Accountants

• Parmalat - so much for the Italian example
• Auditor liability
• Wither IFAs
• Hong Kong �most free�
• Gold: the rising currency

Parmalat - so much for the Italian example

The collapse of the Italian food giant, Parmalat, has led to decisive action by one of the group�s two main auditors, Grant Thornton, in a bid to recover its good name. The global network, Grant Thornton International, has sacked its Italian arm - Grant Thornton SpA - without even waiting for preliminary results from state investigations into culpability for the collapse of the group because of the apparent disappearance of about 10bn euros.

After initial feedback from an internal Grant Thornton inquiry, David McDonnell, chief executive of Grant Thornton International, said: �Our first responsibility is to our clients around the world. They need to be assured of our commitment to maintain the reputation and integrity of Grant Thornton International. As a result of our ongoing investigation it is clear that Grant Thornton SpA will not be able to operate in the foreseeable future in an effective way to protect the reputation of the Grant Thornton International name and the reputation of the other independent firms in the Grant Thornton International network.

�Grant Thornton SpA has been unable to provide sufficient assurances or access to the appropriate information and people in an acceptable time frame. We have lost confidence in Grant Thornton SpA and are therefore acting clearly and decisively to protect our clients and the reputation of all of the other independent firms in the international network.�

A spokeswoman for Grant Thornton dismissed speculation that the reputational damage caused by the Parmalat failure could jeopardise the continued existence of either the network or other national firms. She said: �We have absolute confidence in the Grant Thornton International network and there is no question of that whatsoever.�

But the revelation that another audit client of the Italian Grant Thornton firm had collapsed, accused of similar fraud, is damaging to the brand. Cirio Finanziaria, also a food producer, allegedly carried its own deficit of over 100m euros arising from fraudulent activities and is now in administration. However, Grant Thornton International pointed out that Grant Thornton SpA had only ever audited one year�s accounts of Cirio, which it had qualified.

A possibly significant similarity between the collapse of Parmalat and Cirio is their extracurricular activities. Parma football club has become one of Italy�s top sides through the investment of Parmalat, which had a 98.7% stake in the club. Meanwhile, the majority shareholder in Cirio also had the controlling stake in another leading Italian club, Lazio, previously managed by England manager Sven Goran Eriksson. Like Parma, the Lazio team had been pushed into financial crisis through its connection with a failed business.

The situation of Parmalat�s other main auditor, Deloitte, is significantly different. While two Italian Deloitte partners, Adolfo Mamoli and Giuseppe Rovelli, have been questioned by Italian investigators, the firm issued a statement making clear it was standing by them. Deloitte stated: �We will of course continue to co-operate fully with the authorities to establish the facts of the matter, and to help them separate these from rumour and speculation. Deloitte will also pursue all appropriate legal remedies for injury to the reputation and business of our people, the Italian practice and the global organisation.

�Deloitte Italy believes it behaved properly throughout and in accordance with the standards in force in Italy at the time. It is important to reiterate that the Italian practice issued a very carefully considered mid-year review report on 31 October drawing attention to certain critical issues in Parmalat�s financial statements.�

However, Britain�s Liberal Democrat opposition party launched an attack on the UK Deloitte firm, following the Parmalat crisis. Its shadow Treasury minister, Norman Lamb, called on the UK chief executive, John Connolly, to resign, after newspaper reports pointed out that he had previously been criticised by the Joint Disciplinary Tribunal for his role in the audit of fraudulent investment managers Barlow Clowes. Lamb said: �In terms of restoring confidence, both generally and in terms of Deloitte, it seems to me that Connolly�s position is no longer tenable. For someone in charge of their UK operation to have been so heavily criticised by a financial watchdog seems extraordinary.�

A spokeswoman for Deloitte responded: �This is something which happened in the past. We are not making any further comment.�

But neither Deloitte nor Grant Thornton will find it easy to avoid severe reputational damage as a result of the Parmalat collapse. Both firms� international networks are being sued by a Parmalat institutional director, Southern Alaska Carpenters Retirement Trust, alleging violations of the Securities Exchange Act of 1934. The lawsuit further alleges that �Parmalat�s senior insiders, together with Parmalat�s legal, accounting and financial advisers, concocted a massive scheme whereby they overstated Parmalat�s reported profits and assets for more than a decade.�

A third firm of auditors has been sucked into the Parmalat affair. Dutch authorities are said to be conducting a preliminary inquiry into claims that HLB International - which operates in the UK as Numerica and AV Audit - may have had a member of its Dutch audit practice serving as a director of a Parmalat subsidiary, while other auditors from the HLB group were responsible for the company�s audit. HLB International did not respond to our calls seeking a comment, but HLB has elsewhere denied the allegations, insisting that there were no irregularities in its work. Herman Muus, an auditor at HLB den Hartog, was quoted as saying: �It is totally wrong [to say] that we provided both an accountant and a director at the same time.�

Initially it seems that there are three important areas of concern thrown up by the Parmalat scandal. Commentators had suggested in response to the Enron collapse that it was important to provide a counterweight to the dominance of what has since become the Big Four by assisting the growth of mid tier firms - like Grant Thornton. Second, the unravelling of Parmalat highlights - as the Ahold crisis did previously - the particular difficulties in conducting accurate audits of multi-national groups.

The third concern is that the Parmalat experience throws a challenge to advocates of enforced audit rotation as a means of reducing weak audit procedures, because Italy is one of the few jurisdictions which applies statutory audit rotation - every nine years in its case. But Professor Peter Moizer of Leeds University dismisses suggestions that the Parmalat scandal undermines the case for mandatory audit rotation.

�I don�t think it proves anything,� said Moizer, �except that the Italian audit system isn�t very good.� He suggested that the wider auditing and commercial environment of Italy was at fault, rather than audit rotation playing any part in Parmalat�s failure. �This was waiting to happen,� he argued. Moizer added: �I think audit rotation is on balance a good thing�, but then conceded: �You could argue whether audit rotation is feasible with so few major firms now.�

Roger Adams, ACCA�s executive director - technical, agrees that no conclusions on audit rotation can be drawn from the Parmalat case. �Deloitte & Touche were doing 51% of Parmalat�s audit and Grant Thornton doing 49%, even though Grant Thornton had been rotated out of audit after its nine years,� said Adams. �Rotation probably has to mean rotation. If an auditor steps down after a specified time, it shouldn�t continue to do one of the subsidiary company�s audits.�

But Adams added that he would be concerned if the problems with various companies� audits of subsidiaries led to a requirement that all companies in a group should be audited by the same firm. The auditing of subsidiaries� liabilities has been a key factor in the reporting failures of both Parmalat and Ahold. Adams suggested that requiring a single auditor to be responsible for a group would play into the hands of the Big Four and further undermine the opportunity of mid-tier firms to expand. The most recent analysis of audits of the FTSE 350 companies shows that the Big Four have actually increased their proportion of audits.

The European Commission is, though, considering amendments to the way in which group audits are conducted. Jonathan Todd, spokesman for European Internal Market Commissioner, Frits Bolkestein, said that the Commission may bring forward new controls later this month, aimed at overcoming any weakness arising from more than one audit firm having responsibility for group accounts. These would �make the group auditor fully responsible for all aspects of the consolidated accounts�, said Todd.

David York, ACCA�s head of auditing practice, pointed out that this is already the situation in the UK and in most countries, though not in Italy, the United States and Spain. He said that he thought it was appropriate for the group auditor to take full responsibility for the consolidated accounts. He accepted that in Italy, for example, this would lead to the group auditor being required to do more work to ensure that the consolidated accounts were not incorrect because of a reporting failure by a subsidiary company.

ACCA�s new chief executive, Allen Blewitt, commented that recent corporate failures in Europe illustrated that European accountants could not say that they were immune from similar events to the Enron collapse. They had to recognise that even with strong rules and regulators, a management determined to commit fraud could do so - if external auditors, internal corporate governance controls, analysts, credit rating agencies and bankers failed to do their job properly.

�The current fiasco can also be blamed on an historic unwillingness by European politicians and regulators to tackle national differences and the piecemeal approach to market regulation which has resulted from this inaction,� added Blewitt. He said it was essential that there was a common and integrated approach to audit and market regulation across the European Union, including the 10 new member states, with effective adoption of International Accounting Standards. But tougher standards, he said, would only drive up the quality of financial reporting if they were accompanied by improved working practices amongst directors and external auditors.

Auditor liability

Investigations into the activities of three audit firms in connection with Parmalat has led to renewed interest in the issue of limitation of auditor liability. Why, ask many firms, should auditors potentially take the financial weight of corporate bankruptcy, when the main blame lies with a company�s directors and management?

The UK�s Department of Trade and Industry (DTI) has stepped into this debate with its consultation paper on director and auditor liability. Alongside the possibility of maintaining the current system, the review asks for views on whether companies should be allowed to limit the liability of directors against claims for negligence. In relation to auditors, the consultation asks for views on whether auditors should be allowed to contract with their clients to limit their liability.

If liability limitation were permitted, it might be capped as a multiple of the audit fee, capped at a multiple of total fees paid to the auditor including non audit services, capped as a multiple of the auditor�s turnover, or capped at a fixed rate, with one rate for the Big Four firms and lower rates for smaller firms. But the possibility of a system in which liability is apportioned in relation to responsibility has been rejected.

Trade and Industry Secretary, Patricia Hewitt, said: �A competitive and efficient audit market is fundamental to strong corporate governance and a successful, responsible business environment. The right principles on liability play an important part in achieving this. There is an important balance to strike, and despite considerable debate no consensus has emerged. We do not want regulations that are so stringent, complex or unclear that honest, capable people are put off being directors or auditors. Equally the law must be firm and robust to deal fairly with cases where something has gone wrong - as a result of either negligence or dishonesty.�

ACCA expressed its unhappiness at the rejection of proportionate liability. John Brace, ACCA�s Deputy President, said: �We welcome the fact that the DTI has acknowledged the important problem of professional liability and has agreed to start a new public debate with the accountancy profession. But we are disappointed that the scope of the consultation is limited and rules out proportionate liability as being outside the scope of the exercise - especially as Australia, a country with a similar legal system to ours, has just decided to go down the proportionate liability route.

�We still believe that proportionate liability is the fairest and most rational basis for assessing the proper extent of the auditor�s financial liability for losses incurred by third parties who relied on erroneous opinions given by auditors on companies� financial statements. Enabling auditors to limit their liability to a client by contract is not, in our view, the ideal solution since it is the professional equivalent of a pre-nuptial agreement - it envisages failure at the outset. But we will consider supporting arrangements which provide for a realistic level of liability for the auditor and which, at the same time, safeguard shareholder interests.�

The DTI has also published its proposals for increasing the audit exemption threshold for SMEs from £1m to £5.6m turnover. New definitions for an SME came into force on 30 January and will apply immediately to eligibility for some tax breaks on capital equipment. But the definitions will only apply on audit thresholds from 30 March. ACCA criticised the short notice of the announcement and lack of prior detail which, it said, had left companies and accountants confused and short of knowledge.

Wither IFAs

Two of Britain�s largest and best known firms of independent financial advisers - the David Aaron Partnership and RJ Temple - have collapsed, amidst a widening fall-out from the latest consumer investment scandal: the mis-selling of so-called �precipice bonds�. There are growing rumours of more IFAs facing severe financial crisis from mis-selling claims, which threatens to accelerate a process of major sectoral consolidation and reform.

Precipice bonds are financial products which promised attractive returns if specified share indices gained by a predicted amount, but the holders� capital stake would be all or partially lost if the nominated index fell. Not surprisingly, given the worldwide fall in share values from 2000 to 2002, holders of precipice bonds found their capital values falling over the edge. Now, many clients have complained of product mis-selling, suggesting that sellers - many of whom are IFAs - failed to make the risk character of the bonds sufficiently clear.

The UK regulator, the Financial Services Authority, is already undertaking a major review of the marketing and manufacture of precipice bonds. A quarter of a million people bought these high income bonds, investing a total of £5bn. In December the FSA fined another of the largest IFAs, Chase de Vere, £165,000 �for approving and issuing a misleading direct offer promotion�, relating to precipice bonds, to 236,000 prospective customers and in two million national newspapers.

The FSA has compiled a table showing which IFAs completed the most sales of precipice bonds and is currently working its way down the list, looking at the ways in which the bonds were sold. It is therefore very likely that more firms will be fined - or go into administration if they have insufficient reserves to pay both fines and client compensation. David Aaron Partnership was one of the leading sellers of precipice bonds, having sold several millions pounds worth of the products. It is widely assumed that the firm has gone into administration in anticipation of a volume of mis-selling claims which it is unable to meet.

As well as failing to notify clients of the risk to their capital from precipice bonds, several IFAs - including the David Aaron Partnership - are likely to face accusations from bondholders that they did not make it sufficiently clear which financial services company issued the bonds. Several firms referred to large banks as holding the funds, allegedly without making it completely clear that companies such as Abbey National Treasury Services had merely helped design the products and placed money offshore for them and did not have ultimate responsibility for the bonds� administration.

Clients of David Aaron and RJ Temple - which also sold large numbers of precipice bonds - may find their compensation limited as a result of their ceasing business. RJ Temple is now in liquidation and any claims for compensation must be lodged with the Financial Services Compensation Scheme, which can only pay out a maximum of £48,000.

Finbarr O�Connell of KPMG, a corporate recovery partner and joint administrator of David Aaron Partnership, said: �Our priority is to seek a buyer for this business which has a contact list of approximately 150,000, and, so far, we have received interest from a number of parties.� For the present, any client with a mis-selling claim should lodge this with KPMG. But if there is a substantial volume of claims this could jeopardise the possibility of the firm being sold.

Precipice bonds were not only mis-sold by IFAs. Complaints have also been lodged against investment companies for products that were directly sold and banks also face calls for compensation. Last September, Lloyds TSB was fined £1.9m for mis-selling precipice bonds and had to set aside a further £98m for compensation to 22,500 clients of the products. It is easy to see that IFAs which sold similar quantities of the bonds are unlikely to have access to the funds necessary to pay compensation and fines of this level. It is thought that the total compensation bill to be paid by the industry could exceed £1bn.

Even before the precipice bonds crisis, the IFA sector was going through major restructuring. Ironically, publicity material from the David Aaron Partnership from a few months ago stated: �We view the rapid industry changes with �open eyes� and our team are representative of the new generation of IFAs.�

Perhaps more truly representative of the new generation of IFAs are actually subsidiaries of major financial services groups. Bradford & Bingley, for instance, was initially converted from a mutual building society to a banking Plc, but is now a group comprising various brokering arms which both provide advice and sell group and non-group products. Member companies include the IFAs Charcol, previously John Charcol Brokers, MarketPlace and Charcol Holden Meehan, previously Holden Meehan, which specialised in providing advice on ethical investment.

Towry Law, another leading IFA, was part of the British loss-making operations of AMP (formerly called Australian Mutual Provident). This was demerged and listed as a new business called HHG at the end of last year, with group companies including the Henderson Investment Management and Pearl Assurance. The second largest IFA ownership is held by Aegon, a major life assurer, which has the majority stake in six leading IFAs, including Millfield and Aurora Financial, and a minority stake in several others. Another of the country�s largest IFAs is Hargreaves Lansdown, which also has divisions offering execution only sharedealing, share brokerage, an on-line funds supermarket and investment management.

Trends towards the simultaneous consolidation and corporatisation of the IFA sector seem bound to quicken with the introduction of the so-called depolarisation rules in coming months. This will free-up firms that are currently tied agents of one provider, to enable them to offer advice favouring the products of other providers. Firms will be able to continue to call themselves �independent� provided they advise from across the market and offer clients the opportunity to pay by fee, rather than by commission.

The ending of the existing polarisation rules will be accompanied by a requirement on firms to explain clearly to consumers what advice or service is being offered. Firms will no longer have to comply with the so-called �better than best� requirement, under which an IFA cannot recommend the product of any provider which owns 10% or more of the firm.

Continued market shake-out seems inevitable. Aegon�s spokesman, Scott White, commented: �What you have on both sides of the financial services chain - the distribution and production sides - is considerable pressure on cost margins and market share. Then you have the amount of regulatory pressure on the IFA side as well. It�s not rocket science to predict fewer manufacturers on the product side and fewer distributors. The winning companies at the end of that process will achieve more significance in terms of size of market share. The downside is that a number of good providers and advisers could fail to obtain the necessary capital and the market could lose.�

Mass market IFAs in a low margin environment will increasingly focus on distribution rather than advice, except where clients can afford to pay fees. But this will not necessarily disadvantage those accountancy firms which are also IFAs, which tend to concentrate on advice for the affluent.

Peter Miller, a financial adviser with accountants Hacker Young, says that because his firm is a relatively new arrival into the IFA sector, it is not having to change its market focus in the way that some other IFAs are being forced to do. But, he agrees, the IFA market will break down into more niches. �The mass market of yesteryear will not provide the easy pickings that were once on offer,� he suggests. �Unfortunately, those with relatively small amounts to invest will find it difficult to obtain the advice they require.�

The fall-out from the changes to the industry is not restricted to IFAs. Lloyds TSB was praised by many analysts when it purchased Scottish Widows life assurer five years ago as a British pioneer of the bancassurance model. But following the recent departure of its finance director, Philip Hampton, doubts have grown about the sustainability of the structure, with speculation that it might sell Scottish Widows. As well as the fine for mis-selling income plans, there have been other concerns that the strategy of selling insurance products from the bank�s retail network has not proved as successful as predicted.

Hong Kong �most free�

The annual Index of Economic Freedom has ranked Hong Kong as the world�s most free economy for the 10th successive year. Singapore and New Zealand are next but are poised to overtake Hong Kong on current trends, suggest the Index�s compilers.

The Index, published jointly by the Wall Street Journal and the Heritage Foundation, ranks economies according to their market freedom and is not a judgement on political structures, or human rights. But political structures can impact on economic systems and so, says the Wall Street Journal, �it�s hard to see how Hong Kong can retain its ranking as number one�. Secure property rights were key factors in placing Hong Kong and Singapore at the top of the table.

Perhaps the most significant factor in the rankings is that it highlights changes taking place in Europe, with countries about to enter the European Union making great strides in liberalising their economies. Estonia has shot up to sixth in the list, behind only Luxembourg and Ireland amongst European states. Mary Anastasia O�Grady, co-editor of the study, added: �The most impressive European performance, as measured by improvement, goes to the Slovak Republic for its �reduced taxes, liberalised prices, accelerated pace of privatisation and restructured banking sector�. The Index notes that �foreign investment has increased and the banking sector is dominated by foreign capital.��

The study explains that tax competition within the European Union has been a major factor in liberalisation, with several former Soviet states now offering zero corporation tax rates. Ireland continues to be the most attractive member state of the established EU countries, with a corporation tax rate of 12.5%, compared with the EU average of 30%.

Overall, there is only a marginal increase in economic liberalisation, with 75 countries moving ahead with market liberalisation initiatives, compared with 69 declining. Most countries in the Asia Pacific and sub-Saharan regions are regarded as �unfree�, while Latin America appears to be moving away from economic liberalism, with Venezuela now ranked as �repressed�.

However, in a plea which coincided with the publication of Hong Kong�s high ranking, ACCA called on Hong Kong�s Financial Secretary to cut the level of taxation on middle income earners. Instead, suggested ACCA, there should be a surcharge on those earning more than $HK10m a year and a wholesale review of Hong Kong�s tax system.

Meanwhile, leaks from an internal European Commission report also suggest significant economic changes taking place amongst EU member states. This found that the UK had ceased to be the country providing least state aid to industry, following the Government�s bail-out of British Energy and increased subsidy to the not-for-profit company running the rail infrastructure, Network Rail. Finland remains the biggest provider of industrial subsidy, as a proportion of GDP.

In a separate, published, report the Commission has revealed the best and worst performers in implementing EU laws. Denmark is easily the most compliant member state, with all Commission directives applied into domestic law, bar five. The next best performer is Spain, which still has 14 Commission laws to put into national law. France and Belgium are worst, having failed to apply 54 EU directives, while France has also been taken to court by the Commission for non-compliance more often than any other member state. France said it was taking steps to speed up the transference of directives into national law.

Gold: the rising currency

An apparently perpetually falling dollar has had its often unwelcome impact on the euro and sterling, driving up their value and making manufacturing exports more expensive. Alongside this has been a constant increase in the desirability of gold.

Since 1999, gold has risen in value by more than 50% against the dollar. Investment in gold has come from large and small investors and has spread beyond the largest economies. Its attraction has been reflected not only in commodity prices, but also in mining stocks.

In China, the IPO of Fujian Zijin Mining Industry - owners of China�s largest gold mine - has become the most popular new listing in six years, being oversubscribed on its public portion by a factor of 743. As well as attracting enormous interest from the retail market, a 1.4% stake in the company was purchased by the world�s fourth largest gold producer, Gold Fields of South Africa.

But other recent listings in China, while not reaching the level of demand for Fujian Zijin, have also been very well received. Insurance firms PICC Property and Casualty and China Life Insurance have shown strong gains on the market after launch, as has Chia Hsin Cement Greater China Holding. The H-share index of Chinese companies listed in Hong Kong more than doubled last year.

Nor was last year�s share boom in emerging markets restricted to China. There was record investment in developing nations last year, leading to a sharp fall in debt in the emerging markets. This was assisted by credit agencies upgrading credit ratings of several developing markets, notably Russia.

But important steps still need to be taken to strengthen the financial infrastructure in many developing economies. China�s move to a market economy was provided with a major boost when the Government invested $45bn, 10% of the country�s foreign exchange reserves, in the two largest retail banks, the Bank of China and the China Construction Bank. This goes a small way towards propping up the banks against expected losses caused by non-performing loans, which are estimated at $422bn by the Chinese Government and could be even higher.