Carillion watchdog report: how its ‘misleading’ finances were produced

Last week, three former Carillion directors were landed with nearly £1m worth of provisional fines for what the Financial Conduct Authority (FCA) described as their roles in hiding the contractor’s sinking fortunes. Their actions amounted to “misleading [and] reckless […] market abuse”, the watchdog said.

If it were not in liquidation, the contractor itself would have been fined £37.9m.

At the time of its collapse, the Birmingham-headquartered company was the second-largest contractor in the UK and employed 43,000 people globally.

But when it disclosed an expected provision of £845m in July 2017, it shocked the market. Carillion’s share price tumbled by 39 per cent. Within three days it had fallen by 70 per cent. Six months later it collapsed.

In four lengthy reports, stretching to nearly 300 pages in total, the FCA has set out what it believes happened inside the contractor, from 1 July 2016 to 10 July 2017.

The FCA reports paint a picture of directors keeping crucial information from their audit committee and board, and changing their financial policies to paint a rosy picture of an increasingly desperate sink into collapse.

Former chief executive Richard Howson has been given a provisional £397,800 fine, while chief financial officer Richard Adam was handed one totalling £318,000. His successor, Zafar Khan, has been given a provisional fine of £154,400.

The trio are taking the regulator’s findings to the UK’s appeal court, known as the upper tribunal, which will decide whether to uphold the FCA’s fines or take further action.

Pressure to meet ‘unrealistic financial targets’

As the contractor moved through 2016 and into 2017, it was facing mounting problems on a range of jobs. These included its £286.1m scheme to design and build the Royal Liverpool Hospital, and a £296.9m job to construct the Midland Metropolitan Hospital.

But those issues did not fit with the budget and re-forecasting challenges laid out by Carillion’s senior management. The plans were becoming “increasingly challenging and difficult to achieve”, the FCA said.

Management put “significant pressure” on people within Carillion’s UK construction arm to “apply increasingly aggressive contract accounting judgements” to raise the apparent financial performance of projects. The employees who were pressured into the changes viewed those targets as “unrealistic”, according to the financial watchdog.

Mounting pressure from directors to reduce the reported costs on projects led to the adoption of new financial reporting methods, the FCA said.

The contractor began to use negative accruals on a number of large projects, including the Royal Liverpool Hospital and Aberdeen Western Peripheral Route. They had been “generally prohibited” by the contractor beforehand, but were adopted in an attempt to “hold the position” on its profit margin, the FCA said.

The negative accruals were claims that Carillion had against customers and suppliers on jobs that it treated as discounts on what it owed, even though the claims had not been realised.

The accounting approach effectively allowed Carillion to reduce its costs on projects.

In an internal email, a staff member said they could not make their profits meet the contractor’s targets and so costs had to be suppressed. “This has, unfortunately been done by applying negative accruals,” the email continued.

An investigation into the use of negative accruals by Carillion found the process was used on four major projects. The FCA report names three of these: the Royal Liverpool Hospital, Aberdeen Western Peripheral Route and phase one of the Battersea Power Station redevelopment. The use of the accruals across all four amounted to a £102m difference in its accounts.

Howson was told about the investigation into negative accruals and he was “regularly updated” on the progress of the investigation, according to the watchdog.

It was found that the use of negative accruals should be reversed, but that this would see costs jump. An internal statement published by the contractor said: “High-level instructions such as to ‘hold the position’ (i.e. maintain the traded margin) may, if crudely implemented, have unintended consequences.”

But, rather than restating its most recent accounts, as had been suggested, Carillion attempted to justify its 2016 accounts by “significantly increasing the value of certain claims”. In some cases, Carillion introduced “new claims or revenue streams” to bolster its position, the FCA said.

Reviews held back

On a quarterly basis, the contractor carried out major reviews into the work it was carrying out. These focused on the financial exposure linked to individual projects and included a traffic light system to show how serious the issues were.

Howson and other senior directors received a major contracts summary once they were finished.

In October 2016, one such summary identified a “likely” exposure to Carillion’s construction arm in the UK of £173m. Eleven of the 16 projects it had noted were marked with a red flag, and the amount had increased by £14m in comparison with the prior quarter.

Howson was also informed about the levels of financial risk at the contractor. Risk was forecast to reach around £172.7m by the end of December 2016. In January 2017, it was revealed that it had ballooned to £258.4m by December.

Due to his experience in the construction field, Howson “must have understood” the meaning of the revelations. “However, Mr Howson took no meaningful steps to understand, assess or address the increasing levels, and accumulated values of hard risk being reported to him,” the FCA said.

‘Must have been aware’

Howson’s reports to Carillion’s board and audit committee “painted a much more optimistic picture” than internal discussions showed, the FCA said. By reporting revenue “traded, not certified”, the accounts included revenue that had not yet been agreed with clients, thus giving it an additional boost.

The amounts reported in the announcements to the committees were false, and omitted vital information about what the revenues from certain jobs actually were. Howson, the FCA said, “must have been aware […] [with] his extensive knowledge of the construction industry” that the information would have been “highly relevant” to both the board and the audit committee. Despite that, he “failed” to ensure information was presented to either of the groups.

When Carillion put out its huge provisions for the first time in mid-2017, and saw its share prices dive, the monthly management accounts for its UK projects had provisions that were “broadly unchanged” at £17m. In fact, its provisions were much higher.

External auditors, who carried out a review of 58 of Carillion’s projects, covering nearly half of its revenue for the year, had recommended a provision of £695m in July 2017.

Howson, Khan and Adam are taking the FCA’s case to the upper tribunal appeal court.

Effects still being felt

The effects of Carillion’s collapse are still being felt across the industry.

At the time of its liquidation, Carillion was building the Midland Metropolitan Hospital. The job was thrown into disarray as the contractor fell apart and it is now six years behind schedule. Balfour Beatty took over the project after Carillion went bust.

The Royal Liverpool Hospital, which Carillion was also building, is set to open by October, some five years later than expected, with the facility being completed by Laing O’Rourke.

Carillion’s construction arm was estimated to have liabilities of close to £7bn when it went bust. It owed £1.9bn to creditors at the end of 2016, according to its last published set of accounts. It was known to have 30,000 suppliers – with some subsequent administrations blamed on its demise and the money it owed.

As one CN reader said on social media last week, after the fines were announced: “[They don’t] bring back all the companies that were left high and dry though, [do they]?”

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