In the wake of the recent subprime crisis and the accompanying credit crunch, Gordon Brown is concerned about economic turbulence ahead. There is no denying the depth of the unfolding crisis. Banks have been queuing up for financial support from taxpayers. The European Central Bank is providing nearly £250bn to alleviate the crisis. The UK taxpayer has poured nearly £50bn into Northern Rock alone and central banks are also busy pouring money into the banking system. Yet broader questions about the systemic failures are not being addressed.
All of the troubled banks boasted good governance. They had executive directors, unitary boards, independent non-executive directors, ethics committees, audit committees, auditors and risk assessment processes. Yet none of these alerted the stakeholders, or the regulators, of the dangers of their business model to themselves and the financial system.
Off balance sheet accounting, that is, the practice of not fully reporting corporate assets and liabilities, was highlighted as a major vehicle for cooking the books by the Enron scandal. Banks excelled at such practices during the 1980s Latin American debt crisis, a forerunner of the current subprime crisis. Yet the same practices have continued unabated. Bank directors admit that they have been very economical with information about their company's assets and liabilities. Banks created structured investment vehicles (SIVs) and other structures to keep troubled items off their balance sheets and report higher profits. Auditors were happy to approve such accounts. None of the credit rating agencies objected. Profit forecasts were met and stock markets were appeased. This also made some directors rich as their salaries, bonuses and share options are linked to reported profits. The linking of director remuneration to profits is an open invitation to massage profits. The same directors are now asking the taxpayers to bail them out. None have been forced to return their gains. None have been held personally responsible and prosecuted for publishing misleading financial statements. The banking industry has not been investigated for its practices.
Belatedly, the corporate dominated Financial Services Authority is calling for reforms of accounting practices, but it has failed to explain why it continued to accept poor practices. Can it really claim to have scrutinised the accounting practices of banks? It should be prosecuting directors for publishing misleading financial information, especially as they made financial gains from inflated profits, but it can't seem to get off its bended knees. Chancellor Alistair Darling also wants to clamp down on dodgy accounting practices, but has failed to explain why he did not address these issues during his tenure at the Department of Trade and Industry. The UK accounting regulator, the Financial Reporting Council (FRC) states that during 2008-2009 it plans to examine a sample of the accounts of banks and financial services companies. Even though SIVs have been freely used by banks for many years, none of the FRC's accounting standards make any mention of such practices. By any measure, there has been a major regulatory failure that should be independently investigated.
Enron, WorldCom, Tyco, Parmalat, iSoft, Barings, Farepak and other companies implicated in headline-making scandals had non-executive directors. Banks also boasted audit committees and non-executive directors. In theory, non-execs are independent of the executive board and provide independent voices within companies. The reality is that they are often friends of executive directors and therefore cannot bite the hand that feeds them. They hold multiple appointments and sit on the boards of a number of companies. Due to multiple directorships they are unable to devote sufficient time to the affairs of all companies and are in no position to offer informed, independent advice. They are not elected by bank depositors, employees or other parties who bear substantial risks and thus lack an independent accountability base. Those on the non-exec gravy train can earn around £30,000-£60,000 for attending board meetings 12 or so days a year. Audit committees staffed by non-executive directors are supposed to evaluate risks, internal checks and balances and quality of published accounts. Yet none made any effective assessment of the risks, or alerted shareholders, savers, regulators, or the general public of the risks. None blew the whistle on banking practices. None have been hauled in by any regulator for failings in their duty to invigilate the main board.
Despite recurring scandals, under the weight of corporate power successive UK governments have shied away from effective reforms to the governance of large corporations. The mantra has been that executive directors, non-executive directors and external auditors can check corporate excesses. The subprime crisis once again exposes the fiction of such claims. Without a thorough investigation of the way banks are governed, structure of company boards, effectiveness of regulators, rights of savers, methods of director remuneration, quality of financial information and silence of auditors, meaningful reforms cannot be introduced. Yet none of this is on the government agenda.