Equitable accountants

Last week the Accountants' Joint Disciplinary Appeal Tribunal released its verdict on the role of Ernst & Young as auditors of Equitable Life. The charges were of 'professional incompetence' in carrying out the audit of Equitable Life's accounts for 1998, 1999 and 2000 and of 'a lack of objectivity and independence'.  These proceedings were on appeal from the Joint Disciplinary Tribunal decision of October 2008. The Tribunal had found Ernst & Young 'guilty' on both charges but this judgement was not published pending the appeal.

It is to be hoped that the verdict of the Appeal Tribunal is final. Equitable Life's collapse can be dated to 2000 when the House of Lords issued its devastating judgement against the life assurance company and ten years is a very long time for this to be hanging over all concerned. Both the original Tribunal and the Appeal Tribunal have had to consider evidence not just about the highly complex nature of accounting for mutuals but also what should be best practice for the extremely specialist job of their auditors. To give some idea of the difficulty of resolving this matter one has to bear in mind that the demise of Equitable Life followed three entirely different court decisions in the same case and that none of those decisions followed the unequivocal legal advice that Equitable Life's directors had received. The Joint Disciplinary Scheme has worked thoroughly, painstakingly and, crucially, with enormous professional expertise to reach its verdict and it is very hard to see how justice could be better served by any other process.

With the benefit of hindsight the evidence is damning; Ernst & Young issued successive clear audit reports on accounts that effectively ignored the whole problem of guaranteed annuities even after the Court of Appeal had ruled, at least partially, against Equitable Life. At best the audit staff appear complacent and one might almost describe them as useless. However, in amongst the vast sea of evidence from reports, memoranda, audit working papers, emails and witness statements there was virtually no tangible material that suggested that Ernst & Young was ever guilty of a lack of objectivity and audit independence. So the original tribunal upheld this 'charge' against the auditors on the basis that the failings in the audit process were so severe that they must have come about because the auditors were too close to the company and its directors.

That one of the large firms of accountants, with all its systems and procedures, could still be guilty of a lack of objectivity and independence regarding a major audit client was an appalling indictment. Not as shameful, perhaps, as the revelations about a shredding orgy at Arthur Andersen when Enron imploded but still highly, perhaps fatally, damaging for Ernst & Young. However, the more favourable decision on appeal has removed the element of guilt by implication leaving us with an account, albeit long and highly technical, of an audit that was feeble and inept but not corrupt. Many accountants, including the Accounting and Bookkeeping College, will share the relief of Ernst & Young and especially Paul McNamara, the audit partner, that justice has finally been done.

Equitable Accounting

The new UK government, unkindly called the Lib-Con coalition, has started work already. Amongst its first measures, aside from reducing the salaries of ministers by 5%, has been the announcement that the members of Equitable Life are to receive compensation as recommended by the Parliamentary Ombudsman. Equitable Life, before its takeover by Halifax Building Society (subsequently HBOS and then the Lloyds Banking Group) had its headquarters in Aylesbury as does the Accounting and Bookkeeping College.

The members of Equitable Life were certainly misled. Each year the directors declared dividends for the with-profits members that were outstanding by the standards of the pensions industry. Very few alarm bells rang until Equitable Life lost a court case brought by a group of investors who believed they were entitled to guaranteed annuity payments. When Equitable Life had sold these annuity contracts its actuaries had seriously miscalculated how expensive the obligations would be. Suddenly it was clear that there wasn't unlimited cash in the pot and the members would have to go short. So little cash, in fact, that Equitable Life was effectively bust.

Throughout this story there was precious little evidence of supervision by the financial authorities. Initially some aggrieved members were looking to the auditors, Ernst & Young, for not sounding the alarm. Auditors had taken the blame for previous corporate fiascos like Enron and seemed like a promising source of funds for the aggrieved. Ernst & Young, however, had a cast iron defence: the convention in the financial services industry, which they were bound to follow, was that the auditors should only examine the assets of the business because auditors are not actuaries and they would not be able to form a worthwhile opinion on the liabilities which, in this case, would be the amount due to be paid out in pensions. Ernst & Young had duly tested Equitable Life's assets and found the figures in the accounts to be true and fair. The directors' error had been in understating the liabilities.

As ever, this one-sided form of accounting could not tell the whole truth or, in this case, anything like the truth. An absence of regulation can only be the responsibility of the regulatory authorities, if any, so the members of Equitable Life resorted to parliament and the Financial Services Authority. The Parliamentary Ombudsman has correctly ruled in their favour. The country will carry the cost, or at least some of it, of this failure.