philip Green should lose his knighthood. I know it is not the most important thing in the world but it is a reflection about the pace at which you work.
Stephen Haddrill
The most important thing in the world is that we produce a solid report and that if—and I stress “if”—anything goes to tribunal that that tribunal is successful. That is what matters.
Antoinette Sandbach
Mr Haddrill, it is also a principle of law that justice delayed is justice denied.
Stephen Haddrill
Yes, I agree, but the worst thing that could happen is that we cut corners on any case, bring a case to tribunal and it is thrown out on those grounds.
Antoinette Sandbach
Are you saying that you do not have the resources within 19 months, which is a significantly long period of time, to have a speedy and in-depth investigation?
Stephen Haddrill
We do have the resources and we certainly have the resources to commit to the Carillion case, including whether we expand it into the members in business.
Antoinette Sandbach
We are talking about BHS here. Has there been a change in position in the last 19 months that means that you are better placed now in relation to Carillion than you were with BHS?
Stephen Haddrill
We had expanded the team considerably up until about two years ago but we have had a further expansion since then so, yes, we do have the resources.
Antoinette Sandbach
What does that mean in numbers, when you say you have expanded the team?
Stephen Haddrill
We have now 30, 32, a mix of lawyers and forensic accountants primarily.
Antoinette Sandbach
As opposed to what?
Stephen Haddrill
As opposed to if I go back two years it was probably something like 23, 24. I would have to check.
Chair
Maybe you could get back to us with the precise details of that, Stephen Haddrill.
Stephen Haddrill
Yes, I will.
Chair
Sarah Albon, can you tell us about your investigation into Carillion and perhaps also give us some timescales?
Sarah Albon
Certainly. As the Committee is no doubt aware, Carillion and its subsidiaries was made up of 326 companies, of which 199 are based in the UK. So far 16 of those companies are in some form of insolvency. The Official Receiver has a duty to investigate the cause of failure of any of those companies in insolvency and also the conduct of the directors involved in reaching that point. It is probable that more of the companies will also be placed into a form of insolvency, so at the moment the final scope is not yet determined. There were 169 directors across the whole group at the point of insolvency, 36 of whom were in the different companies that are currently in some form of insolvency. At the moment, the investigation is targeting those 16 companies and the 36 directors but, as I say, may be expanded as further companies become insolvent. The Official Receiver is under a statutory duty to investigate and the Secretary of State, as you are no doubt aware, wrote to me and asked that we expedite the investigate to the degree that it is possible. In normal insolvencies we would wait until we had a first report from the liquidator, which is due under statute to be sent to us within three months of the date of insolvency, but recognising the genuine public interest and concern in this particular collapse we have put a parallel team of investigators in alongside and underneath the Official Receiver so that the twin duties of liquidation and investigation can carry on simultaneously and immediately. It is very early to say precisely what the timescale will be. At the moment, we do not even have the full scope of the investigation clear as further companies become in scope, as further companies become insolvent, but we are clear that we want to look at all of the things that have been the subject of public concern at the moment. We will be looking at the treatment of any dividends, any payments into the pension scheme, the levels of remuneration and the appropriateness of those in the context of the failures of the company.
Peter Kyle
Mr Haddrill, to what extent did poor corporate governance lead to the collapse of Carillion?
Stephen Haddrill
It is something that I hope will emerge through the investigation.
Peter Kyle
You have been watching them for a while now. Did they break the code of conduct of corporate governance at all?
Stephen Haddrill
I think I would draw a distinction between what we have been doing in looking at the auditing and the financial statements. We set the corporate governance code but we do not enforce the corporate governance code. That is enforced by the shareholders. What we will want to understand is how the directors reached the decisions that they took, particularly towards the end of the last financial year, how they took the decision in relation to going concern and whether that was soundly based. That is the sort of thing that would underpin any investigation that we conduct into the directors.
Peter Kyle
In your opinion, at these early stages do you feel that there is cause for concern about the way the company was governed?
Stephen Haddrill
I think there must be enormous cause for concern about how the company was governed. That is not a conclusive point of view because we need to look into these matters.
Peter Kyle
We are not expecting conclusive anything at this point in time.
Stephen Haddrill
No, I agree, but I think we all look at what has happened with a degree of incredulity, so we certainly need to understand on what basis the directors were taking those decisions.
Peter Kyle
What difference could better reporting and enforcement have played in this? You will be aware that the BEIS Select Committee last year released a report on corporate governance. We suggested a whole raft of increased enforcement, declarations and powers for your organisation. To what extent do you think that some of those recommendations, had they been implemented, could have made a difference?
Stephen Haddrill
I think that there are areas where our powers need to be strengthened. One of the things that arose from that report was that the Secretary of State agreed that the regulatory bodies should work more closely together and we have been doing that. We have a new memorandum of understanding between us and The Insolvency Service and with the FCA. The intention there is to make the best possible use of our powers in combination. I think we need to go a bit further than that because goodwill takes regulators a certain way but as we saw before the financial crisis, regulators can collaborate and then they stop collaborating. I would like to see some structure around that.
Peter Kyle
To give you an example, in our report we said that, “Given the broader powers that we have recommended in this report, the Government should consider reestablishing, renaming and resourcing appropriately the FRC to better reflect and expand its remit and powers”. The Government rejected that. Do you think that that needs to be relooked at now?
Stephen Haddrill
I do think that some aspects of those powers need to be looked at. Our powers in relation to enforcement should be looked at, particularly the point I made earlier about members in business being subject to enforcement only if there is misconduct needs to be looked at. The misconduct test is a very high bar for us to pass to prove a case there. I think that there are aspects of our ability to review the report and accounts ought to be expanded. We review the financial statements and the strategic report but governance statements elsewhere and the annual report are not within our remit.
Peter Kyle
We are going to come back to this. You mentioned the MOU a second ago. When will that be in place?
Stephen Haddrill
It is. It has just been signed.
Peter Kyle
Good. Will you be talking to institutional investors to find out why they sold their shares and how they engaged with the board and the reasons why they were—
Stephen Haddrill
Yes. The issues around stewardship are perhaps not part of the formal investigation but I think they are certainly the sort of thing that we need to explore. We have announced that we will be reviewing the stewardship code during the course of the coming year. We have already put out some questions that we want answers to and I think this is a very good case to inform that consideration.
Peter Kyle
Thank you. My final avenue of questioning to you is about how effective your organisation actually is. I have been chair of governors of a school for a long time. We could never have got away with doing in the school what Carillion was getting away with in the last couple of years. It was basically trading insolvently; its finances were not robust. If we had been doing that in the school, Ofsted would have known it within months. They get inside the organisation; they look at it from top to bottom; they make prescribed opinions about the way it is being governed and run. Here we have a FTSE 250 company that is integrated within our public service delivery for our country and yet you were not getting inside that organisation, rolling your sleeves up, having a look at how it was being run and being opinionated at the time that it really mattered. We have to ask ourselves what is the point of your organisation if it can’t turn around an organisation at the point it would make a difference rather than just trying to mop up the pieces afterwards?
Stephen Haddrill
That is a very important question and I think what you are effectively saying is that do we want an organisation in relation to the general run of corporations, as opposed to the financial services sector where you have a sort of prudential approach. As far as possible, the PRA will seek to be involved heavily before something goes wrong at a bank, but in the general corporate sector that is not the position that the UK has adopted. We do not have powers to review the quality of corporate governance and our powers to review reports and accounts and audits are there and we use them.
Peter Kyle
Specifically what powers are missing? What is it that prevents you from—
Stephen Haddrill
What we are looking at is what we see after the event, after the company has prepared its report and accounts, and then we take action. We take considerable action with the auditors. We may seek—
Peter Kyle
What action have you taken that could have in any way altered the direction of Carillion in the last two years?
Stephen Haddrill
What we do not have the ability to do is to see into the way the company is running, is developing its business model and so on.
Peter Kyle
Answer the question: what action have you taken that has changed the direction tangibly of Carillion in the last two years?
Stephen Haddrill
We have not been able to take action to change the direction. We reviewed the report and accounts three years ago and we required some additional disclosures in the report and accounts. There were about a dozen things.
Peter Kyle
So, you are toothless?
Stephen Haddrill
No, we are not toothless. Frankly, I think we are one of the most effective audit regulators in the world. We are much more transparent, much more powerful than any other audit regulator in the world, but an audit regulator looks at the audit that has been done after the event.
Peter Kyle
You can’t say two things simultaneously, which totally contradicts yourself. You have not had the power to do anything to turn around an organisation that is failing, that you have shareholders fleeing, and on the other hand say that you are one of the most effective regulators in the world. You can’t say those two things.
Stephen Haddrill
I can certainly say that in relation to audit regulation because I think we are one of the most effective audit regulators in the world, but it is the responsibility of the directors. I think that lies at the heart of your point. It is the responsibility of the directors to run the company. The shareholders, particularly the institutional shareholders, have a responsibility to look at that and we have a responsibility to review what happens and to call it out if what we see in those reviews is not satisfactory. That is what we do in relation to audit and in relation—
Chair
You said, Mr Haddrill, that two or three years ago you asked for some disclosures. What were they and were you happy that they had been met? Did you come back to look at them at any time since? Two or three years is quite a while ago and it seems that perhaps the company deteriorated quite quickly after that.
Stephen Haddrill
There were about a dozen points that we asked for further disclosure on. The company satisfied us on a few of them and then made the extra disclosures that we were looking for in relation to some. I think the most important one was in relation to the range of possible outcomes of some of the contracts. They did make a statement about that in their next set of report and accounts.
Chair
Were you happy then that their report and accounts were fine? Were you happy last year and the year before?
Stephen Haddrill
We do not have the resources to review the report and accounts every year but we did go back and review it. We looked at what they had done and I think they also made a reference to the fact that they had been in discussion with us.
Chair
There was no need since that time—was it two years or three years ago? Do you remember when that was, Mr Haddrill?
Stephen Haddrill
I think it was 2015, so two years ago.
Chair
You had no cause for concern or to look back?
Stephen Haddrill
With hindsight, clearly it would have been better to have had a further look but at the time there was not a basis for us to do that.
Antoinette Sandbach
Your chairman made an announcement that the FRC had been actively monitoring the situation at Carillion for some time. When did that monitoring start?
Stephen Haddrill
The monitoring of the audit I think is what was being referred to there. That started after the profit warning in July.
Antoinette Sandbach
10 July 2017?
Stephen Haddrill
Yes.
Antoinette Sandbach
But as you have referred to, you had already gone in and raised concerns with KPMG about the audit in 2015-16?
Stephen Haddrill
I was talking about the concerns we had with the company about their report and accounts rather than with the audit. I think the last time we reviewed the audit was 2013 with KPMG.
Antoinette Sandbach
Given the concerns that you raised with KPMG in 2015-16, why didn’t you immediately at that point look at the audit?
Stephen Haddrill
As I said, in those matters that we raised we were looking for extra disclosure but they did not affect the financial statements themselves. They did not affect the numbers.
Antoinette Sandbach
It turns out that that is an assumption you are making, Mr Haddrill. That is not fact, is it?
Stephen Haddrill
It was an assumption that was valid at the time. We shall see as we look back whether that—
Antoinette Sandbach
We don’t know because you have only just launched your investigation so you can’t say that, can you?
Stephen Haddrill
I think I can base a view about what happened in the light of the evidence that we had. We had evidence that some of the disclosures were not as full as they should be.
Antoinette Sandbach
How can shareholders look at the governance, as you suggested they should, if some of the disclosures are not as full as they should be?
Stephen Haddrill
That is why we asked the company to correct them, which they did.
Antoinette Sandbach
Within two years that company has gone bust owing billions.
Stephen Haddrill
Yes, and I think one of the most important questions is how does—
Antoinette Sandbach
Clearly the disclosure was not sufficient, was it?
Stephen Haddrill
The disclosure was in accordance with the requirements of the law and the accounting standards after it was corrected.
Antoinette Sandbach
You set the accounting standards or the good governance code.
Stephen Haddrill
The accounting standards are established by the International Accounting Standards Board and adopted by the European Union through to the UK.
Antoinette Sandbach
But we have the power in the UK to set our own accounting standards, don’t we? We can set higher standards.
Stephen Haddrill
Not in relation to accounting, no. They are adopted from the international board by the EU. Those are the standards that apply for listed companies. We can’t set a higher standard.
Antoinette Sandbach
You are saying that you have no ability to assess whether or not those standards are sufficient to provide enough information to shareholders to hold the board to account?
Stephen Haddrill
We have the ability to assess whether the standards are adequate but we don’t have the ability to change them. If we felt that a standard required attention like that we would have to go back to the European Union or to the international board and persuade them to make a change.
Antoinette Sandbach
In relation to the code that you can set—
Stephen Haddrill
Yes, the corporate governance code.
Antoinette Sandbach
—which is the governance code, is misconduct assessed against that code?
Stephen Haddrill
No. There is not regulatory enforcement of the code. The code is enforced, if that is the right word, by shareholders.
Antoinette Sandbach
Basically, what you are telling us today, Mr Haddrill, is that we can’t rely on the audited accounts of any major company because you can’t enforce it, we can’t rely on hidden debt or, for example, the overstatement of goodwill.
Stephen Haddrill
No, that is not right. You are mixing up two things. You are mixing up the enforcement of corporate governance, which is a stewardship responsibility, first of the directors and then of the shareholders, and the report and accounts of the company.
Antoinette Sandbach
But isn’t the auditor effectively supposed to provide an independent view that can be relied on by shareholders to present a fair and true position of the company?
Stephen Haddrill
Absolutely. The directors must produce accounts that are true and fair. Those are reviewed by the auditor and the audit opinion should confirm that. If the auditor has any reason not to confirm that it must either persuade the company to do something else or report that. We have introduced in the last three years an extended auditor report to make sure that auditors do explain what they have done and what their views are.
Antoinette Sandbach
Clearly that failed, didn’t it?
Stephen Haddrill
I think there is a risk here that a number of very powerful interventions that have been made are being undermined, in your view, by one failure.
Antoinette Sandbach
Mr Haddrill, this was the most shorted stock on the stock exchange. At the time of the statement, and indeed before the March 2017 accounts, over 23% of Carillion stock was shorted. Did that not set alarm bells ringing at the FRC?
Stephen Haddrill
We did not review the company as a result of that, no.
Antoinette Sandbach
Why not?
Stephen Haddrill
As I said, we had reviewed it in 2015.
Antoinette Sandbach
And found its disclosure to be unsatisfactory.
Stephen Haddrill
Yes, but at that point we did not think that the lack of disclosure was symptomatic of something more serious.
Antoinette Sandbach
Carillion did operate aggressive accounting practices. Should that have been more of a concern to the auditors?
Stephen Haddrill
I think that since we might be moving into an investigation of the directors, it would be inappropriate for me to comment.
Antoinette Sandbach
Mr Haddrill, I am sorry, I don’t accept that. You knew that you were coming to this Committee. You did not announce your investigation on 10 July 2017. I do not accept that it is inappropriate for you to answer that question to this Committee, having known that you were coming here to give evidence at the point that you announced your investigation, I think just yesterday.
Stephen Haddrill
We have announced the investigation into the audit. We started our inquiries into the quality of the audit immediately after the profit warning. We have now completed those and we are doing a formal investigation. In relation to the financial statements and the conduct of the directors in that regard, the FCA has been conducting its own inquiries. We have its information and we will be reaching a view as soon as possible on whether to extend our investigation into the directors.
Antoinette Sandbach
Earlier in evidence to my colleague Peter Kyle you said that you had just signed a memorandum of understanding. There is absolutely nothing that would have prevented that memorandum of understanding being signed after the BHS collapse, is there?
Stephen Haddrill
No, there isn’t, but we were asked by the Secretary of State to do that—I can’t remember exactly when he did—and we set about doing it straight away.
Antoinette Sandbach
Why did you wait to be asked?
Stephen Haddrill
We already had a memorandum of understanding with the FCA. What we have been doing is upgrading it, effectively, improving it.
Antoinette Sandbach
The reality is over £725 million has been lost to a pension scheme really due to the fact that the underlying financial assumptions have changed and it is the taxpayer that has to pick that up.
Stephen Haddrill
I think we should start by looking at what the quality of the decision-making of the directors and of the auditor was, and that is exactly what we are doing.
Antoinette Sandbach
You are responsible for looking at the audit standards and reassuring the public that we can rely on those standards and that those give sufficient information to shareholders. What lessons have you learnt after the profit statement that wrote off £825 million in July, within just two years of your last look at Carillion’s accounts?
Stephen Haddrill
That is going to be the subject of the investigation. We will explain what we have found when we have completed that investigation.
Antoinette Sandbach
But you have just said that you started on 10 July 2017.
Stephen Haddrill
Yes, but we do need to make sure that the investigation that could lead to a prosecution is not prejudiced by statements that we make today on the basis of our initial inquiries. What we need to do is conduct a very thorough investigation, including into why the directors determined to make a going concern statement when they produced their report and accounts and then only a few months later reversed that. Well, not reversed it but included—
Antoinette Sandbach
Yes, they reversed it. They wrote off £825 million.
Stephen Haddrill
Yes, they wrote off that sum but they did not state at that point that it was no longer a going concern. That is what I meant by reversed.
Antoinette Sandbach
Wasn’t that obvious given that the stock fell, the value of Carillion fell that day by something like 50% and this in a company that, as I said, a year before had been shorted by 23%?
Stephen Haddrill
The question that we need to get to the bottom of is whether the events that ultimately happened in January were foreseeable and the directors should have taken different action and the auditors should have taken different action in July or whether they unfolded in a way that was unexpected.
Antoinette Sandbach
But you had been investigating in that period between July and before the company went into liquidation.
Stephen Haddrill
We were reviewing the audit. I want to distinguish between the legal process and the investigation and our review of the audit. We have done a thorough piece of work on reviewing the audit but these audits are thousands of documents. This company is made up of hundreds of different subsidiaries and so on. It is a major piece of work.
Antoinette Sandbach
But that is why the auditors are there, to reassure shareholders or pension recipients in my constituency whose hard-earned money has been lost.
Stephen Haddrill
You are absolutely right, it is the responsibility of the auditor to provide an external view on whether the directors have taken the right judgment on going concern. It is our job then, if there are issues around that, to look into it and look into that audit, which is what we are doing.
Chair
I want to explore slightly further what exactly has happened between July and the middle of January. Stephen Haddrill, your chairman wrote to the Business Secretary of State on the day of the collapse of Carillion saying that, “We have powers to investigate the circumstances relating to the audit of Carillion as well as the actions of the relevant accounting professions”. For six months I presume, and in your answer to Antoinette Sandbach, that you have been looking at the KPMG audit.
Stephen Haddrill
Yes.
Chair
You have now announced that you are doing something formally but for the last six months you have been actively monitoring. From the work you have done in the last six months, do you think that KPMG’s audit was found wanting, just 10 months ago?
Stephen Haddrill
If I answer that I would prejudice the investigation. Can I put it a different way? Perhaps that would help the Committee. What we have said is that we believe there is a good reason to investigate and we have identified the auditor’s work on going concern, the auditor’s work in relation to pensions and the auditor’s work in relation to whether the assessments by the directors of the outcome of the contracts was satisfactory.
Chair
For six months, as in the words of your chairman, you have been actively monitoring this situation in close consultation with other relevant bodies. Antoinette Sandbach has made the point, I think very powerfully, that you have a responsibility to investors, people with a pension with the company, and so on, to actively monitor but then also report. For six months you have been looking at this situation. I guess it comes to the point about are you properly resourced to do your job and do you have the powers to do your job. For six months you were presumably so worried about this business that you were actively monitoring it and yet in those six months did you make any public statements about Carillion or about its audit?
Stephen Haddrill
Not specifically about Carillion. We put out each year some guidance to audit committees and that is public guidance seen by investors, about the—
Chair
Was it public knowledge that you were actively monitoring?
Stephen Haddrill
No.
Chair
I guess this is part of the problem, isn’t it? Peter Kyle made the point about the school where he is a governor. If Ofsted had concerns about a school in any of our constituencies, parents would know about that. I feel that investors in the company had the right to know that you were actively monitoring a situation, presumably because you were concerned about it. Why wasn’t that information in the public domain and why didn’t you, over those six months of actively monitoring, the most critical six months probably for that business in its short 19-year life—nobody knew you were actively monitoring, no one knew what you were monitoring or whether you had found anything.
Stephen Haddrill
That is a very good point. The reason is that we are not able to disclose the individual companies that we look into and the audits that we look into because there is a confidentiality requirement built into the companies legislation. We have sought to get round that in some respects. We can talk about it now because the company has failed and because we have launched an investigation.
Chair
That is sort of like closing the gate after the horse has bolted, isn’t it? We can have a very great discussion now. That is not going to get the money back for anybody who worked for the business or anybody saving for a pension or any shareholder who lost money or the subcontractors that have not been paid for six months. The best time, Mr Haddrill, for you to have been speaking about this would have been the time where you were actively monitoring because then decisions could have been made.
Stephen Haddrill
I think that the requirement in companies legislation for confidentiality needs to be reviewed.
Chair
Thank you. Which of your directors is responsible for the review that is happening into the KPMG audit of Carillion?
Stephen Haddrill
We have a director called an executive counsel, a lawyer, and she is responsible for taking that case forward.
Chair
What is her name?
Stephen Haddrill
Claudia Mortimore.
Chair
I was looking at your annual report and accounts for 2016-17 and it says in the experience for your executive director for corporate governance and reporting that he had a 17-year career at KPMG. What is his responsibility?
Stephen Haddrill
First, he left KPMG about 2000, maybe even slightly before, so he has been a long time out of the firm. His responsibility is in relation to accounting standards, corporate governance and the review of reports but he is not responsible for taking these investigations and cases forward.
Frank Field
Two of the last three finance directors of Carillion came from KPMG. KPMG has conducted the audit for the last 19 years. Did that not sound a warning to you? Given the oligarchy that now exists among the accountancy firms, shouldn’t we be considering a recommendation to the Government to break them up?
Stephen Haddrill
I will answer that one first. We feel that there should be more competition in the major accounting and audit area. We asked the Competition Commission in something like 2012—I can’t remember exactly—to do a review and they did. They made a number of recommendations that have been implemented. To some degree, there is more competition among the big four themselves but there has been no entry to the market by other firms at that top end of the corporate sector.
Frank Field
There would be if you broke the companies up.
Stephen Haddrill
I think the Competition Commission—the CMA now— at some point will need to review the effectiveness of what they recommended and look at it again.
Frank Field
And the first question?
Stephen Haddrill
Sorry, can you remind me?
Frank Field
It was that two of the last three finance directors came from KPMG. KPMG has been the auditor for the last 19 years. Following Rachel’s question, didn’t that put up a signal to you?
Stephen Haddrill
There are rules about the extent to which auditors can join companies. I think there is a two-year cooling-off period. I would need to check what the situation is.
Frank Field
But they are all mates, aren’t they? This is going back to your previous problem. There are four companies dominating the scene. They appear in all papers in one guise or another. You are going to recommend that the relevant body looks at breaking up these companies?
Stephen Haddrill
We are going to propose to the CMA that they look again at whether there can be more competition in the sector. What the remedy is I think is for them. We have strengthened what we call the independence rules in relation to the extent to which an audit firm can be engaged with a client to provide non-audit services and the extent to which auditors and company directors can move between those institutions. They were changed in 2016 and they are certainly much stronger than they were.
Frank Field
We will come back to that. Thank you.
Peter Kyle
Mr Haddrill, less than three years ago Carillion changed the rules by which it could claw back directors’ pay. Should that not have sounded a klaxon in your organisation?
Stephen Haddrill
Again, it comes down to this point that we don’t have powers or responsibility to look into governance matters and that is really a governance matter, not an accounting or an audit matter.
Peter Kyle
They changed the rules from previously that directors’ pay could be clawed back if there was corporate failure. They changed it to one of gross misconduct. They raised the bar into the heavens. Why would a company do that?
Stephen Haddrill
I think it is important, as we are doing the investigation, to look into whether that was a factor that has led to some of the events that have happened and whether it is a factor that the auditors should have taken some account of.
Peter Kyle
But once again this points to something that we, in retrospect, see was a very clear indication of a company in distress, one that the regulator did not detect, did not act on, did not get involved in, did not make public the information or draw attention to it in a way that could have allowed the different actors who have control over the organisation to act in a way that could change things.
Stephen Haddrill
I think what you are highlighting is a rather fragmented oversight of companies in this country. That information about remuneration packages is something that ought to be scrutinised by the shareholders as the stewards of the business. That is why I come back to: is the stewardship code that we operate effective?
Peter Kyle
I think what I am highlighting, to be blunt, is that the FRC has been useless when it comes to Carillion.
Stephen Haddrill
Well, I reject that. What the FRC has done is—
Peter Kyle
It did collapse.
Stephen Haddrill
I know and companies do collapse. We do not have a system where regulation is designed to stop companies collapsing. It is designed to set certain standards of behaviour for directors for accounting and for audit and to make sure that those standards are complied with.
Peter Kyle
But clearly the standards were not complied with. You are the organisation that is tasked with monitoring and regulating those standards.
Stephen Haddrill
But what we do not have is the ability, that say Financial Services or the PRA would have, to look inside the business. We do not know what is going on inside the business more than what is evident from what they publish.
Peter Kyle
Would you welcome those powers?
Stephen Haddrill
I would welcome stronger powers to be transparent about the sort of things that we are finding.
Peter Kyle
Is that a yes?
Stephen Haddrill
It is a yes for some. I don’t think that we would be well served in this country by having a corporate regulator that can go into every company and say, “How are you doing it?” There has to be a degree of enterprise here and a degree of acceptance that there will be failure sometimes.
Peter Kyle
But the market works on information and clearly things were hidden within Carillion. This rule of changing the clawback of directors’ pay in the event of failure was buried deep in the small print of an annual report. These are the things that most people would not know about. I am not asking you to go in and run the company for them if you think a few things have gone wrong but having the power to highlight, to point to, to allow the market and the actors involved in a company to act is the kind of thing that we do need to be doing.
Stephen Haddrill
I think that takes us back to what I was saying earlier on about powers. Remuneration is an area where our ability to scrutinise the company through its report and accounts—our writ does not run there.
Peter Kyle
Have you ever asked for these powers in the past?
Stephen Haddrill
Yes, we have.
Peter Kyle
But they have been rejected?
Stephen Haddrill
It was when we said to the Select Committee that we wanted the ability to review the report and accounts as a whole, not just certain bits of it, and we have not yet had a positive response to that.
Antoinette Sandbach
Mr Haddrill, can you explain to us the section of the Companies Act that requires companies not to pay dividends out of capital?
Stephen Haddrill
I am sorry, you are getting beyond my ability as a non-accountant. Let me write you a note on that.
Antoinette Sandbach
I am not an accountant either. Are you saying that you are not aware of that provision?
Stephen Haddrill
I am aware of the general provisions of the Companies Act in relation to the company’s responsibility on paying dividends.
Antoinette Sandbach
We know that Carillion paid £376 million in dividends for the period of 2012 to 2016, despite making just £159 million in cash from its operations. Was that something that you were aware of when you looked at the accounts for 2015-16?
Stephen Haddrill
I would have to check whether we looked at that particular thing. I imagine that we would have done but let me confirm that. The dividend policy—
Antoinette Sandbach
How quickly could you confirm that to us? That is rather key to the issue as to whether or not there was misconduct and whether or not the company was acting legally or its directors were acting legally. How quickly can you confirm that to us?
Stephen Haddrill
We will come back in the next couple of days.
Chair
I think it would be very helpful to the Committees if we could have answers to all the questions that we put today by the end of this week.
Antoinette Sandbach
Do you accept that concerns have been raised by the Local Authority Pension Fund Forum and others that your accounting standards do not enable anyone to have a meaningful assessment of a going concern, which effectively is the issue with Carillion?
Stephen Haddrill
I don’t accept that it is impossible to have a meaningful—I think that is too broad a statement. I think where the problem lies is that the going concern judgment is thought by the public and by many investors to be a judgment over the next year or the year after.
Antoinette Sandbach
Did you receive a copy of the counsel’s opinion that confirmed the substantial legal flaws with the International Financial Reporting Standards?
Stephen Haddrill
That is the Bompas opinion, I think you are referring to?
Antoinette Sandbach
Yes.
Stephen Haddrill
Yes, we have that. We have reviewed it. We have had our own counsel’s opinion and, frankly, that does not confirm that. Ministers in 2013 gave their own views on that matter and they thought that our interpretation was appropriate. We think that we have interpreted company law rightly in relation to dividends and the true and fair judgment and we have made that clear.
Heidi Allen
I am going to apologise in advance for being potentially a little bit rude but I want to make a point. I was just reflecting on what Peter was asking and reading your profile here, you were appointed in 2008 as a member of the Financial Crisis Advisory Group, a high level advisory group set up by the International Accounting Standards Board and the Financial Accounting Standards Board to consider the financial reporting issues arising from the global financial crisis. I am asking the question on behalf of ordinary people. The financial crisis was possibly too much enterprise. You have said in relation to Carillion that perhaps it is not your job to get inside and you can’t stifle enterprise. Private Eye, the magazine, have a thing it calls a non-job. We are 10 years on from your appointment, which was a role explicitly to deal with the sort of financial crashes we saw. Why is it that Peter is still having the conversation with you 10 years on about do you not have the powers you need? Should you not have asked for those more forcefully to make your job mean something?
Stephen Haddrill
That was a short-term advisory appointment I had when I was not in my current role. I was there when I was Director General of the Association of British Insurers and they asked me to give an investor view at that time. Sorry, I don’t know if that answers your question.
Heidi Allen
The heart of it is that these roles are to assist and help the general public make sure that things like the financial crash don’t happen again. I find it unacceptable that Peter is having to ask you a question about why you don’t have the powers and why you haven’t asked for them. Surely that is your role.
Stephen Haddrill
I can assure you we have been asking for them and regulators don’t always get all the powers that they want. We did seek powers in relation to audit. We got them in the end through the decisions of the European Union and they were implemented in 2016.
Heidi Allen
You have been the chair of FRC since 2009.
Stephen Haddrill
Chief Executive.
Heidi Allen
That is still quite a long time. If that is your role, don’t you bang down the door to get those powers and call it out if you don’t have them?
Stephen Haddrill
Absolutely, and I certainly take that as a criticism. We have not achieved what we want. All I would say is that that has been against a background of a lack of Government interest, frankly, over a period of time until the last couple of years, in expanding regulators’ powers. That is certainly what we have faced. If you take the audit regulations that came in in 2016, for example, the Government issued a direction that we should delegate as much as we possibly could under the European directive and regulation to the professional bodies. We did not find that right at the time. We thought that as the audit regulator we should be able to hold all those powers to ourselves rather than delegate processes to the professional bodies. That is the sort of historical background to where we are today.
Chair
Thank you, Mr Haddrill. The Liaison Committee is seeing the Minister Lidington next Wednesday and one of the questions we might pose to him is what lessons could be learnt about the powers available to the FRC. Before we move on to ask some questions about The Insolvency Service, can I ask a couple of factual questions? KPMG has been the auditor of Carillion since its inception, for 19 years, and has earned £30 million worth of fees during that period. Is it the FRC’s view that it is appropriate or good practice to have the same auditor for almost 20 years?
Stephen Haddrill
The law requires the audit to be retendered after 10 years. The incumbent can keep that role for 20 years. That is what the law says.
Chair
I am not saying as the law. What is your view about good practice? Do you have a view about it?
Stephen Haddrill
We do have a view and in fact we wrote into the corporate governance code that there should be retendering—we didn’t write “in rotation”—before that law came into effect. We are there to make sure that the companies and the audit firms stick with the law, so that is what we have to do.
Chair
Do you think perhaps that law needs revisiting with fresh eyes?
Stephen Haddrill
Those regulations came in only less than two years ago. I think we will need to review them to see how they are working. One of the things that is happening is the combination of rotation and the independence rules means that in some sectors we may well end up with even fewer than four people competing for the job. There are things that we need to review.
Chair
Related to that, are auditors of companies allowed to provide other paid services to the company that they are auditing?
Stephen Haddrill
There are quite strict rules around that. There is a whole list of prohibitions that they can’t provide services on and then there is a cap on the value of the services that they can provide, which I think is about 70% of the audit.
Chair
If they received £30 million in fees for the audit since 1999, you are saying that could earn £21 million of other fees from the company they are auditing over that 19-year period?
Stephen Haddrill
Yes, except that they have to consider whether in taking on that contract, even within that cap, it could lead to any risk to the audit. If it would do and it can’t be mitigated they should not take that work on.
Chair
Does the FRC have information about what other services KPMG was providing to Carillion? Would you able to tell us that?
Stephen Haddrill
We should be able to do that, yes.
Chair
If you could do that and how much they were worth and what sort of services, we would be very grateful for that information. Do you know what the biggest asset was on Carillion’s balance sheet?
Stephen Haddrill
Goodwill, I think.
Chair
Goodwill was worth £1.57 billion. That seems quite surprising. Is it good practice to have goodwill as the biggest asset on your balance sheet? Without goodwill, the liabilities would have been greater than the assets. It was only the goodwill that kept the assets higher.
Stephen Haddrill
It is not untypical. What is happening is that increasingly companies’ balance sheets are made up of goodwill. They are made up of intangible assets rather than bricks and mortar and all the rest of it.
Frank Field
Can you tell us what goodwill is, Stephen?
Stephen Haddrill
I can’t give you the strict accounting definition but it is—
Frank Field
It is an item that disappears once the company is in trouble, isn’t it?
Stephen Haddrill
Absolutely. I think this whole issue about how to account for intangible assets and whether too much of the proportion of the balance sheet is in that sort of asset is something that, frankly, we are all struggling with.
Chair
Do the FRC and FCA account for goodwill in the same way?
Stephen Haddrill
It doesn’t arise really.
Chair
The FRC allows goodwill to count as capital resource. I don’t believe the FCA does. Is that correct?
Stephen Haddrill
I will check that.
Chair
If you could check that.
Stephen Haddrill
What we do will be consistent with the accounting standards. They may have different financial regulations for banking.
Frank Field
Goodwill appearing in these accounts does not do much good for the pension scheme. Over the time that Rachel has asked you about, with £1.5 billion goodwill, the pension deficit doubled. Shouldn’t that be taken into account? Goodwill to whom?
Stephen Haddrill
The question in relation to pensions is what is the company able to afford to pay in to the trustees.
Frank Field
Isn’t it misleading to say goodwill when you have this mega deficit appearing? I still don’t understand what goodwill is. Who decides the sum that Rachel was questioning you on?
Stephen Haddrill
It will be decided by the directors in accordance with the accounting standards and then audited.
Chair
Everything else was written down, all of their other assets were written down apart from goodwill. Would you expect that to sound some alarm bells, that all the other assets of the business were being written down but good old goodwill keeps on giving, £1.57 billion?
Stephen Haddrill
I think that is a good point for the investigation.
Chair
Thank you. We will move on now.
Rachel Maclean
Sarah Albon, with regards to timescale of your inquiry, when will people know whether those directors of Carillion have been guilty of misconduct?
Sarah Albon
As I tried to indicate at the beginning, at the moment the process of putting the companies into some form of formal insolvency has not concluded yet. We do not yet have the full scope of the directors who are in scope of the investigation absolutely clear.
Rachel Maclean
When do you expect to get that?
Sarah Albon
I imagine that the insolvency process will continue for another few weeks, possibly a small number of months. As I say, there are up to 169 current directors across the whole group. We would also want to look at anybody who had recently been a director of any of the failed companies. I do recognise that this can be incredibly frustrating for members of the public, who have an absolute right to know what has gone on and a completely understandable desire to know that quickly. As with the FRC’s investigation, what we are doing is preparing a case to bring to court, potential misconduct of these individuals, and the companies—
Rachel Maclean
I understand that—thank you for that—but you must have done this sort of work in a large-scale company before. What is your ballpark best estimate, given your experience?
Sarah Albon
The average time that it takes us to conclude investigations and get all the way through to an outcome of disqualification or a decision that there is nothing more to do is 21 months. This is clearly at the more complex end, so one would expect in some ways that it would take longer, but, because it is of such public significance, we are putting considerable resource into doing the investigation. I think—
Rachel Maclean
You are putting more resource in so that it could potentially be faster?
Sarah Albon
It potentially could. One significant constraint that we are already coming across is the incredibly poor standard of the company’s own record keeping. In preparing for this Committee, it took some hours to identify how many directors we may even potentially be targeting because the company had not kept its own records properly up to date. It is hardly forensic accountancy to find out how many directors there were, but nevertheless it should have been absolutely, straightforwardly available.
Frank Field
The auditors passed the company.
Sarah Albon
Yes, I am aware of that, and I guess it is something that we need to now look at.
Rachel Maclean
You are struggling with that. You talked about 169 directors. How far back will you go to previous directors that may not be directors anymore?
Sarah Albon
We will go back to previous directors. Essentially, all of this investigation is aimed at understanding the cause of the failure of the company.
Rachel Maclean
How far back will you go, then? What is the cut-off?
Sarah Albon
Typically, only two or three years. There is no formal legislative bar on how far you look back. It is just that it is harder to prove a causal link to failure the further back in time you go, when the company obviously kept trading and kept trading. If somebody had resigned from the company 10 years ago, I think it would be almost impossible to say that their actions that long in the past provided a direct causal link to its failure today.
Rachel Maclean
Yes, I understand. How much will this process cost the taxpayer overall?
Sarah Albon
There are two processes here. One is the process of liquidation itself, and the other is the investigation. It is important to keep those two separate. Generally speaking, in large companies that fail, whether they go through a form of liquidation or administration, there are sufficient funds in the company to pay for the costs of the winding up.
Rachel Maclean
That is not the case in this one, is it, though?
Sarah Albon
The reason, as far as I have been able to ascertain, that uniquely a listed company of this size and scale has gone through compulsory liquidation is because there was not an insolvency practitioner who was prepared to take on the administration because there was not, in their understanding, sufficient certainty that there was enough money left in the company to pay their costs.
Rachel Maclean
Is that also your understanding?
Sarah Albon
Yes. It is early days, but it seems to us to be more likely than not that there will not be sufficient assets to meet even the costs of winding up the company.
Rachel Maclean
What we have also understood from our briefing is that not only is it not clear how many directors there are, it is also not clear what is the scale of the assets and liabilities of the company. There is a doubt there. Is that right?
Sarah Albon
That is right. Obviously, one of the major things that my team on the liquidation side will be doing is their very best to preserve what value there is remaining in the company and to achieve that for the benefit of the creditors of the company.
Frank Field
This company was audited?
Sarah Albon
I think the companies were all audited, yes.
Frank Field
You are telling us this tale past the audit.
Sarah Albon
That is true.
Rachel Maclean
I want to ask about the role of the special managers that have been appointed. How has that process been managed? Who has made those decisions to appoint them?
Sarah Albon
Special managers can be appointed by an Official Receiver to assist him in carrying out his duties, and essentially we have done that just because of the scale of this. The actual appointment is made by the court, so an application is made to court. That sets out the scope of the special managers, including things like the remuneration and the level of bonding that they have to ensure that they can meet any costs of their own if they fail. That is a process that happens under the governance of the court.
Rachel Maclean
Is that objective, given that we hear that PwC is going to potentially earn £50 million from its role of having special managers?
Sarah Albon
I think the £50 million is a figure that is potentially the cost that was an early assessment of all of the specialists, so that would not just be the cost for PwC. It would include legal costs and quantity surveyors and other specialists that the liquidator is likely to need to engage in order to assess the value of the assets that remain.
Rachel Maclean
What we have been told is that is just PwC’s fees. It could be earning £50 million in fees.
Sarah Albon
It is far too early to say. I am aware of one figure of £50 million that has been used as an early estimate of overall costs, but that was not purely PwC fees. It was all professional fees.
Rachel Maclean
Going back to the scale of the global liability, you are not able to give a figure at all. Can you be transparent with the public as and when you are able to arrive at these figures? Will the public be informed? Will you be making announcements? What is the process of managing that transparency?
Sarah Albon
As part of a process of liquidation, we invite individuals and companies who are owed money by the company to submit what is called a proof of debt. We also, however, have to take a pragmatic view of the extent to which we want to forensically go through everybody’s claims that they are owed money by the company if the company itself has no money to pay those individuals. There is only any point establishing precisely what is owed to whom at further cost if there is actually some money left to give them at the end of that process.
Rachel Maclean
The special managers in the liquidation process mean that the people who are trading will continue to be paid as much as possible. Is that right?
Sarah Albon
Yes. The Government have asked the Official Receiver to continue to maintain services as far as possible in the public sector and also into the private sector clients to the extent that they are prepared to pay the full cost of that. What happens is that those individuals and subcontractors who are contracted by the liquidator or his special managers will be paid in full for the services that they provide post the point of liquidation. However, the thing that obviously is a difficult factor but also an inevitable truth is that there is a bright line drawn at the point of insolvency. Many of those individuals who will now still be paid for continuing to provide services will nevertheless also have a claim in the liquidation for work that they provided before the date of liquidation, and many of those claims will probably find at the end of the day there are not sufficient assets to pay.
Rachel Maclean
They will not be paid, but will the ones that will be contracted now, after the point of liquidation, be sticking to the 120-day payment schedule that Carillion used to engage in, or will it be a more reasonable payment schedule?
Sarah Albon
We would be looking to use normal industry-standard payment schedules in line with good practice.
Rachel Maclean
Which is how many days?
Sarah Albon
It varies, but within the normal rules of ensuring that services have been received and not paying in advance and those kinds of things. We would be looking to pay the contractors as quickly as we can.
Rachel Maclean
Thirty days, 60 days?
Sarah Albon
I would need to write to you on that. We are having to use Carillion’s own financial management system, payroll, and all of the systems that it has in place because there is not an alternative structure you can just import in. The only reason I am hesitating is because I am honestly not sure of the extent to which those systems are manipulable by us now quickly to change payment schedules and those kinds of things.
Stephen Kerr
Does The Insolvency Service have the powers and resources it needs to deal with a large failure like Carillion?
Sarah Albon
We certainly would not have had the resources without the use of special managers, which is why we made the application to court for that purpose. In the liquidation itself, as I said, there are some 199 UK companies that we need to consider and working with the directors of the companies that are still solvent in the group to consider whether they should also go through some form of insolvency. It is certainly the case that we have needed to quickly boost our capacity through the use of special managers. In terms of the investigative resource, we have well qualified investigators, and we would routinely—and will in this case—boost their powers through the use of external forensic accounting teams and other legal specialists as they see need to draw that in. In short, I think the answer is yes.
Stephen Kerr
In short, the answer is, yes, you do feel you have the powers and the resources. What about the statutory framework that we currently operate to in this country in respect to insolvency? We are slipping down the world rankings from the World Bank’s perspective in terms of the fitness of that framework. Would you like to comment on that?
Sarah Albon
The World Bank a couple of years ago changed some of the ways that it assessed those different forms, and it is certainly the case that a country that has something more akin to the American Chapter 11 procedures would rank more highly. The Government issued a consultation paper, I think a couple of years ago now, looking at those things, and—
Stephen Kerr
In 2016, yes. Have you had discussions with the Government about that consultation?
Sarah Albon
I have, although not recently, but I believe that there is still commitment from the Government to introduce some of those changes when parliamentary time allows, but obviously parliamentary time does not allow very much just at the moment.
Stephen Kerr
It seems like this might become a pressing matter, given the events of recency. Do you have an expectation about when the Government might respond to their own consultation paper?
Sarah Albon
I am afraid I do not.
Chair
That is something we could follow up with the Minister, Stephen.
Stephen Kerr
Right. Lessons that are learned from the investigations that are conducted by the service: what impact do they have? How do they feed back into the ecosystem of business in this country?
Sarah Albon
We have close working relationships with officials in BEIS, and would certainly discuss with them and with Ministers anything that we felt was coming out of things that we found were thematic as opposed to one-off. We have good channels to feed those kinds of concerns back into the team that would be responsible for company law.
Stephen Kerr
Are there any examples of any recent themes that you have fed back in?
Sarah Albon
Recently there have not been significant similar themes. We are in the very early stages of this investigation, but, as I said, it is an extremely unusual set of circumstances where you see a company of this size going into compulsory liquidation for lack of sufficient funds to fund any other form of insolvency.
Stephen Kerr
Are there any changes in the insolvency rules, as they currently stand, that you would like to see that could have prevented or lessened the impact of what happened at Carillion?
Sarah Albon
I do not think that there is something that is inherent in the insolvency rules that will make a difference. By the time a company has reached insolvency, whatever procedure it goes through, people are going to lose out significantly, unfortunately. This is almost the definition and the nature of it. Whether it is an individual or a company, it is somebody who can no longer afford to meet all of their commitments. To the extent that it is possible to do something preventive, you need to look further up the food chain, not at insolvency but at the rules that are relevant to a solvent company and how it conducts its business in the days prior to any insolvency.
Stephen Kerr
There has been, rightly, a lot of media focus on the remuneration packages and bonuses of the directors. What can the Official Receiver do to reclaim pay and bonuses from directors?
Sarah Albon
The Official Receiver has wide-ranging powers as liquidator to seek to reclaim monies that have been paid out inappropriately and to the detriment of creditors. There is no freestanding subsection that says, “Under this section, I can claim your bonus back or the pay”, but it can certainly look at the reasonableness of remuneration packages in the full—