Maybe you missed it. Or perhaps you were stuck in some interminable queue at an airport. But the United Kingdom’s audit watchdog revealed in August that a disciplinary tribunal had slapped audit giant KPMG with a £13m (€15m) fine, parked it on the naughty step with a severe reprimand, and ordered it to conduct a series of reviews into what went wrong.

  • A tribunal ruling in the Silentnight case has little relevance for most DB sponsors
  • The UK pensions regulator has served notice that it will take a hard line on wrongdoing
  • UK corporates can expect dividends and share buy-backs to face close scrutiny

The long trail to the tribunal began after the Financial Reporting Council (FRC) received information from the Pensions Regulator (TPR) that something was amiss with KPMG’s dealings in the sale of mattress maker Silentnight to new owners. The allegation was that one of KPMG’s partners helped tip Silentnight into insolvency so that the private equity firm HIG could snap it up cheaply and dump its defined benefit (DB) pension scheme on the Pension Protection Fund.

The firm’s fine and sundry telling-off followed a four-week tribunal last year and a follow-up hearing this June. Alongside this, former KPMG partner David Costley-Wood received a more manageable fine of £500,000, and the now familiar severe reprimand. He was also banned from both his professional body, the ICAEW, as well as from holding an insolvency practitioner’s licence, for 13 years.

Responsibility for audit regulation in the UK rests with the FRC. It in turn delegates its power to recognised supervisory bodies. Membership of one of these bodies is a requirement for anyone wanting to carry out statutory audits in the UK.

When something goes wrong, the road to the naughty step starts with the FRC’s imaginatively titled Accountancy Scheme, which has been through no fewer than 10 iterations since 2004. Somewhat ironically, the most recent change removed restructuring matters from its scope.

But what, if anything, does this newly electrified regulatory environment mean for the UK’s declining universe of about 5,600 or so DB schemes? That all depends.

Evolution, not revolution
“The outcomes and messages from the regulator aren’t going to change how most trustees and corporates behave,” says Ryan Cox, a senior covenant consultant at Aon. “The actions taken by HIG in this case are an outlier.” Adrian Bourne, a senior consultant with Willis Towers Watson, agrees: “A lot of the actions we have seen from the regulator recently have been about reiterating existing messages – it is evolution, not revolution. The regulator does a good job, as does the covenant industry, too, in creating a culture around pension schemes through best practice.”

He continues: “It would be interesting to know what action TPR would have taken in the Silentnight case had it possessed the new arsenal of powers afforded it under the 2021 Pension Schemes Act. But short of doing anything egregious, which I can say my clients don’t, if you get good advice, you’re going to stay on the right side of the law.”

Ultimately, he adds, the issue boils down to being a responsible employer and taking a reputational hit when mistakes are made. But even so, might the fallout from Silentnight not have the unintended consequence of deterring lenders in, say, the private credit space from throwing a lifeline to struggling firms?

“Yes, it could – where pension liabilities are material,” says Cox. “If you make the market for lenders of last resort smaller, then employers that might have survived could fail and that is invariably the worst outcome for a pension scheme. However, the regulator is clear that a lender of last resort who pulls funding for legitimate business reasons has nothing to fear.” Whether this reassures lenders remains to be seen.

Few would question the tenacity with which TPR pursued what is normally a difficult foe to tackle – private equity. “TPR’s powers are much greater if they can be aimed at UK-based individuals,” says Cox. “And in this case, there were indeed individuals in the UK and so that opened up a wealth of information to the regulator. I think they wanted to send out a message that they can tackle well-equipped and well-resourced parties.”

What is unusual about the case is that TPR issued two warning notices, with the second notice upping the ante and demanding payment of the full solvency debt. HIG challenged the regulator and lost. This hardening of TPR’s resolve, suggests Cox, was down to pressure from the scheme’s trustees to push for more.

Parallel universe
All this talk of misconduct and pension scheme regulation is far removed from the parallel universe of IAS 19 accounting. Here, survey after survey since the start of the pandemic has – at least on the surface – painted a picture of healthy balance sheet positions for many leading UK sponsors. What these survey findings mask, however, is that some DB scheme sponsors face real challenges.

And so it is perhaps unsurprising that covenant advisers are taking little account of the IAS 19 accounting numbers. “The focus,” says Bourne, “is on technical provisions and solvency deficits. In the current climate, there is a focus on cash and liquidity being able to fund the former and over what timeframe. It goes back to that affordability point. What cash is in the business?” 

Nonetheless, there are still some corporate finance chiefs who do care about IAS 19 – a lot – because of the optics and investor relations. Although, he adds, at the “business end” of the calculation, “it is more about cash and funding – after all, the scheme can be a very visible asset on the balance sheet under IAS 19 that when assessing technical provisions becomes an equally large deficit”.

At the same time, another corporate red-button topic to consider is dividends. The question of payouts to shareholders has rocketed to the top of the political agenda in the UK following the collapse of services and outsourcing firm Carillion. The issue has not passed the FRC by. Its 2021 Annual Enforcement Review reveals that eight of its 48 regulatory interventions on accounting matters in the previous 12 months involved either dividends or share buy-backs.

But investors nonetheless have a case that schemes have not always shared in the pain – certainly not where shareholders have recapitalised a business or guaranteed some of its borrowings.

The case does, however, leave both investors and the UK’s audit watchdog to decide whether KPMG has put the worst behind it or whether further pre-emptive action is necessary. “It is encouraging that the FRC seems to be showing no preference to protect KPMG, which was a suspicion of mine in the past,” says Tim Bush, who leads on governance and financial analysis with Pensions & Investment Research Consultants. “I am also encouraged by the fact that some senior KPMG alumni have left the FRC. And KPMG in the US also had problems with its regulator.

“Given the latest findings against the firm, I think there is a strong public interest argument for putting the firm into some sort of special measures. In fact, PIRC recommends voting against KPMG’s re-election as auditors of any listed company in the UK as a matter of policy. Fundamentally, with bad audits, investments may be worth less or even worthless. Poor quality is a major ethical issue that the profession and the FRC must now address.”

KPMG says that its “broader controls and processes have evolved significantly since this work was performed over a decade ago”. And Mr Costley-Wood? He no longer works for KPMG and is, rumour has it, ‘en vacances’. Maybe you caught a glimpse of him in that queue?