Accounting: Just ignore the FRC

The UK government’s release of documents under the Freedom of Information Act has brought into question the Financial Reporting Council’s pronouncements on distributable profits. Stephen Bouvier explores the issue

Tim Bush, head of governance and financial analysis at Pensions & Investment Research Consultants (PIRC), appeared on BBC radio at the end of August with a disarmingly strategy for dealing with the UK’s accountancy watchdog: just ignore it.

The call to sideline the body that oversees the integrity of accountancy and audit in the UK is just the latest humiliation for the Financial Reporting Council (FRC). Ever since the Financial Crisis of 2008, the FRC has struck long-term investors as an organisation that rarely missed an opportunity to fail them.

Perhaps unsurprisingly, it was the issue of distributable reserves – the amount of retained profit that a company’s accounts show it has available to distribute to shareholders – that prompted the former Hermes fund manager to label the FRC as an irrelevance.

The issue of whether accounts prepared using International Financial Reporting Standards (IFRS) present a true and fair view of a business’s financial health has dogged the FRC’s dealings with long-term investors such as pension funds and insurers. 

Among them is the Local Authority Pension Fund Forum (LAPFF), which has taken legal advice on two occasions from commercial lawyer George Bompas QC. Bompas has reasoned that defective IFRS accounting standards put companies at risk of paying illegal dividends out of illusory IFRS profits. 

Indeed, in the run up to 2015’s reporting season, the LAPFF wrote to FTSE 350 chairmen and warned them that FRC guidance was “contrary to the requirements of the law”.

For its part, the FRC has argued that the LAPFF is wrong. Companies, it insists, can safely rely on the figures reported under IFRS, subject to applying the true and fair view override in exceptional circumstances.

However, documents released by the UK government under the Freedom of Information Act reveal an uncomfortable truth for the FRC: the body speaks with no legal authority on the matter. This public airing of an unspoken truth is a blow to the regulator’s credibility as an enforcer.

Earlier this year, PIRC hit upon the idea to fire off a Freedom of Information Act request to the Department for Business Innovation and Skills (BIS). The request was simple: it wanted to know precisely what the FRC and BIS had been discussing behind the scenes.

Despite a failed bid to block the release of the documents – some 53 pages of emails and telephone notes – it emerged that BIS officials had restrained unidentified FRC officials from publicly stating that Bompas and LAPFF were wrong. The FRC has declined requests from IPE to identify those staff members.

One unnamed BIS official wrote: “I am concerned by the wording in the first paragraph. We have never said that the views [of George Bompas QC and the LAPFF] are ‘incorrect and may be disregarded’.

“What we have said is that the Companies Act 2006 does not require the disclosure of a separate figure for distributable profits. Ultimately, whether the views of the LAPFF are incorrect would be a matter for the courts.”

But at the FRC’s Annual Open Meeting on 16 September 2015, the council’s chief executive, Stephen Haddrill publicly said George Bompas had got it wrong: “[T]he Government’s legal service also looked at it, and ministers confirmed that the way that international accounting standards had been implemented in the UK under European law was correct, so I am absolutely clear that what Mr Bompas has been saying is not correct.”

“No-one ever said that the distributable reserves would need to be one number – any more than suggesting that undistributable items should be one number. The pertinent issue is that unrealised and realised profits can’t be mixed up or else the real numbers will be hidden in a second set of books” Tim Bush

And in December, the FRC told The Times newspaper: “There is no uncertainty. This has been confirmed by BIS, which is responsible for company law.” The BIS press office pounced on the statement: “This is the text of this morning’s Times article on the LAPFF letter to FTSE 350 chairmen. Note that the line from the FRC quoted at the end of the article was not cleared with us.”

In subsequent press statements, the FRC shifted to safer ground: “The FRC and the government have confirmed that the Companies Act 2006 does not require the separate disclosure of a figure for distributable profits.” 

This change of tack has not gone unnoticed. Bush says he suspects that the FRC has constructed an entirely fictive dispute in order to wrong-foot critics. Again, the FRC has declined to comment. 

Bush is much less reticent: “No-one ever said that the distributable reserves would need to be one number – any more than suggesting that undistributable items should be one number. The pertinent issue is that unrealised and realised profits can’t be mixed up or else the real numbers will be hidden in a second set of books.

“This is precisely the kind of word-game that the FRC played with its response to Bompas’ two opinions. The relevant issue is whether the accounts enable a determination of what is distributable or not based on the numbers as stated in the accounts. The FRC has created a non-question to deny any requirement for a single figure for distributable profits. But, that’s a red herring.”

Prof Stella Fearnley, an accounting academic and IFRS sceptic, says the solution is simple: “We need some kind of SEC-type commission to investigate and re-think the regulatory structure for financial reporting and auditing for the UK Listing Authority and financial services. We also need to change the law to make it tough enough to deal with the problems that we know we have. 

“At the moment, we have accounting and auditing under the FRC along with corporate governance. The FRC has now been recognised as a single competent authority by the EU. This doesn’t make a major difference in practical terms, although it will require them to do more audit inspections. 

“Yet, this is a body that has let the UK down by failing to raise public objections to IFRS and not revealing what they know about the defective accounting model. No-one will convince me that what we saw in the run-up to the crisis was anything other than a bubble. But, who had the bottle to stand up and say something?”

Certainly, the picture that she paints as an insider in the run up to the 2008-09 financial crisis is unimpressive. Fearnley continues “What I cannot say is what the FRC’s audit inspection unit did or did not look at. Although I was a member of the Professional Oversight Board [POB], the inspection function was an aspect of the POB’s work that I had to disengage from because I had declared a number of conflicts of interest, one of which was my membership of the Institute of Chartered Accountants of England and Wales’s council.”

What is surprising about this state of affairs is Fearnley’s recollection that in 2004 the FRC maintained no conflicts register. Her disclosures, she says, were voluntary. Again, the FRC has not responded to this charge. She adds: “There were howls of protest from the audit firms that did not want details of inspections being made public at all. Equally, you can only inspect for and enforce what is there. We have ended up with a situation where we have buried ourselves in rules and box-ticking when the real question is whether the audit opinion was wrong and not whether all the boxes were ticked.”

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