OPINION:AN ERROR at EU level may answer the important question on everyone's lips. Why was the Irish accounting profession not called to account for failing to reveal losses at financial institutions? The problem was exposed when Anglo Irish Bank announced impressive profits five years ago at a time when it was bankrupt. The recent revelations by Bloxham stockbrokers suggests that the profession is in no rush to change or even explain what is going on.
Unlike Ireland, the UK opened a House of Lords inquiry into the matter, during which concerns were raised about the quality of Irish bank audits.
The lords found that the UK big four accounting firms were too dominant and dangerous, that the quality of their work in bank auditing was questionable, and that they deliberately used EU-backed flawed rules known as the International Financial Reporting Standards (IFRS) which they knew to be misleading.
This, however, was only a side show. The real issue is revelations that show a profession that ignored company law and realised that protecting bankers’ bonuses was far more lucrative than serving the interests of shareholders who pay them or regulators who rely on them.
The UK inquiry was, for instance, given evidence showing how accounting groups lobbied to change company law rules so that directors of loss-making and bankrupt banks can award themselves bonuses by failing to disclose losses and calculating artificial profits.
Worryingly, Irish government officials have given these proposed changes their full backing. According to one official, the new Companies Consolidation and Reform Bill intends to remove prudence – ie the requirement to reveal losses – from company law. This is despite warnings from Nama’s Brendan McDonagh, who told an Oireachtas committee of his concerns that banks were giving misleading information about their loan losses to the stock exchange and to shareholders.
The list of IFRS critics is growing. Irish bank regulators claim they were unaware that auditors were ignoring company law by not revealing losses. Central Bank governor Patrick Honohan repeatedly voiced his frustration at the IFRS rules that allow banks to delay disclosing bad news.
A former PwC partner claimed the IFRS rules are “not fit for purpose”.
Nigel Lawson, who served as finance minister under Margaret Thatcher, criticised the rules for allowing banks to pay bonuses based on “paper profits”.
A shareholder association has questioned how the accounting profession can undermine the law in this way. Iain Richards of Aviva Investors described the IFRS rules as “a material cost to the taxpayer and to shareholders because dividend distributions have been made and bonuses paid that were imprudent”.
In Ireland, the Nyberg report drew the same conclusion: “the higher reported profits also enabled increased dividend and remuneration”.
PIRC, the UK corporate governance consultancy, has written to Brussels to have the IFRS rules changed. Although officially the EU has not admitted the error, official EU documents suggest there are concerns.
Recently the Irish Central Bank warned that Irish banks will need to raise more capital. The likelihood is that while the international standards are in force in their present form, shareholders will be reluctant to burn their fingers again. Even bankers are unwilling to trust each other, worried that there is still a mountain of losses waiting to be revealed.
A potential solution is to make the accounting rules “shareholder”-friendly as opposed to “bonus”-friendly.
However, standing up to bank lobbyists and telling them their bonuses will suffer under new reforms is not an attractive proposal for many politicians. One politician was allegedly warned “even if it is the law”, changing the IFRS rules “might have unintended consequences”.
According to Syed Kamall MEP, the EU acted illegally by adopting the advice of various accounting committees and he has questioned whether conflicts of interest within these committees exist.
In 2008 the accounting profession commissioned a legal opinion from Martin Moore QC. Hoping that Moore would confirm their view that as long as they complied with the IFRS rules they met company law requirements, Moore instead said that “mechanical compliance” with accounting standards was alone insufficient to meet the requirements of company law.
To the embarrassment of EU officials, Moore also warned it was illegal for the EU to endorse standards if they permitted entities to conceal losses. He presented case law to confirm that concealment of losses was illegal.
A UK minister who claims to have the backing of the accounting profession admits that banks can hide losses under these rules but that the practice is legal. The minister revealed that as long as banks keep an internal set of books that comply with company law, they are free to publish another set that does not reveal losses but complies with IFRS rules.
The report to Brian Lenihan that underestimated Irish bank losses was based on IFRS figures.
The accountants who commissioned the Moore opinion nevertheless reassured the House of Lords that there was no clash between company law and the IFRS rules. The Lords, fearful they were misled, wrote to the UK government producing evidence that accountants had unsuccessfully lobbied to change company law rules so that banks could conceal losses.
Internal documents reveal the EU is close to admitting it got it wrong.
The revelation could enhance Ireland’s bargaining position as the omission would suggest the EU contributed to Ireland’s banking problem by enacting accounting rules that were contrary to company law.
Cormac Butler is author of Accounting for Financial Instruments, published by Wiley
