MPs: Wretched state of audit sector evident in Thomas Cook collapse
Auditors have lost their objectivity and are too close to the firms they are assessing, the UK accounting regulator’s top enforcement official told MPs investigating the collapse of travel agency Thomas Cook.
Elizabeth Barrett, executive counsel and director of enforcement at the Financial Reporting Council (FRC), told a committee of MPs that major auditors were failing in their duty to adequately challenge management.
Thomas Cook, the world’s oldest travel company, collapsed in September with £1.7bn of debt despite being given a clean bill of health by auditors PwC and EY.
Crossing the line
Over a two-day session, members of the government’s Business, Energy and Industrial Strategy Committee (BEIS) said the auditors had been “complicit” in the demise of the 178-year-old travel business.
MPs were told PwC and EY earned more than £23m from “non-audit” work, on top of around £32m they were paid for reviewing Thomas Cook’s books.
Hemione Hudson, PwC’s head of audit, said: “I do understand that people are concerned.”
She said that the firm would not allow the arrangement to occur today, however, this is down to a rule change that forbids the practice occurring. BEIS committee chair Rachel Reeves said if the guidelines had not been updated then PwC would not have changed its policy, and that auditors were “waiting for legislation rather than doing the right thing”.
Wednesday’s session focused on the role of the regulator and the bookkeeping of Thomas Cook during the years it accumulated debts through a series of risky mergers, acquisitions and other deals.
Barrett said a point had been crossed as auditors were regarding audited entities as clients, and as in the case of Thomas Cook, appropriate levels of scrutiny were not being delivered.
“From an enforcement perspective, we find auditors have lost their objectivity in where that line between client relationship and separate dispassionate independent reviewer should lie,” Barrett said.
She said the regulator is scrutinising “audit assumptions” made by EY, the tour operator’s most recent auditor, as well as whether accountants adequately pushed back against management assumptions, but declined to offer detail more due to an ongoing FRC probe into EY’s role in the collapse.
“There are questions over culture for audit firms,” said David Rule, FRC executive director of supervision. “We do find problems often around challenge of management, and it reflects a culture of not being willing to do that.”
The Insolvency Service chief executive Dean Beale revealed KPMG and consultancy firm AlixPartners, brought in to deal with the liquidation, had billed £11m in fees for three weeks of work assisting the official receiver.
On Tuesday, EY said Thomas Cook still owes it £900,000 in unpaid fees.
Regulator under fire
The role of regulators and auditors has come under closer scrutiny since the collapse of Carillion and resulted in a string of recommendations to uphold standards and strengthen trust in the audit process.
Reeves said lessons had not been learned from the Carillon debacle and reform of the audit sector was occurring “after the horse has bolted” given the downfall of Thomas Cook.
Earlier in the year, several calls were made to break up the Big Four over claims there were too many conflicts of interest, given the overlap of providing non-audit services to firms they were meant to be vetting.
Independent MP Antoinette Sandbach said the regulator had to take its share of the blame and asked if the FRC had been sleeping on the job given Thomas Cook’s problems were evident from at least 2013 when the firm carried out a refinancing.
“We know the assets purchased by Thomas Cook were losing money. Shouldn’t alarm bells have been ringing at the FRC?” she said. “There was a flag-waving around the refinancing. What protection is there for customers, shareholders, clients? What oversight is there?”
Two reviews into the state of the audit sector have been carried out since 2018, the first led by Sir John Kingman, chairman of Legal & General, and the second by the Competition and Markets Authority.
The resultant findings have led the government to abolish the FRC and replace it with another regulator, amongst other findings. However, the reforms require multiple acts of legislation to be triggered.
“Since Kingman, we have had another collapse of a public company, and it has thrown up more questions that the regulator is looking at, but this is all after the horse has bolted, similarly to Carillion,” said Reeves. “There is a need to reform the audit sector, and looking at what has happened at Thomas Cook hopefully the government will speed this up.”
Barrett said she was keen for the recommendations to be introduced around enforcement “asap”.
“We have an important opportunity to reshape the market for financial statements, and the obligations placed on auditors,” she said. “It would be better to get it right than rush it.”
No peace or goodwill
Two former Thomas Cook CEOs and the company's former chief financial officer were also grilled on their part in the travel agency’s downfall, with MPs laying into the trio for their refusal to accept blame for their actions.
“Everyone we’ve seen from Thomas Cook has blamed everyone apart from themselves,” said Reeves. “They never look at themselves, the decisions they’ve made, and reflected on those. It’s the volcanic ash, the hot weather in the UK, the depreciation of sterling, the debt acquired by someone else. It would be good for someone from Thomas Cook to say they wish they had made different decisions instead of passing the buck.”
MPs were told the auditors had warned Thomas Cook in a letter to management there had been “potential for manipulation” in the reporting of goodwill in the annual statements, and that these numbers were artificially inflated.
Harriet Green, who ran the company from 2012 to 2014, said there was overall goodwill of £2.6bn when she started and this had reduced slightly when she left the business. The figure had been heavily written down in 2019 by £1.1bn.
Former CFO Bill Scott said he would not use this term, but recognised the difference in approach to the issues of goodwill. He denied auditing is “a cosy club” and said there was challenge about the use of goodwill, but refused to accept the firm erroneously overstated its assets in relation to its performance.
Scott said the 2018 heatwave disrupted trading to such an extent it caused a damaging decline in profitability, undermining assumptions in the business plan. MPs pressed him on whether he had made a mistake.
“With the benefit of hindsight it appears unusual there could be that level of decline,” Scott said.
Manny Fontenla-Novoa, who ran the company from 2003 to 2011, also deflected accusations that financial management during his tenure was responsible for the firm’s troubles.
Of the tactics employed, Stephen Kerr said Thomas Cook was “using its suppliers as a bank” by paying late and not declaring those liabilities on the balance sheet, making suppliers wait 60 to 90 days in some cases to be paid, although Fontenla-Novoa was adamant the firm abided by industry standards.
Fontenla-Novoa oversaw a huge expansion and acquisition spree, which included the ill-fated purchase of MyTravel in 2007. MPs accused him of pursuing risky deals due to the financial rewards on offer. Between 2008 and 2012, Fontenla-Novoa earned £12m, including £5m for the MyTravel deal, despite the company’s net debt having doubled and its profits wiped out.
The former CEO banged on the table repeatedly as he defended his actions, citing the 2010 Icelandic ash cloud and a struggling pound as reasons that the tour group entered “tough times”.
MPs were not impressed by the excuses given by the former bosses, however, and the trio were urged to take more responsibility as the probe continues.
“A bit more humility would help, but I feel we have missed that today in your case, Manny,” Reeves said.