‘Those who lived in the tower were badly failed … by those who were responsible for ensuring the safety of the building and its occupants.’ That is the conclusion of Martin Moore-Bick, chair of the panel inquiring into the 2017 fire at Grenfell Tower, London, in which 72 people died. The final report, published on 4 September, serves as a stark reminder that disasters have many causes and blame can be widely spread.
Similar points can be made about corporate scandals. In the same week as the Grenfell report appeared, the Labour government introduced legislation, the Water (Special Measures) Bill, that would enable the imprisonment of senior executives of water companies that pollute rivers, lakes and seas. This type of sanction avoids the problem of imposing fines on a financially stretched company that should be prioritising investment.
Water off course
Thames Water is a prime example. After years of overdistributing profits despite heavy investment needs, it had accumulated about £16bn in net debt by its 31 March year-end. This is more than a dozen times its EBITDA, and the majority of operating profit went on net finance charges. Nevertheless, nearly £200m in dividends has been paid to other group companies over the past five years. Both directors and auditor PwC have declared material uncertainties over its going concern status.
What astonishes is the neglect by all involved of the importance of financial resilience
A report by the regulator Ofwat, published in August, summarises the triggers for Thames Water breaking conditions of its operating licence. After failing to raise new equity, the company lacks a 12-month ‘liquidity runway’, and Moody’s and S&P have downgraded its debt to junk, which breaches a requirement to have an investment-grade rating from two issuers.
Instead of slapping an enforcement order and fine on Thames Water, Ofwat has accepted undertakings from the company to turn the business around and secure new equity. If it fails, the backstop is a special administration regime, a bankruptcy procedure that stops short of renationalisation.
Blame can be widely spread. But the astonishing thing is the neglect by all involved of the importance of financial resilience at a company providing an essential public service. Ofwat points out in its August report: ‘Water companies are responsible for ensuring they remain financially resilient and are required by Ofwat to have robust and transparent financial arrangements.’
The former has clearly neither happened nor been enforced. The same can be said of the latter: one of the companies in its complicated structure, Kemble Water Finance, defaulted on bonds in April.
Thames Water reminds me of the financial crisis. Light-touch regulation led to overreaching ambition at Royal Bank of Scotland. It also has similarities to Carillion, which the public sector happily used as a contractor because of its low-priced bids. The resulting losses fed into its demise.
Autonomy’s accounting had been questioned before the HP takeover
Overmighty bosses
The blame game is much easier in cases of fraud, such as Enron, Parmalat, FTX and Wirecard (which is still involved in criminal and civil law suits), where the focus falls on overmighty bosses. Each case also involved lax corporate governance and auditing, and the companies were often cheered on as champions by investors and governments.
Many scandals, however, either don’t end up in court or the case collapses. At the mildest end of the scale lies Thomas Cook. As I wrote in 2019: ‘There were enough red flags flying in Thomas Cook’s last annual report to wrap the leaning tower of Pisa.’ More severe tests of the boundary between rule-bending and rule-breaking include Tesco’s falsification of accounts in 2014; the fraud case against Tesco executives collapsed in 2019.
Among the most dramatic examples is Autonomy. Hewlett-Packard bought the software company in 2011 for US$11bn – more than 12 times annual sales and at around a 70% premium to a share price inflated by unrealistic expectations. HP subsequently wrote off US$8.8bn amid protests about Autonomy’s accounting practices. Autonomy CFO Sushovan Hussain was convicted of fraud and went to jail in 2018. Now free, he remains banned from working in the UK’s accounting industry.
High valuations of technology companies exert pressure to deliver heroic sales growth and profit margins
In June this year his boss, the late Mike Lynch, was acquitted of criminal charges by a jury in San Francisco. His celebrations were cut short in August in the tragic sinking of his yacht Bayesian off the coast of Sicily.
Autonomy’s accounting, notably revenue recognition, had been questioned before the HP takeover. In 2020 a tribunal in the UK, reviewing Deloitte’s audit work from 2009 to 2011, imposed a then record fine of £15m and ordered the payment of £5.6m in legal costs.
Current high valuations of technology companies exert heavy pressure to deliver heroic sales growth and profit margins. Let’s hope none of them is bending the rules to breaking point to deliver.
