When Carillion's Leaders Missed The Biggest Risk Of All
Members of Parliament aim criticism at directors as well as executives
The investigation of the collapse of Carillion plc, the U.K.’s second-biggest contractor and a major government service provider, has in a few weeks produced hundreds of pages of testimony and documents and withering verbal criticism by members of Parliament (MPs) directed at the company’s executives, accountants and pension regulators. The MPs recently aimed their critique at the company’s directors, accusing them of ignoring warnings of the dire situation created by Carillion’s huge debt and money-losing contracts.
Rachel Reeves, chair of the Business, Energy and Industrial Strategy Select committee, said that while Carillion’s difficulties were obvious to many observers, auditors and regulators, the firm’s directors “did nothing” to prevent the collapse. The company’s audits were “a colossal waste of time and money, fit only to provide false assurance to investors, workers and the public.”
Frank Field, chair of the Work and Pensions Select Committee, accused the company’s former finance director, Richard Adam, of “dumping” his remaining shares “at the first possible moment” following his retirement in December 2016. Adam sold shares worth more than $1 million by May 2017, according to financial data published by the committee.
Adam told the House of Commons committee that he disposed of the shares “in accordance with the procedures that the company put in place for everybody” and that he did not wish to keep them any longer or keep shares “of any substance in any company” in his retirement investments because of the risk.
During hours of testimony before members of Parliament on Feb. 6, the former leaders of Carillion owned up to numerous mistakes, which, combined with unexpected hardships, contributed to the company’s collapse on Jan. 15. Among them were the money-losing Aberdeen bypass project in Scotland, the inability to collect payments from work in Canada and the Middle East, the need to rebuild a key beam in a Liverpool hospital and an acquisition 10 years past that added to the company’s pension fund deficit.
But on the central matter under discussion—the company’s perception of the risk it was facing, its accounting methods and whether the top managers and directors met requirements for honest public disclosure—Carillion’s leaders were less contrite, even in the face of sarcasm and pointed accusations from members of Parliament.
On these points, Carillion’s executives claimed their judgments were reasonable and honest. They took pains to describe the complications of managing fixed-price construction contracts.
Richard Howson, who was replaced as chief executive last September after more than 20 years with the company, offered an explanation of how a contractor is obligated to continue funding and working on a project even when the cause of problems and final payment are disputed.
Crossrail Payments Noted
On Carillion’s contract for work on the big London Crossrail project, a value of $41.8 million won in 2014, the company’s costs and liabilities were around the $125-million range, but Carillion had only been paid $105.9 million, Howson testified. “So as was normal,” he continued, “we had to fund the construction of the project up to the end. Within two months of the end, we sought to settle our final account, and we settled our final account at just over $139 million, and the cash came in by year-end. In the intervening period, we had paid our suppliers.”
Prompted by the Carillion hearings, a prominent U.K. executive offered his thoughts about government outsourcing and a new approach going forward.
Rupert Soames, chief executive of Serco plc, which also provides outsourced services, is calling for the government to establish a code of ethics for outsourcing companies to prevent the practices that may have led to and worsened Carillion’s chaotic fall and liquidation.
Under Soames’ proposal, the U.K. would require companies to pay their subcontractors on time, properly fund their pensions schemes, maintain sensible balance sheets and foreswear, said Soames, “opaque financing to flatter their cash flow.” In exchange, public agencies would refrain from saddling contractors with “unmanageable” risk, such as the requirement that they bear risk for regulatory and legal changes for 10 years.
The inquiries include the company’s pension obligation, which cannot be met, and the role of KPMG, its accountant, in representing it as a going concern, albeit one with problems, in the last months of its operation. KPMG has replied that it relies for its accounting on numbers from its client and that “it does not follow automatically” from a company’s collapse “that management was wrong or that the auditor did a bad job.”
A recovery plan undertaken by Carillion’s leaders was fashioned to put the company on the mend, despite a huge $1.8-billion debt and several bad projects that drained working capital. Having issued three profit warnings since last July, Carillion failed to secure funding from its creditors. With sales of about $7 billion a year and losses forecast to exceed $1.4 billion, the firm had become virtually worthless.
The aftermath has been bitter for 1,371 employees who have lost their jobs, according to U.K.’s Insolvency Service. Another 8,100 jobs have been saved as the company’s parts are acquired by other employers as part of the liquidation.
As the inquiry unfolds—new documents were posted on the House of Commons website as ENR went to press—Carillion’s executives are seen in changing perspectives. Emma Mercer, the former chief financial officer who served in the position only a short time before the company’s final crisis, is one example. As her former colleagues did, Mercer noted at the Feb. 6 hearing that they were all engaged in a restructuring effort at Carillion. The MPs at first seemed to treat her as roughly as they treated her former colleagues.
But following a recent review of minutes from Carillion’s directors meetings in May, the MPs wrote that Mercer was “raising concerns about the accounts” she found and took some of the actions of a whistle-blower but that her concerns failed to trigger adequate responses from Carillion’s directors.
'Aggressive' Carillion Accounting
In her testimony on Feb. 6., Mercer said that in 2016, before she became CFO, the company had several bad projects that culminated in the company’s “provision,” or write-down, to recognize the possible losses. She also testified that the company took a more aggressive approach to accounting at that time and that the approach required judgments about when a contract is considered to be finished and what the final payment would be.
When Carillion’s management saw contracts deteriorating in 2017, the aggressive accounting made it very difficult to “withstand those deteriorations,” she said. Mercer’s predecessor as CFO, Zafar Khan, said he didn’t believe earnings had been manipulated.
Field, the pensions committee chair, said the board minutes showed that Mercer had actually raised concerns that went largely unheeded last May. The “revelations threw up some serious questions, not least for the company’s auditors, KPMG, including whether the 2016 year-end” numbers could be trusted.
That Mercer had to go through, in Fields’ words, “whistle-blowing procedures to get her concerns about accounting irregularities taken seriously by the Carillion board is extraordinary.”