The major news story everyone missed: KPMG hit with record fine for their role in the Carillion Collapse.

In 2018 the Carillion group of companies were bankrupt owing £1.5 Billion ($2.9 billion Australian), at the time, the largest bankruptcy ever in the UK.  The latest news is in October 2023, KPMG was fined a record £21 million (AU$40 million) for a ‘textbook failure’ in its audits of Carillion. This long running saga raises questions of ethics both within KPMG and the Carillion Board, and controls. Did the Board and Auditors not know (a management failure), or was it a case of not wanting to know the true situation (a governance failure)?  

A wider question for another time is the way the ‘big four’ accounting firms operate. String together Arthur Andersen and Enron in the USA (2001), KPMG and Carillion in the UK (2018), and PWC and the Australian Tax office (2022) suggests there are major structural issues with the ‘big four’ partnership model.

The Carillion Story

Carillion was created in July 1999, following a demerger from Tarmac Ltd., which had been founded in 1903. Following the demerger, Tarmac focused on its core heavy building materials business, while Carillion included the former Tarmac Construction contracting business and the Tarmac Professional Services group of businesses (I worked for Tarmac Construction in 1971/72 – it was a great company in those days).

As an independent company, Carillion undertook a series of acquisitions and expansions including:

• 2001, expansion into the facilities management services sector
• 2001, acquired the 51% of GT Rail Maintenance it did not already own
• 2002, bought Citex Management Services
• 2005, acquired Planned Maintenance Group
• 2006, Mowlem support services business
• 2008, Alfred McAlpine
• 2008, Vanbots Construction in Canada
• 2011, Eaga, an energy efficiency business rationalised later in the same year
• 2012, 49% interest in The Bouchier Group, providing services in the Athabasca oil sands area
• 2013, the facilities management business of John Laing
• 2014, 60% stake in Rokstad Power Corporation, Canada
• 2015, Outland Group, a specialist supplier of camps and catering at remote locations in Canada
• 2022, Ask Real Estate, a Manchester-based developer

All of these acquisitions came at a cost, in March 2015 concerns about Carillion’s debt situation were raised and by October 2015, Carillion had become hedge funds’ most popular share to ‘sell short’ as analysts questioned the lack of growth and rising debt; the company’s share price fell 19% over the same period.

On 10 July 2017, a Carillion trading update highlighted a £845 million impairment charge in its construction services division, mainly relating to three loss-making UK PFI[1] projects and costs arising from Middle East projects. These and other write downs together exceeding £1 billion occurred only a few months after KPMG had given an unqualified audit opinion on the correctness of Carillion’s accounts.

However, despite these problems, in the five-and-half-year period from January 2012 to June 2017, Carillion had paid out £333 million more in dividends than it had generated in cash from its operations. But, net cash from operations was also needed to pay for investments, and interests on debt (Carillion’s interest charge was £30 million in 2016).

The Carillion Collapse

At the time of its implosion in January 2018, Carillion employed 43,000 people in defence, education, healthcare, transportation and construction and service activities. It had around 420 contracts with the British public sector and many other commercial contracts in the UK and overseas.

Reporting at the time highlighted the aggressive growth strategy, a complex internal management structure, a fuzzy governance structure, poor supervision of daily activities, and the loss of control on some of its flagship projects.  

Carillion had liabilities of £7 billion and just £29 million in cash when it went into liquidation. The primary cause of the Carillion collapse is undoubtedly the actions of its directors and managers and there are ongoing court actions against these people. However, the role of an auditor, is to provide an independent assessment of the organisation’s accounts, to identify the types of issue that lead to the collapse of Carillion and provide either assurance, or warnings to both shareholders and creditors.

The KPMG Involvement

KPMG were the auditors for Carillion, their involvement in this saga was finalised a couple of weeks ago when Britain’s accounting regulator, the Financial Reporting Council (FRC), fined KPMG a record £21 million (AU$40 million) for a ‘textbook failure’ in its auditing of the Carillion accounts. The FRC said the number, range, and seriousness of the deficiencies in the audits of Carillion including not challenging Carillion management, and a loss of objectivity were exceptional, which meant that Carillion was not subject to rigorous, comprehensive, and reliable audits in the three years leading up to its demise. The FRC fine would have been £30 million, but was discounted due to admissions and co-operation by the auditor.

In addition to this fine KPMG and its partners have received the following penalties:

• KPMG was ordered to pay £5.3 million in costs
• The lead auditor for 2014 to 2017 was fined £250,000 and banned for 10 years after a discount to reflect his cooperation and admission of failures.
• The lead auditor for 2013 was handed a £70,000 penalty
• Three other auditors were respectively; banned for eight years and fined £45,000, banned for seven years and fined £30,000 and banned for eight years and fined £40,000
• KPMG was also fined £14.4 million in 2022 after providing false and misleading information to the FRC during spot checks on its audits of Carillion and another UK company
• In February, KPMG paid an undisclosed sum to settle a separate £1.3 billion legal claim by the company’s liquidators, who claimed the auditor had missed ‘red flags’ resulting in the group’s accounts being misstated.

The FRC found that KPMG had failed to respond to numerous indicators that Carillion’s core operations were lossmaking and that it was reliant on short term and unsustainable measures to support its cash flows. The Carillion case is the 16th since 2018 in which the FRC or an industry tribunal has imposed sanctions against KPMG. It takes the total penalties and costs levied against the firm in that time to more than £95 million — far more than its rivals. 

Conclusions

The lack of press coverage of this saga in Australia at least can be attributed to the coverage of first the referendum, then the war in the Israil, plus the years of investigation and multiple trials since the Carillion collapse in 2018.  The still largely unanswered questions include:

1. Can large organisations really be that bad at controlling major projects?  My answer is yes – look at London’s Crossrail project[2], HS2, and a long list of other projects.
   
2. A more focused controls question is are the controls failure on this type of project a question of not knowing, or not wanting to know?  My answer is in Carillion’s case, the Directors did not want to know! Other situations are likely to vary[3].
   
3. Who is responsible for the controls and reporting failures? My answer is the governing body. It is the Board of Directors who set the standards required from management and you do not get good controls without a significant investment[4].
   
4. What about the Auditors?  My answer is both governments and corporations need to seriously rethink the way they engage with the ‘big four’, and the ‘big four’ need to be completely restructured – the ‘partner model’ has clearly failed.

For more on the failure of organisations to govern projects see: https://mosaicprojects.com.au/PMKI-ORG-005.php#Process4

[1] PFI = Private Finance Initiative, a form of PPP (Public-Private Partnership) contract.

[2] For more on the Crossrail saga see: https://mosaicprojects.com.au/PMKI-ITC-012.php#Crossrail

[3] For more on the link between governance and project controls see: https://mosaicprojects.com.au/PMKI-ORG-005.php#Process3

[4] See Predicting Completion – A Governance Requirement: https://mosaicprojects.com.au/PDF_Papers/P214-Predicting_Completion-a_Governance_Requirement.pdf