Monday 22 July 2019

Two Anglo transactions were deliberate attempts to deceive

Niamh Brennan

Financial statement fraud is a deliberate attempt to deceive users of these documents, especially investors.

There are two elements to financial statement fraud -- intent and deception. Intentional misrepresentation of transactions is one way of committing financial statement fraud.

Two transactions in Anglo Irish Bank's financial statements have come to light, which I believe meet this definition.

Company directors are required to prepare accounts which give a "true and fair view". In Ireland we have a "principles-based" accounting system to ensure accounts are "true and fair". Under Irish company law, companies are required to comply with accounting standards. Not to do so is an offence.

One of the main principles of accounting is that transactions are accounted for in accordance with their commercial or economic substance. Companies should not deliberately enter into transactions whose purpose is to give a misleading or unrepresentative impression of the company's position. This is called window dressing. A common way of window dressing is two companies entering into circular transactions, in order to distort amounts in the financial statements of one or both companies.

Secret

From what we know, Anglo Irish Bank appears to have entered into transactions with two companies in order to window dress its accounts.

In the first circular transaction, Sean FitzPatrick, Anglo Irish Bank's former chief and chairman, hid borrowings of up to €122m. He did this in a secret warehousing arrangement with Irish Nationwide Building Society.

This deception had been going on for eight years. The secret borrowings were paid off shortly before each account's year end using funds from Irish Nationwide. The borrowings were put back on Anglo Irish Bank's books shortly after each year end.

In the second circular transaction, it seems that shortly before its September 2008 year end, Anglo Irish Bank put €4bn into Irish Life and Permanent (IL&P).

In turn, IL&P deposited the same money back with Anglo Irish Bank. This was put through a non-banking subsidiary of IL&P.

Presumably this was done to make it look as if the money came from customers rather than from another bank. Customer deposits are more highly regarded than inter-bank deposits. The circular transaction was unwound shortly after the year end.

The definition of financial statement fraud does not require that investors suffer a loss. But this is almost always the case.

The question is -- had Anglo Irish Bank shareholders known about Sean FitzPatrick's loans, and had they known the true amount for Anglo Irish Bank's customer deposits, would they have sold their shares? Would they have avoided some or all of the losses they subsequently incurred?

Why would companies such as Irish Nationwide and IL&P facilitate these transactions? What was in it for them?

It is the duty of company directors to look after the best interests of their company. How could these transactions have been in the best interests of those two companies?

The two companies could end up suffering financial losses, in addition to reputational damage.

It has been reported in the media that shareholders in Anglo Irish Bank are contemplating litigation. They may very well pursue Irish Nationwide and IL&P for damages in respect of their roles in colluding and conspiring with Anglo Irish Bank's fraudulent financial reporting.

I feel sorry for the non-executive directors. I suspect they did not know what was going on. The biggest risk for non-executive directors is executive directors and managers hiding information from them. It is impossible to be a good director in such circumstances.

Where were the auditors? Detection of window dressing is a key procedure in auditing, especially in challenging economic conditions when the temptation for such practices is greater.

To conclude -- out of bad comes good. There are lessons to be learned from this. We need to get Ireland Inc's reputation back on track and our banking system in order. The whole country is depending on it.

Niamh Brennan is Michael MacCormac Professor of Management and Academic Director of the Centre for Corporate Governance at University College Dublin.

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