109.While ultimate responsibility for the success of a company rests with the board, shareholders have an important role in holding the board to account for its performance. Under the principles set out in the FRC’s Stewardship Code, investors monitor the performance of companies in which they invest, including by checking on the effectiveness of leadership and the quality of reporting. The Code sets out a menu of options for escalating stewardship activities where there are concerns, from private meetings with board members to public statements and voting against resolutions at annual general meetings. It states that investors should be willing to act collectively with other investors when there are risks that threaten to destroy shareholder value or at times of “significant corporate stress”.
110.The stewardship activities of some of the major shareholders in Carillion in March 2017 are set out in the table below. The different approaches adopted in the final months of trading are in part a reflection of the different investment strategies of the investors and the preferences of their clients. For BlackRock, most of their investments were through passively managed funds which were sold automatically as Carillion shares fell out of the tracked indexes. The Canadian investor, Letko, Brosseau & Associates, on the other hand, continued to see Carillion as a long-term investment and were willing to consider offering additional support even after the initial profit warnings. Shareholders, including BlackRock, did push back successfully on proposals by the remuneration committee to increase the maximum bonus opportunity from 100% to 150%, but these objections were a protest against the pay proposals rather than a proxy for discontent with the company’s performance.
Table 1: Investor engagement
Shareholding on 1 March 2017 (%)
Discussions with board prior to March 2017, including in February on remuneration arrangements. Voted in favour following changes to maximum bonus proposals. Long and short positions held for clients. No engagement after March 2017. Majority of shares held in passive funds, sold in line with changes to indexes arising from profit warnings.
Brewin Dolphin Ltd
Met CEO and FD on 9 March 2017 for routine shareholder meeting and options for improving financial position discussed. Shareholdings reduced during 2017 in the light of changing assessment of the investment, accelerated after July profit warning.
Deutsche Bank AG
Not proprietary investments. Shares held on behalf of clients and for hedging purposes. No engagement with Carillion management.
Kiltearn Partners LLP
Continued to buy Carillion shares on behalf of clients until early July 2017. Kiltearn voted all its shares against the Remuneration Report in May 2017 due to “excessive” pay award to the CEO and concerns about debt and working capital levels.
Met CEO on 17 July to discuss funding gap. Concluded that recovery was “unlikely” and that no effective assessment could be made of its finances due to unreliability of published financial information. Began selling shares on 3 August 2017. Kiltearn met CEO on 13 October and, unconvinced by his answers to questions, sold all shares by 4 January 2018.
Letko, Brosseau & Associates Inc.
No change in plans or engagement after March 2017 until July profit warning, although a routine review call, requested on 13 June, was not met. After an urgent call on 10 July, shares held on basis that there was a “fair chance” of Carillion remaining a going concern; a further injection of capital considered. Further engagement around September profit warning. After November profit warning, view was taken that recovery was “unlikely” and all shares sold rapidly.
Standard Life Aberdeen
Standard Life1 began to gradually divest in December 2015 owing to concerns about financial management, strategy and corporate governance. Bi-annual meetings with Carillion board from 2014, at which concerns were raised about widening pension deficit, high levels of debt, weak cash generation an unwillingness of board to change strategic direction. Meeting with CEO on 17 July, by which time shareholding was minimal. All shares sold by end of 2017.
Source: Letters from investors and oral evidence. Shareholding figures from Carillion Annual Report 2016.
* According to Kiltearn, this figure should be 10%. ** According to Standard Life Aberdeen, this figure should be 0.56% at this date.
1 Standard Life merged with Aberdeen Asset Management in in August 2017. Aberdeen held limited shares in Carillion during this period, mainly in passive funds, and had little direct engagement with the board.
111.Effective stewardship by investors depends in large part on the availability of trustworthy financial reporting and on honest engagement with board members in response to the raising of concerns. The Carillion board failed on both these counts. In private meetings with the board, the Standard Life representative, Euan Stirling, referred to the fact that “the financial statements have been made to reflect a much more optimistic outlook for the company”, and that there was “a gloss to the presentations that we felt did not reflect the true business circumstances”. BlackRock shared the view that management teams were “overly optimistic” and retained its position of not actively investing in a company it did not view as an “attractive investment proposition”. For Standard Life, direct engagement was an important element of their investment strategy, and they began to divest as those meetings revealed that the board was not going to change direction in the face of their concerns. Other investors, with less resources to devote to direct engagement, relied heavily on the published financial information. Murdo Murchison, Chief Executive of Kiltearn Partners, told us that, in the light of the July 2017 profit warning, that information “could no longer be considered reliable”:
What was brought to the table in July last year was evidence of misstatement of profits over a prolonged period of time, evidence of aggressive accounting and evidence of extremely poor operational management, which was completely at odds with the way the business was presented to the marketplace.
Following the July 2017 profit warning, Kiltearn met Keith Cochrane, by then interim Chief Executive of Carillion, on 17 July and 13 October. Unimpressed by his inability to offer “any meaningful information” about how the company proposed to address its financial problems or “give answers that Kiltearn considered satisfactory to relatively straightforward questions”, they determined they could only continue to sell shares.
112.Representatives of the institutional investors were, at best, frustrated by the behaviour and performance of the Carillion board. Kiltearn, unhappy with the level and timeliness of financial disclosures, were considering legal action in respect of what they considered could be “dishonest concealment” of information in the 2016 annual report. In spite of these significant concerns on the part of some major investors, as a group these owners of the company did not manage to act in a co-ordinated manner to exert effective influence on the board of Carillion.
113.Major investors in Carillion were unable to exercise sufficient influence on the board to change its direction of travel. For this the board itself must shoulder most responsibility. They failed to publish the trustworthy information necessary for investors who relied on public statements to assess the strength of the company. Investors who sought to discuss their concerns about management failings with the board were met with unconvincing and incompetent responses. Investors were left with little option other than to divest.
114.It is not surprising that the board failed to attract the large injection of capital required from investors; we are aware of only one who even considered this possibility. In the absence of strong incentives to intervene, institutional investors acted in a rational manner, based on the information they had available to them. Resistance to an increase in bonus opportunities, regrettably, did not extend to direct challenges to board members. Carillion may have held on to investors temporarily by presenting its financial situation in an unrealistically rosy hue; had it been more receptive to the advice of key investors at an earlier stage it may have been able to avert the darkening clouds that subsequently presaged its collapse.
115.It is the responsibility of the board of directors to prepare and approve the company’s financial accounts. The role of the auditor is to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement. If they are unable to obtain sufficient appropriate audit evidence to support that assessment, they should issue a modified opinion on the accounts, noting the areas of the accounts that are the cause of that modification.
116.KPMG were Carillion’s auditors for all 19 years of the company’s existence from 1999. Such a long tenure inevitably calls into question whether they could provide the independence and objectivity that is crucial to high-quality audit. Legislation passed in 2014 requires listed companies to change their audit firm after a maximum of 20 years. Transitional arrangements, however, meant that Carillion would not have had to replace KPMG until 2024. KPMG said that its independence was not impaired after 19 years auditing Carillion. Michelle Hinchliffe, KPMG’s Head of Audit, said she did not believe this was “too long to be impartial” and that “independence for me is a mindset. For myself and all my fellow partners, independence and integrity are absolutely critical to our profession”.
117.Over 19 years, KPMG charged Carillion £29 million in audit fees, alongside additional charges for taxation and other assurance services. Carillion’s financial statements show that over that period, KPMG never found reason to offer a qualified audit opinion on the accounts. On 29 January 2018, shortly after Carillion collapsed, the FRC announced an inquiry into the 2014, 2015 and 2016 audits, with particular focus on the “company’s use and disclosure of the going concern basis of accounting, estimates and recognition of revenue on significant contracts, and accounting for pensions”. KPMG welcomed the investigation, stating “it is important that regulators acting in the public interest review the audit work related to high profile cases such as Carillion”.
118.When we questioned KPMG about the provision Carillion made in July 2017, KPMG’s responses mirrored those of Carillion’s directors: the causes all related to events that took place after the publication of the accounts on 1 March 2017. They listed factors including “worsening delays leading to forecast reassessments”, “unexpected site-specific developments” and “the developing political and economic situation in the Middle East, particularly events in Qatar”, as being responsible for the contract provision.
119.Those conclusions followed an enhanced management review of key contracts in May 2017, which was audited by KPMG. KPMG noted that the review was a “deep dive”, and “beyond the level of detail that would typically be completed by the audit team”. They also highlighted some of Carillion’s aggressive accountancy practices, including that “claims are booked earlier in the Group than would be by certain others in the industry” and that there was “a lack of consistency and guidance around the Group in when to recognise value on claims”. That these findings only became apparent after “deep dives” raises questions over the adequacy of KPMG’s core audit work. Peter Meehan, the KMPG Audit Partner who signed off the accounts, told us that his company’s previous work was extensive, citing large numbers of site visits. Yet KPMG neither identified nor challenged Carillion’s aggressive approach to revenue accounting on specific contracts.
120.KPMG was aware that recognition of contract revenue was the most significant risk in Carillion’s accounts: it is acknowledged as such in its 2016 audit report. The report narrative, however, merely described in general terms the inherent risks around accounting for construction contracts and described generic audit procedures carried out to mitigate that risk. KPMG did not in any way allude to Carillion’s unusually optimistic outlook. Murdo Murchison told us that his investment company relied on audited financial results, but they were “clearly not a good guide” to the state of Carillion. More valuable information was included in KPMG’s February 2017 presentation to the Carillion audit committee, which noted that “overall the traded position on contracts is challenging, but when considered in conjunction with the provisions [ … ] is reasonable”. That conclusion too was flawed, but it did at least admit to contract challenges. This concern was not, however, deemed worthy of inclusion in KPMG’s published audit report.
121.KPMG’s blind spots with regard to Carillion were not isolated to its audits of that company. The FRC examines a sample of audits for each major audit firm operating in the UK in annual audit quality reviews (AQR). Though Carillion was not part of the FRC’s 2016–17 KPMG sample, the report of that review called on KPMG to “re-assess [its] approach to the audit of revenue and the related training provided” and found that “insufficient revenue testing was performed on certain audits”.
122.The AQR report also noted weaknesses in KPMG’s testing for impairments to goodwill, stating that there was sometimes “insufficient challenge of management’s assumptions”. Carillion’s balance sheet was propped up by goodwill. In the 2016 accounts it was recorded as £1.6 billion, 35% of the company’s gross assets and more than double its net assets of £730 million. This goodwill was accumulated through acquisitions, as the difference between the book value of the company purchased and the price Carillion paid. It accounts for intangible assets of the purchased companies, such as the workforce, brand, and synergies with Carillion. It is reasonable to posit that these assets might decline over time, particularly if, like Eaga for example, the purchased business proved to be loss-making. Accounting standards require the assumptions used to estimate goodwill to be tested each year to evaluate whether it should be impaired, or reduced in value, in the accounts.
123.Carillion’s goodwill was never impaired in its annual accounts. This indicates the company remained confident that the amount it paid for each acquisition was justified due to the continued economic benefits it expected to derive from them. This is difficult to justify for some of Carillion’s purchases. £330 million of goodwill was recorded when Eaga was purchased in 2011, yet after five consecutive years of substantial losses, that figure remained unchanged, despite Philip Green admitting the purchase was a “mistake”. KPMG’s 2017 half-year update to the board indicates the flimsiness of Carillion’s calculations that justified not impairing any of their goodwill. They found that “historically at least 80% of the Group’s net present value has been derived from the perpetuity calculation”. This means that 80% of the value of cash flows Carillion hoped to achieve through acquisitions was predicated on the assumption that those cash flows would continue in perpetuity. Such assumptions were not disclosed by the company or its auditor. The Secretary of State for Business, Energy and Industrial Strategy has confirmed that the FRC are looking at Carillion’s treatment of goodwill as part of their investigation.
124.KPMG audited Carillion for 19 years, pocketing £29 million in the process. Not once during that time did they qualify their audit opinion on the financial statements, instead signing off the figures put in front of them by the company’s directors. Yet, had KPMG been prepared to challenge management, the warning signs were there in highly questionable assumptions about construction contract revenue and the intangible asset of goodwill accumulated in historic acquisitions. These assumptions were fundamental to the picture of corporate health presented in audited annual accounts. In failing to exercise—and voice—professional scepticism towards Carillion’s aggressive accounting judgements, KPMG was complicit in them. It should take its own share of responsibility for the consequences.
125.Carillion’s board were supported by an assortment of companies offering a range of professional services. Among these were Deloitte, who alongside KPMG, EY and PwC comprise the “Big Four” audit and professional services firms. Deloitte acted as Carillion’s internal auditors, charging on average £775,000 a year since 2010. The role of internal audit is to “provide independent assurance that an organisation’s risk management, governance and internal control processes are operating effectively”. Although Deloitte made a number of recommendations through their internal audit reports, they rarely identified issues as high priority. Only 15 out of 309 recommendations between 2012 and 2016 were deemed as such. Likewise, across 61 internal audit reports in 2015 and 2016, only a single report in 2016 found inadequate controls. They were responsible for advising on financial controls such as debt recovery, yet were unaware of the dispute with Msheireb over who owed whom £200 million. They also did not appear to have expressed concern over the high risk to the business of a small number of contracts not being met. Deloitte were responsible for advising Carillion’s board on risk management and financial controls, failings in the business that proved terminal. Deloitte were either unable to identify effectively to the board the risks associated with their business practices, unwilling to do so, or too readily ignored them.
126.Deloitte’s role with Carillion was not confined to internal audit. Among other roles, they acted as advisors to the remuneration committee, offered due diligence on the disastrous takeover of Eaga in 2011 and then received £730k for attempting a subsequent transformation programme at Eaga. Such widespread involvement in Carillion was simply par for the course for the Big Four accountancy firms. Over the course of the last decade, they collectively received £51.2 million for services to Carillion, a further £1.7 million for work for the company’s pension schemes and £14.3 million from Government for work relating to contracts with Carillion.
127.EY, another member of the Big Four, were particularly heavily involved with Carillion after the profits warning in July 2017. They were appointed to oversee “Project Ray”, a transformation programme designed to reset the business. Carillion paid them £10.8 million over a six-month period, in part to identify up to £123 million of cost savings, mainly to be met through a 1,720 reduction in full-time UK employees. Those savings were not achieved before the company collapsed. EY also helped negotiate the agreement with the pension Trustee to defer £25 million in deficit recovery contributions and a “time to pay” arrangement with HMRC in October 2017 that deferred £22 million of tax obligations. As we noted earlier, EY even suggested extending standard payment terms to suppliers to 126 days. Their own fees, however, were not deferred. On Friday 12 January 2018, three days before the company was declared insolvent and one day before Philip Green wrote to the Government pleading for taxpayer funding to keep the company going, Carillion paid EY £2.5 million. On the same day, it paid out a further £3.9 million to a raft of City law firms and other members of the BigFour.
Table 2: Carillion’s payments to advisers on 12 January 2018
Amount paid (£)
Willkie Farr & Gallagher UK
Sacker & Partners
Mills & Reeve
Lazard & Co
Freshfields Bruckhaus Deringer
Ernst & Young
Slaughter and May
128.Philip Green told us that Carillion “took advice every step of the way” from a range of big name advisers:
We sought very strongly at Carillion to make sure that we had quality advice, whether it was Slaughter & May as our lawyers, Lazard as our bankers or Morgan Stanley as our brokers. We believed we had high quality advice in the Carillion situation [ … ].
Though Philip Green listed Morgan Stanley above, his board marginalised them as brokers in July 2017. This decision was taken after Morgan Stanley told the Carillion board that it would not underwrite a proposal to raise further equity. This was because it had concluded that “Carillion’s senior management could neither produce nor deliver an investment proposition that would convince shareholders and new investors to support the potential rights issue”. After Morgan Stanley’s representatives left that board meeting, the board concluded the broker’s position was “not credible” and that while it would be necessary to “continue to work with them as brokers in the short term that would clearly change in the future”. Morgan Stanley confirmed that HSBC were appointed as joint corporate broker on 14 July and that thereafter “Carillion sought our advice less frequently”.
129.Carillion’s directors were supported by an array of illustrious advisory firms. Names such as Slaughter and May, Lazard, Morgan Stanley and EY were brandished by the board as a badge of credibility. But the appearance of prominent advisors proves nothing other than the willingness of the board to throw money at a problem and the willingness of advisory firms to accept generous fees.
130.Advisory firms are not incentivised to act as a check on recklessly run businesses. A long and lucrative relationship is not secured by unduly rocking the boat. As Carillion unravelled, some firms gave unwelcome advice. Morgan Stanley explained that the opportunity to raise equity to keep the company afloat had passed. Carillion simply marginalised them and sought a second opinion. By the end, a whole suite of advisors, including an array of law firms, were squeezing fee income out of what remained of the company. £6.4 million disappeared on the last working day alone as the directors pleaded for a taxpayer bailout. Chief among the beneficiaries was EY, paid £10.8 million for its six months of failed turnaround advice as Carillion moved inexorably towards collapse.
131.Trustees invest the assets of a pension scheme and are responsible for ensuring it is run properly and that members’ benefits are secure. In this role, trustees negotiate with the sponsoring employer on behalf of the scheme members. As we noted earlier in this report, a single trustee board (the Trustee) represented the large majority of Carillion’s DB scheme members.
132.Gazelle, who acted as covenant advisors to the Trustee, told us that Carillion may have set out to “manage” the Trustee so that it “did not present an effective negotiating counterparty” to the company. This was done in part through the “dominating influence” of Carillion employees, who faced an inherent conflict of interest, on the Trustee board. Robin Ellison, the Trustee Chair, disagreed stating that “all the directors of the trust company were independently-minded”. Gazelle also cited Carillion’s budgetary control over the Trustee that “may have limited the ability of the Trustee to itself obtain detailed advice on more complex issues”, and pressure exerted on the scheme actuary by Carillion at trustee meetings.
133.Despite these limitations, and as we considered earlier in this report, the Trustee pushed Carillion hard to secure additional contributions to fund the pension deficits. They also consistently acted on advice from The Pensions Regulator on their approach to dealing with company. Both the 2008 and 2011 valuations were agreed well outside the statutory 15-month deadline as the Trustee sought to obtain a better deal. Although agreements were eventually signed by the Trustee and Carillion on these valuations, Robin Ellison argued that they were effectively “imposed”. As Mr Ellison noted, “the powers of pension fund trustees are limited and we cannot enforce a demand for money”. TPR does have a power to impose contributions, and the Trustee wrote to TPR requesting “formal intervention” on behalf of scheme members with regard to the 2013 valuation and recovery plan.
134.The pension trustees were outgunned in negotiations with directors intent on paying as little as possible into the pension schemes. Largely powerless, they took a conciliatory approach with a sponsor who was their only hope of additional money and, for some of them, their own employer. When it was clear that the company was refusing to budge an inch, they turned to the Pensions Regulator to intervene.
135.The Pensions Regulator had an active interest in the Carillion pension schemes for the last decade of the company’s life. While it was involved in negotiations between Carillion and the Trustee over the 2008 valuation and recovery plan, this involvement was “less intense” than its “proactive engagement” on the 2011 valuation. Following the July 2017 profit warning, TPR participated in a series of meetings to discuss the company’s deferral of pension contributions.
136.Earlier in this report, we found that, having adopted an intransigent approach to negotiation, Carillion largely got its way in resisting making adequate deficit recovery contributions following the 2011 valuation. TPR argued, however, that its involvement led to an increase of £85 million in contributions by Carillion across the recovery period. This figure is derived by comparing Carillion’s initial offer of £33.4 million for 16 years with the final agreed plan, which had contributions rising from £25 million in 2013 to £42 million by 2022. To what extent TPR were responsible for that increase is unclear. What is not, though, is that the £85 million was a long way short of the additional £342 million the Trustee was seeking through annual contributions of £65 million. The agreed plan was also heavily backloaded, with initial contributions of £33 million matching the company’s offer and steps up in contributions only occurring in later years, when it would regardless be superseded by a new valuation and recovery plan. Gazelle described the TPR’s intervention as “disappointing” and expressed bafflement at how Richard Adam “managed to persuade the Pensions Regulator not to press for a better recovery plan”.
Figure 7: 2013 pension deficit recovery plans
Source: Analysis of Trustee minutes and scheme annual reports
137.If a company is failing to honour its obligations to fund a pension scheme, TPR has powers, under section 231 of the Pensions Act 2004, to impose a schedule of pension contributions. In 13 years, however, TPR has not used that power once with regard to any of the thousands of schemes it regulates. During the course of the 2011 negotiations, TPR repeatedly threatened to use its section 231 powers, making reference to them in correspondence on seven different occasions between June 2013 and March 2014. Carillion correctly interpreted these as empty threats. That is no surprise, given TPR’s evident aversion to actually using its powers to impose a contribution schedule.
138.TPR were also willing to accept recovery plans in the Carillion schemes that were significantly longer than the average of 7.5 years. Carillion and the Trustee’s agreed recovery plans averaged 16 years in both 2008 and 2011. TPR told us they do not want their approach to be “perceived as focused too heavily on the length of the recovery plan” and that longer plans may be appropriate where the trustees and employer have agreed higher liabilities based on “prudent assumptions”. Carillion, however, explicitly rejected more prudent assumptions, but was still allowed lengthy recovery plans.
139.There is also little evidence that TPR offered any serious challenge to Carillion over their dividend policy, despite their guidance acknowledging that dividend policy should be considered as part of a recovery plan. In April 2013, TPR confirmed to both the company and Trustee that they were “not comfortable with recovery plans increasing whilst dividends are being increased”. When questioned about Carillion’s dividend policy, however, TPR argued Carillion’s ratio of dividend payments to pension contributions was better than other FTSE companies and that they “cannot and should not prevent companies paying dividends, if that is the right thing to do”. TPR argued this approach to dividends is in keeping with their statutory objective to minimise any adverse impact upon the sustainable growth of sponsoring employers in its regulation of DB funding. This objective, however, only came into force in 2014, after both the 2008 and 2011 valuations. Carillion’s growth did, of course, not transpire to be sustainable.
140.TPR also has statutory objectives to reduce the risk of schemes ending up in the PPF and to protect member’s benefits. The PPF expects to take on 11 of Carillion’s 13 UK schemes, meaning the members of those schemes will receive lower pensions than they were promised. Even paying out lower benefits, the schemes will have a funding shortfall of around £800 million, which will be absorbed by the PPF and its levy-payers. TPR clearly failed in those objectives.
141.Following Carillion’s liquidation, TPR announced an investigation into the company which would allow them to seek funding from Carillion and individual board members for actions which constituted the avoidance of their pension obligations. We await the outcome of that investigation with interest but question the timing. TPR had concerns about schemes for many years without taking action. There are also no valuable assets left in the company, and while individual directors were paid handsomely for running the company into the ground, recouping their bonuses is unlikely to make much of a dent in an estimated pension liability of £2.6 billion. The Work and Pensions Committee’s 2016 report on defined benefit pension schemes found that TPR intervention tended to be “concentrated at stages when a scheme is in severe stress or has already collapsed”. Carillion is the epitome of that.
142.The Pensions Regulator’s feeble response to the underfunding of Carillion’s pension schemes was a threat to impose a contribution schedule, a power it had never—and has still never—used. The Regulator congratulated itself on a final agreement which was exactly what the company asked for the first few years and only incorporated a small uptick in recovery plan contributions after the next negotiation was due. In reality, this intervention only served to highlight to both sides quite how unequal the contest would continue to be.
143.The Pensions Regulator failed in all its objectives regarding the Carillion pension scheme. Scheme members will receive reduced pensions. The Pension Protection Fund and its levy payers will pick up their biggest bill ever. Any growth in the company that resulted from scrimping on pension contributions can hardly be described as sustainable. Carillion was run so irresponsibly that its pension schemes may well have ended up in the PPF regardless, but the Regulator should not be spared blame for allowing years of underfunding by the company. Carillion collapsed with net pension liabilities of around £2.6 billion and little prospect of anything being salvaged from the wreckage to offset them. Without any sense of irony, the Regulator chose this moment to launch an investigation to see if Carillion should contribute more money to its schemes. No action now by TPR will in any way protect pensioners from being consigned to the PPF.
144.The Financial Reporting Council (FRC) is the regulator of accountants, auditors and actuaries. It has a responsibility for maintaining high standards of financial reporting and auditing, and for pursuing sanctions against those who fall below established professional standards. It also has a wider mission to promote the integrity of UK business through its Codes on Corporate Governance and Stewardship. To this end, it seeks to “encourage companies to produce timely, relevant and trustworthy information about their performance, prospects and board behaviour”. While it can go to the courts to require revisions to accounts or reports, it generally operates by agreement with the companies concerned.
145.The FRC can also take legal action in respect of misconduct and breaches of professional standards, but the UK Corporate Governance Code operates on a “comply or explain” basis. Directors of companies are not subject to legal action for non-compliance with the Code and the FRC only has powers of persuasion in promoting adherence to its principles and guidance. It is principally a matter for shareholders to ensure that the board complies with the Code and runs the company effectively. Whilst the FRC has no business in intervening in the day-to-day management of companies to prevent them failing, it is responsible for maintaining confidence in the system of checks and balances which underpins the UK business environment by actively pursuing any failings in a timely manner, not least to act as a deterrent against future poor performance or misconduct.
146.In respect of Carillion, the FRC identified some concerns relating to disclosure of information as early as 2015. It reviewed the company’s accounts as part of its regular cycle of corporate reporting reviews, the subject of which are determined by risk profiling and the identification of priority sectors. It contacted the company in relation to twelve issues, ranging from a lack of clarity in goodwill assumptions to inadequate explanation of a significant decline in the book to bill ratio. Carillion made the requisite disclosures in subsequent accounts, but crucially, the FRC did not follow up by reviewing Carillion’s accounts the following year, nor by investigating further. The Chief Executive of the FRC, Stephen Haddrill, told us that, “with hindsight, clearly it would have been better to have had a further look”, but that “we did not think that the lack of disclosure was symptomatic of something more serious”. The FRC had not reviewed the auditing of the Carillion accounts by KPMG since 2013. In spite of subsequent reports of aggressive accounting practices and evidence of the extensive shorting of Carillion stock, the FRC did not choose to take a closer look at the accounts of Carillion, nor the auditing of them, until after the first profit warning in July 2017.
147.Shortly after the collapse of Carillion in January 2018, the FRC announced that it had been “actively monitoring this situation for some time in close consultation with other relevant regulatory bodies”. This was not, however, active monitoring of the accuracy of disclosure of information by the company; it was instead a review of the previous audit begun in July 2017. The fact that this review was underway could not be made public until after the company’s collapse due to confidentiality requirements, which Stephen Haddrill told us he had been trying to get around in some respects and were in need of review.
148.On January 29 2018 the FRC announced an investigation into the auditing by KPMG of Carillion’s financial statements from 2014 onwards under its audit enforcement procedure. On 19 March 2018 it announced specific investigations into the conduct of Richard Adam and Zafar Khan, in relation to the preparation and approval of Carillion’s financial statements during this period. Under its existing powers, the FRC can only take action against those with accounting qualifications. Stephen Haddrill told us that the FRC would conduct these inquiries “as fast as possible” but could not estimate any timescale. The FRC routinely aims to complete such investigations in around two years. Mr Haddrill told us that the FRC’s enforcement team had been increased from 20 to 29 since January 2016, with further expansion planned. While we welcome the swift announcement of investigations into the audit of Carillion and the conduct of the Finance Directors responsible for the accounts, we have little faith in the ability of the FRC to complete important investigations in a timely manner. We recommend changes to ensure that all directors who exert influence over financial statements can be investigated and punished as part of the same investigation, not just those with accounting qualifications.
149.The FRC was far too passive in relation to Carillion’s financial reporting. It should have followed up its identification of several failings in Carillion’s 2015 accounts with subsequent monitoring. Its limited intervention in July 2017 clearly failed to deter the company in persisting with its over-optimistic presentation of financial information. The FRC was instead happy to walk away after securing box-ticking disclosures of information. It was timid in challenging Carillion on the inadequate and questionable nature of the financial information it provided and wholly ineffective in taking to task the auditors who had responsibility for ensuring their veracity.
150.Crown Representatives were introduced in 2011 to “manage the relationship between Government and each of its strategic suppliers”, and act as a focal point of for their contact with Government. Carillion easily met the definition of a strategic supplier. Philip Green described Carillion’s relationship with its Crown representative as “transparent” and the “key relationship” it had with Government. Richard Howson said he met with the Crown Representative each quarter and on an ad hoc basis in between.
151.As part of its management of key strategic suppliers, the Cabinet Office is responsible for monitoring “publicly available sources for financial information [ … ] including in particular information about “trigger events” that could potentially lead to the invocation of financial distress measures in Government contracts”. Such information is expected to be shared with the Crown Representative to discuss with the supplier. A profit warning is one such trigger event. Carillion issued three profit warnings between July and November 2017, yet between August and November 2017 there was no Crown Representative in place for Carillion, owing to “normal staff turnover”. The Government have conceded that this was a “longer-than-usual delay” as they sought someone with experience of corporate restructuring rather than company finances. Officials maintained that the July profit warning was a complete surprise to them, but that contact was subsequently stepped up, and 25 meetings between the Government and Carillion were held between July and January.
152.The assignment of a Crown Representative to Carillion served no noticeable purpose in alerting the Government to potential issues in advance of company’s July 2017 profit warning. The absence of one between August and November 2017 cannot have increased the Government’s ability to keep itself informed of the direction of the company during a critical period before its collapse.
153.Carillion formally approached the Government to ask for financial assistance on 31 December 2017, when it became clear that it was a prerequisite of discussions with existing lenders about further support. Though the Government was by that stage involved in discussions with Carillion, the only relief they had granted the company was a deferral of tax liabilities under a HMRC “time to pay arrangement” worth £22 million in October 2017.
154.Discussions with the Government continued over the first two weeks of 2018. The company made a further request to HMRC to defer tax liabilities totalling £91 million across the first four months of 2018. HMRC refused to accept the request at that point, stating that it would have to be referred to their Commissioners. On 13 January 2018, Philip Green wrote a final letter to the Cabinet Office making the case for Government to provide guarantees of up to £160 million to the company between January and April 2018. Unless this money was provided, Mr Green noted the probability that they would have to file for insolvency. He claimed it was in Government’s best interest to provide this funding because they did not have a viable contingency plan in place and allowing Carillion to fall into liquidation would “come with enormous cost to HM Government, far exceeding the costs of continued funding for the business”. Mr Green argued that in such a scenario that there would be “no real ability to manage the widespread loss of employment, operational continuity, the impact on our customers and suppliers, or (in the extreme) the physical safety of Carillion employees and the members of the public they serve”.
155.The Government ignored these claims, aimed at propping up a failing business model, and rejected the request. Ministers rightly argued that “taxpayers should not, and will not, bail out a private company for private sector losses or allow rewards for failure”. £150 million was made available by the Government to support the insolvency in 2017–18, as well as an unquantified contingent liability to indemnify the Official Receiver.
156.In his last-minute ransom note, Philip Green clearly hoped that, faced with the imminent collapse of Carillion, Government would conclude it was too big to fail. But the Government was correct not to bail out Carillion. Taxpayer money should not be used to prop up companies run by such negligent directors. When a company holds 450 contracts with the Government, however, its collapse will inevitably have a signficant knock-on effects for the public purse. It is simply not possible to transfer all the risk from the public to the private sector. There is little chance that the £150 million of taxpayer money made available to support the insolvency will be fully recovered.
157.The Minister for the Cabinet Office, the Rt Hon David Lidington MP, told the Liaison Committee that, in the absence of a Government bailout, there were only two options for the company:
Sarah Albon, Chief Executive of the Insolvency Service told us that private insolvency practitioners were unwilling to take on the administration because there was not “certainty that there was enough money left in the company to pay their costs”. At 6.40am on 15 January 2018, the High Court granted a winding-up order for Carillion plc and five subsidiaries, appointing David Chapman, the Official Receiver, as liquidator.
Box 4: Administration or liquidation
158.The Official Receiver took on two major roles. First, it had to act as liquidator with responsibility to sell Carillion’s assets and distribute the returns to creditors. Untangling Carillion’s businesses and contracts required work at an unprecedented scale for the Insolvency Service. This was not helped by the administrative chaos in which Carillion was left. In particular, the Official Receiver found an absence of basic records. Second, and far more unusually, the Official Receiver was required by Government to take over the running of the wide range of public services provided by Carillion. Given the unique scale of work required to both manage the insolvency and maintain services, the Official Receiver applied to the High Court at the time of the winding-up petition to appoint Special Managers to assist him. Since the liquidation process began, the Official Receiver has secured the employment of more than 11,000 former Carillion employees, ensured the continued operation of public services, and reduced payment times for suppliers from Carillion’s 120 day terms to 30 days. We welcome the work undertaken by the Official Receiver and his team since the insolvency, although we regret that more than 2,000 Carillion employees have been made redundant. The Official Receiver agreed to support compulsory liquidation, and sought the appointment of Special Managers, in the best interests of the taxpayer and has sought to achieve the best possible outcome for employees, suppliers and other creditors.
159.In a letter to us, the Official Receiver explained that due to the speed of the final collapse of Carillion, he was unable to tender for the Special Managers he needed to support him. Instead, he made an immediate choice based on the criteria of “a firm that was not conflicted; which had sufficient resources to undertake this complex liquidation; and that had some existing knowledge of the Carillion group”. It is difficult to envisage how a company might have knowledge of Carillion and not be conflicted. However, the Official Receiver decided, and the High Court concurred, that PwC best met these criteria. PwC had undertaken a range of work for, or relating to Carillion, in the decade leading up to its collapse. Most recently, it had supported the Cabinet Office in its cross-Government contingency planning for Carillion, up to and including advice on insolvency and the continuity of public services. David Kelly, one of the PwC Special Managers, told us that he believed Carillion’s work preparing Government for Carillion’s insolvency did not represent a conflict. This is questionable. But the requirement for “sufficient resources”, which required large numbers of staff to start work on the insolvency within 12 hours of notification, limited the options to the Big Four accountancy firms. Despite PwC’s extensive prior involvement in Carillion, given that KPMG was Carillion’s external auditor, Deloitte its internal auditor and EY was responsible for its failed rescue plan, it was certainly credible for the Official Receiver to consider those other Big Four companies more conflicted. We consider competition and the Big Four in Chapter 3. In applying to the Court to appoint PwC as Special Managers to the insolvency, the Official Receiver was seeking to resource a liquidation of exceptional size and complexity as quickly and effectively as possible from an extremely limited pool.
160.The administrative costs of the liquidation, underwritten by the taxpayer, consist primarily of the work of the Official Receiver and his team, and of the Special Managers and other PwC staff that support them. In appointing the Special Managers, the High Court is also responsible for approving their remuneration by an application from the Official Receiver from time to time. In March 2018 we took evidence from one of the Special Managers, David Kelly, and sought an update on the costs, and potential costs to the taxpayer of PwC’s work. Mr Kelly, who is charged out at £865 per hour, told us that the cost of his firm’s first eight weeks of work would be £20.4 million. PwC’s staff were working at an average hourly rate of £360 per hour, and they had 112 people working on Carillion in the week prior to their evidence. Mr Kelly was able to give no indication of the daily cost of the liquidation, no suggestion of the number of PwC staff that would be required even just a week into the future, and no estimate at all of what PwC’s total fees would be at the conclusion of their work. Across their 15 to 16 workstreams, PwC were unable to suggest any performance indicators for their success, beyond the underpinning priority of the maintenance of critical Government services. While the Official Receiver and the High Court will be able to review and challenge PwC’s fees, we heard little evidence of challenge or scrutiny of the work of the Special Managers to date. The PPF told us that under normal insolvency procedures, their role as an unsecured creditor—when a company collapses with a pension deficit they are often the largest—gives them rights, which they take-up, to scrutinise the work and fees of the administrators or liquidators. They have no formal role, however, in scrutinising the work of the Special Managers.
161.We are concerned that the decision by the court not to set any clear remuneration terms for PwC’s appointment as Special Managers, and the inability of the appointees to give any indication of the scale of the liquidation, displays a lack of oversight. We have seen no reliable estimates of the full administrative costs of the liquidation, and no evidence that Special Managers, the Official Receiver or the Government have made any attempt to calculate it. We have also seen no measures of success or accountability by which the Special Managers are being judged.
162.As advisors to Government and Carillion before its collapse, and as Special Managers after, PwC benefited regardless of the fate of the company. Without measurable targets and transparent costs, PwC are continuing to gain from Carillion, effectively writing their own pay cheque, without adequate scrutiny. When the Official Receiver requires the support of Special Managers, these companies must not be given a blank cheque. In the interests of taxpayers and creditors, the Insolvency Service should set and regularly review spending and performance criteria and provide full transparency on costs incurred and expected future expense.
163.From the tone of the letter sent to the Government on 13 January, it appears that the Carillion board expected the Government to provide the necessary guarantees to keep the company afloat. It states that “to date, the board has been able to conclude that, for so long as key stakeholders (including HM Government) continue to engage meaningfully in relation to the provision of short term funding and a longer term restructuring, it is appropriate to continue”. We do not have information on the substance of the conversations between the board and Cabinet Office officials during the preceding weeks, but it is difficult to believe that the Government would have given an indication that Carillion could expect long-term support, given the clear policy on private sector bailouts enunciated by the Minister. It must have been clear by the end of December, if not much earlier, that an injection of capital from another source was out of the question. Without Government support, insolvency or liquidation must have seemed inevitable. This calls into question whether the board was engaged in wrongful trading.
164.Under insolvency law, a director may be guilty of wrongful trading if they knew, or ought to have known, that there was “no realistic prospect” of the company avoiding liquidation or administration. Once an insolvency process becomes inevitable, directors are obliged to seek to minimise the loss to the company’s creditors. By January 2018, if not before, it must have been clear to the board that only a bailout from Government could save the company. It is of course up to the courts to determine, following any application from the liquidator, whether any offence was committed, and in respect of what period. Given that, as far as we know, no indications had been given that a bailout would be forthcoming, and that the board apparently took no steps to minimise the potential loss to creditors, there must at least be a question as to whether individual directors could reasonably be accused of wrongful trading.
165.Under section 172 of the Companies Act 2006, a director is required to act “in a way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”. In doing so, directors are required to “have regard to” a wide range of considerations, including “the likely consequences of any decision in the long term”, “the interests of the company’s employees”, the need to foster the company’s business relationships with suppliers, customers and others”, and “the desirability of the company maintaining a reputation for high standards of business conduct”. Board minutes from 15 December 2017, exactly one month before the liquidation, show that Philip Green specifically reminded the board of these duties, and of previous advice on them from legal advisors. However, we have seen that, at the very least, there are questions to be asked about the extent to which Carillion’s directors had regard to each of these considerations in running the company. Breaches of these duties can form the basis of proceedings brought by the Secretary of State for disqualification as a director under the Disqualification of Directors Act 1986.
166.In Chapter 1, we argued that the business model was based on generating new business rather than pursuing the long-term strategic interests of the company. We also argued that managers had little regard to the need to foster business relationships with suppliers: late payment practices took advantage of smaller suppliers as a matter of practice. This approach was at odds with any notion of maintaining a reputation for high standards of business conduct. We have also argued that the board failed to look after the interests of their employees and former employees by under-funding their pension schemes in favour of cash elsewhere. In evidence to us, Carillion’s board members did not give the impression that they were acutely conscious of the wide range of legal duties they had, nor of the prospect of any penalties arising from failure in this regard. It is difficult to conclude that they adequately took into account the interests of employees, their relationships with suppliers and customers, the need for high standards of conduct, or the long-term sustainability of the company as a whole. Any deterrent effects provided by section 172 of the Companies Act 2006 were in this case insufficient to affect the behaviour of directors when the company had a chance of survival. We recommend that the Insolvency Service, as part of its investigation into the conduct of former directors of Carillion, includes careful consideration of potential breaches of duties under the Companies Act as part of their assessment of whether to take action for those breaches or to recommend to the Secretary of State action for disqualification as a director.
Box 5: Section 172 of the Companies Act 2006
167.The consequences of the collapse of Carillion are a familiar story. The company’s employees, its suppliers, and their employees face at best an uncertain future. Pension scheme members will see their entitlements cut, their reduced pensions subsidised by levies on other pension schemes. Shareholders, deceived by public pronouncements of health, have lost their investments. The faltering reputation of business in the eyes of the public has taken another hit, to the dismay of business leaders. Meanwhile, the taxpayer is footing the bill for ensuring that essential public services continue to operate. But this sorry tale is not without winners. Carillion’s directors took huge salaries and bonuses which, for all their professed contrition in evidence before us, they show no sign of relinquishing. The panoply of auditors and other advisors who looked the other way or who were offered an opportunity for consultancy fees from a floundering company have been richly compensated. In some cases, they continue to profit from Carillion after its death. Carillion was not just a failure of a company; it was a failure of a system of corporate accountability which too often leaves those responsible at the top—and the ever-present firms that surround them—as winners, while everyone else loses out. It is to the wider lessons of Carillion’s collapse that we now turn.
340 Financial Reporting Council, , Principle 3
341 Financial Reporting Council, , Principle 4
342 [Amra Balic]; , 7 March 2017
343 [Euan Sterling]
344 [Euan Stirling]
345 [Amra Balic]
346 [Euan Stirling]
347 , 2 February 2018
348 [Murdo Murchison]
349 , 2 February 2018
350 [Amra Balic]
351 , 2 February 2018
352 Companies Act 2006, and
353 Financial Reporting Council, , p 4
354 Financial Reporting Council, , p 3
355 Financial Reporting Council, , February 2017, p 4
356 Carillion plc, , p 63
357 [Michelle Hinchliffe]
358 Financial Reporting Council, , 29 January 2018
359 , 2 February 2018
360 , 2 February 2018
361 KPMG, Enhanced contracts review and half year update, 9 July 2017 (not published)
362 As above.
363 [Peter Meehan]
364 Carillion plc, , p 86
365 [Murdo Murchison]
366 Carillion plc, February 2017 Audit Committee papers (not published)
367 Financial Reporting Council, , June 2017
368 Financial Reporting Council, , June 2017
369 Carillion plc, , p 93 and p 109
370 International Financial Reporting Standards, , accessed 1 May 2018. Up until 2004, the reporting standards allowed for goodwill to be amortised rather than tested annually for an impairment. Amortisation reduces the value of an intangible asset annually so if this accounting treatment had still been in force, Carillion would have had to report substantially lower levels of goodwill in their accounts.
371 An impairment of £134 million was included in the interim financial statements for 2017. Carillion plc, , p 1
372 Carillion plc, , p 92
373 , 20 February 2018
374 KPMG, Enhanced contracts review and half year update, 9 July 2017 (not published)
375 , 30 April 2018
376 , 2 February 2018
377 Chartered Institute of Internal Auditors, , accessed 1 May 2018
378 Analysis of Deloitte’s internal audit reports to the audit committee.
379 As above.
380 [Michael Jones]
381 [Michael Jones]
382 , 2 February 2018
383 Work and Pensions Committee, , 13 February 2018. Note that the original total quoted here for pension scheme work was £6.1 million. PwC subsequently informed us that out of a total of £4.6 million that they gave us for work done on the Electric Supply Pension Scheme, only £200,000 related to Carillion. , 23 February 2018
384 , 25 January 2018
385 As above.
386 EY Project Ray Board meeting, Carillion audit committee papers, 22 August 2017 (not published)
387 Carillion plc, Weekly reporting pack, 27 October 2017 (not published)
388 Carillion plc, Weekly reporting pack for week ending 26 November actuals, 8 December 2017 (not published)
389 Business, Energy and Industrial Strategy Committee and Work and Pensions Committee, , 12 March 2018
390 [Philip Green]
391 [Philip Green]
392 Carillion plc, , 5 July 2017
393 As above.
394 , 21 February 2018
395 As above.
396 The Pensions Regulatory, , accessed 22 April 2018
397 Trustee data shows that at the end of 2013, total membership across the six schemes under the trusteeship of Carillion (DB) Pension Trustee Ltd was 20,587 - Carillion plc’s show that total membership across all schemes was 28,785 at the end of 2013.
398 , 29 March 2018
399 As above. Trustees who are employees of the sponsor are a common feature of Trustee boards.
400 [Robin Ellison]
401 , 29 March 2018
402 27 June 2013; , 27 July 2011; , 9 April 2013
403 [Robin Ellison]
404 [Robin Ellison]
405 , 9 April 2013
406 [Mike Birch]
407 , 26 January 2018
408 [Mike Birch], [Lesley Titcomb]
409 , 29 March 2018, p 7
410 Pensions Act 2004,
411 , 12 March 2018. Over 5,500 schemes are eligible for the PPF.
412 As above.
413 The Pensions Regulator, , June 2017, p 7
414 , 12 March 2018
415 The Pensions Regulator, June 2014, p 3
416 Carillion single Trustee, , 29 April 2013
417 [Lesley Titcomb]
418 , 20 February 2018
419 , 26 January 2018
420 £2.6 billion is the provisional estimate being made as to the deficit of the schemes on a section 75 basis, which is the size of the deficit according to how much would be paid to an insurance company to buy-out the liabilities. Although the section 75 debt will not be met as there are insufficient assets left in the company, that is the figure that becomes due on insolvency.
421 Work and Pensions Committee, Sixth Report of Session 2016–17, , HC 55, p 4
422 Financial Reporting Council, , accessed 23 April 2018
423 , 2 February 2018
424 , 2 February 2018. The book to bill ratio is the ratio of the number of orders received to the number billed for.
425 [Stephen Haddrill]
426 [Stephen Haddrill]
427 [Stephen Haddrill]
428 [Stephen Haddrill]
429 Financial Reporting Council , 15 January 2018
430 [Stephen Haddrill]
431 [Stephen Haddrill]
432 Financial Reporting Council, , 29 January 2018
433 Financial Reporting Council, , 19 March 2018
434 [Stephen Haddrill]
435 , 6 July 2016. We note that this period has almost expired in relation to the investigation into the audit by PwC of the BHS accounts.
436 Cabinet Office, , November 2012
437 The defines a strategic supplier as “those suppliers with contracts across a number of Departments whose revenue from Government according to Government data exceeds £100m per annum and/or who are deemed significant suppliers to Government in their sector.”
438 [Philip Green]
439 [Richard Howson]
440 Cabinet Office, , November 2012
441 As above.
442 [on Carillion], 7 March 2018
443 , 30 April 2018
444 Oral evidence taken before the Liaison Committee on 7 February 2018, HC 770 (2017–19), [John Manzoni]
445 High Court of Justice, In the matter of Carillion plc and in the matter of the Insolvency Act 1986, Exhibit: KC1 - First witness statement of Keith Robertson Cochrane, Dated: 15 January 2018 (Not published).
446 Carillion plc, Weekly reporting pack, 27 October 2017 (not published)
447 High Court of Justice, In the matter of Carillion plc and in the matter of the Insolvency Act 1986, Exhibit: KC1 - First witness statement of Keith Robertson Cochrane, Dated: 15 January 2018 (Not published).
448 Carillion plc, , 13 January 2018
449 , 13 January 2018
450 HC Deb, 15 January 2018,
451 HM Treasury, , February 2018, p 475 and p 496
452 Oral evidence taken before the Liaison Committee on 7 February 2018, HC 770 (2017–19), [David Lidington]
453 [Sarah Albon]. Keith Cochrane confirmed that PwC and EY declined to act as administrators. See High Court of Justice, In the matter of Carillion plc and in the matter of the Insolvency Act 1986, Exhibit: KC1 - First witness statement of Keith Robertson Cochrane, Dated: 15 January 2018 (Not published).
454 Carillion Construction Limited, Carillion Services Limited, Planned Maintenance Engineering Limited, Carillion Integrated Services Limited, and Carillion Services 2006 Limited.
455 , 5 February 2018
456 The collapse of Carillion, Briefing Paper , House of Commons Library, March 2018
457 HC Deb 15 January 2018,
458 [David Kelly]
459 “”, Financial Times, 20 January 2018
460 [Sarah Albon]
461 The Official Receiver has been supported by around 3,200 retained Carillion staff (as at 1 May 2018).
462 Insolvency Service, , 23 April 2018
463 Insolvency Service, , 23 April 2018; , 15 February 2018
464 Insolvency Service, , 23 April 2018
465 , 5 February 2018
466 , 2 February 2018
467 [David Kelly]
468 [David Kelly]
469 [David Kelly]
470 PwC, KPMG, Deloitte and EY.
471 , 5 February 2018
472 [David Kelly]
473 [David Kelly]
474 [David Kelly, Marissa Thomas]
475 As above.
476 , 20 February 2018
477 , 13 January 2018
478 Insolvency Act 1986, )
479 Companies Act 2006,
480 Carillion plc, Minutes of the board of directors, 15 December 2017 (not published)
Published: 16 May 2018