Tuesday 23 January 2018

Were the bank auditors conflicted?

The auditors of the big banks were paid huge money to make sure that everything was done correctly. What exactly did they do for the money, ask Nick Webb and Roisin Burke

THE 'Big Three' accountancy firms were paid €164m over the last 10 years to check the books of Ireland's main bombed-out banks, according to research compiled by the Sunday Independent. A large chunk of these pay-ments covered much-talked-about "non-audit" fees, which some investor watchdogs fear cause a conflict of interest for auditors.

Anglo Irish Bank, Bank of Ireland, Allied Irish Banks, Irish Nationwide and EBS will cost the taxpayer more than €75bn to bail out after their incompetent and flawed lending drove them to near collapse.

Over the last 10 years, these banks were primarily audited by KPMG, Pricewaterhouse Coopers and Ernst & Young. Auditors are not changed often. In the last decade there have been two changes. Ernst & Young was replaced by Deloitte & Touche at Anglo Irish Bank last year after the bank was nationalised following a series of scandals. KPMG replaced PwC as AIB's auditor in the wake of the €690m trading losses hidden by John Rusnak at AIB's US operations in 2001. Deloitte & Touche has just become the auditor to the nationalised Anglo Irish Bank.

Our figures can reveal that AIB -- which has already hoovered up €3.5bn of taxpayers' money and may need considerably more -- paid its auditor KPMG far less than Bank of Ireland paid its auditor PwC.

Bank of Ireland paid its auditor PwC €100.6m between 2000 and the year end of 2009. This is far, far more than AIB paid KPMG, which took over the audit in 2002. Between the end of 2002 to the end of 2009, AIB paid its auditor KPMG €49.9m in fees.

Anglo Irish Bank, which may need more than €18bn of state funds, paid Ernst & Young €10.3m over a 10-year period. Ernst & Young resigned as auditor and was replaced by Deloitte & Touche last year. It emerged that Anglo Irish Bank and Irish Life & Permanent had been involved in a scheme to shift more than €7.5bn in to Anglo to make its deposit levels look better. The bank recently reported a loss of €12.7bn -- the largest in Irish corporate history.

Irish Nationwide, which last week revealed a loss of €2.5bn for 2009, was also a customer of KPMG. It paid the firm more than €1.65m in fees from 2001 onward. The EBS paid €1.8m to Ernst & Young from 2001 to the end of 2008, according to our figures.

AIB paid KPMG a whopping €11m over nine years for services outside its audit, including tax advice and providing "assurance to third parties". This is dwarfed by the €56.6m paid by Bank of Ireland to PwC for services including "reporting to regulators" and providing "letters of comfort".

In a four-year period up to 2009, Anglo Irish Bank paid Ernst & Young €1.9m or almost 25 per cent of its entire bill on "non-audit" services.

While most of the fees paid to the big accountancy firms were for plain vanilla audits, large sums were also paid for other services ranging from reducing corporate tax bills to transaction advice.

"When an auditor is a multi-provider of services, is there a conflict of interest?" Labour's deputy leader and finance spokeswoman, Joan Burton, asked.

PIRC, the British advisory group for institutional investors, has urged a ban on the non-audit activity because of fears that it compromises auditors' independence and discourages them from confronting directors on difficult issues.

The auditors being involved in a financial institution in consultancy roles as well as the audit function may be a further reason to have noticed that some banking practices were questionable, Ms Burton points out. "You're on the auditing and consulting side, the two teams don't communicate, but nonetheless some overview of risk profile and soundness must be achieved," she suggests.

It's not just the external auditors that inspect the banks' books, there's supposedly a massive internal auditing machine within every financial institution.

"The internal audit department is enormous within most banks," said Ms Burton.

"However, in many ways it's a complete Cinderella; it's not the glamorous side of banking."

These well-staffed outfits are meant to monitor the institution's accounts compliance with internal controls and laws and regulations. Staff members of banks have flagged iffy situations in the recent past and they've suffered for speaking up.

Two former group heads of internal audit at AIB, Eugene McErlean and Tony Spollen, flagged issues of concern at the bank in the late-Nineties and early part of this decade. "They were required to act with courage and they did, and they were both forced out of their jobs," said Ms Burton.

As braces to add to the internal audit department belt, each bank's board of directors appoints an audit committee made up of non- executive directors. It's supposed to deal with all the financial responsibilities related to the board and they're usually paid extra for their trouble.

'When an auditor is a multi-provider of services, is there a conflict of interest?'

Those on the internal audit committees of bank boards weren't necessarily people with an auditing background.

So that's three layers of audit oversight that are standard in a financial institution. Yet none of these well-paid professionals with internal audit remits in any of the failed institutions, nor the external auditors paid millions for their work, seems to have reported concerns about the practices that led to the banks' collapse before 2009.

The fourth level of auditing oversight is the Financial Regulator. "The regulator's office had a set of auditors, but in recent years the level of auditors there was really not adequate," said Ms Burton.

It's not known as yet if the regulator flagged any concerns with the banks about their practices. "Mr Neary [Patrick Neary, the regulator during the boom], as regulator had to have the courage to eyeball the banks and say: 'This isn't a satisfactory risk profile.' There's no evidence that he did that, and externally he seemed to have said that everything was okay."

Beyond Ireland, there's hardly a big-name auditor that doesn't have a blot on its copy book in the shadow of the global banking collapse.

Anglo's auditors, Ernst & Young, the biggest auditing outfit in the world, was pilloried for its role in helping Lehman Brothers window- dress its dodgy financial structures. It earned $31m (€23m) in fees from Lehman's in the year before it fell apart.

Pricewaterhouse Coopers audited insurance giant AIG, where it did at least flag the fact that the institution's accounting controls were weak. They turned out to be a masterly understatement, as its $85bn US government rescue proved.

Even when auditors perform satisfactorily, many people are simply outraged by the massive fees they charge. Deloitte was auditor for the Royal Bank of Scotland in Britain, netting £58.8m (€68m) in fees in 2008, the same year it needed a multi-billion-euro state bailout.

Irish Nationwide auditor and super-accountancy firm KPMG was US bank Wachovia's auditor.

The fourth-largest bank had to be saved from insolvency by a rescue sale to Wells Fargo. KPMG earned €30m for its work there.

Can auditors be sued if they're found to have missed things they really should have spotted?

"It's certainly happening in other jurisdictions," said Ms Burton. "Professional indemnity means it has become very common in the US, where a number of auditors have faced legal challenges by boards and shareholders."

Ernst & Young's conscience about Anglo is clear. It says all its audits for Anglo were conducted "in accordance with appropriate auditing standards". Its managing partner has been quoted as saying he is "very proud" of the "fantastic job" it did at Anglo.

The new CEO of Irish Nationwide, Gerry McGinn, said in an interview last week that the building society's lending practices in the old Fingleton regime were "shoddy" and "well below standard".

"It seems extraordinary that none of this seems to have been reported by the auditors," said Ms Burton.

Mr McGinn also said that Irish Nationwide had hired forensic accountants from former Anglo auditor Ernst & Young to look for any malpractice that might have occurred.

"At Irish Nationwide and any financial institution, auditors traditionally exercise great caution in their work," said Ms Burton. "Too much risk or risk wrongly balanced should show up and ought to give rise to warning lights at this stage."

As regards concealed directors' loans like Sean FitzPatrick's €87m, looking for loans that disappear and then reappear again is 'Accounting 101', according to Ms Burton. "It's normal practice to scrutinise directors' loans and look at patterns of accounts to ensure they show no sudden changes or reversal of transactions. This is Year One accounting studies stuff."

There's an old saying that an auditor is a watchdog, not a bloodhound, but they are trained to look out for red flags. Auditors are supposed to provide a view of financial statements that is "a true and fair view" according to international audit standards.

"If you had a director with a loan of, say, €1m and on December 31 he repays that loan with a cheque, and then on January 6 he takes out a loan again. . . that's a perfect example of a situation in the accounts that is true, but not fair. It's for window-dressing purposes," said Ms Burton. "There are standard auditing techniques to pick these things up."

The question is, why didn't they seem to pick them up?

Sunday Independent

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