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FCA Decision Notices Issued in Relation to Carillion Plc and its Former Executive Directors

By | 02/08/2022 in Blog posts

On 28th July 2022 the Financial Conduct Authority (FCA) issued Decision Notices in relation to Carillion Plc and three of its former executive directors. The three directors concerned have decided to refer their cases to the Upper Tribunal. The findings in the FCA Decision Notices should therefore be considered as provisional and reflecting only the FCA’s view as to what occurred at Carillion.

The FCA’s findings all relate to alleged breaches of the Financial Services and Markets Act 2001, the Listing Rules and certain market abuse provisions.

Ahead of the decision of the Upper Tribunal the findings of the FCA are yet to be supported but the observations and conclusions made by the FCA have relevance to directors and members of audit committees as to the importance of accurate management information.

FCA allegations

The FCA alleges that:

2.8          [t]here was significant pressure on Carillion Construction Services (CCS)] during the Relevant Period to meet very challenging financial targets maintained by [the Group CEO] (along with other senior management) in the face of clear warning signs that CCS’s business was deteriorating significantly. This led to an increasingly large gap between the assessments within CCS of its financial performance and its performance as budgeted and ultimately reported to the market.

2.9.         This gap was bridged during the Relevant Period by the use of overly aggressive contract accounting judgements in order to maintain CCS’s reported revenues and profitability, especially in connection with certain major construction projects. These judgements did not reflect the true financial position of the projects or the financial risks associated with them. They did not comply with IAS 11, one of the applicable accounting standards governing the recognition of revenue associated with construction contracts.

One of the key assertions of the FCA is that the Audit Committee and the Board were not provided with an accurate picture of financial risks and exposures. The FCA alleges that the Group CEO was aware that certain of the:

reports to the Board and the Audit Committee painted a much more optimistic picture of CCS’s financial performance than that being internally reported by CCS.

On a similar vein the FCS maintains that the Group CEO:

had a central role in reviewing [announcements to the market] and approving them as a Board member. He did so in the knowledge of information reported to him on a number of occasions  . . .  was materially inconsistent with the positive statements made in the [announcements to the market]. [He] must have been aware, particularly having regard to the nature and cumulative effect of the information and the occasions on which it was reported to him, and his extensive knowledge of the construction industry, that this information would be highly relevant to the deliberations of the Board and the Audit Committee when they reviewed and approved the [announcements to the market] . However, [he] failed to ensure that this information was brought to the attention of the Board and the Audit Committee

The FCA Decision Notice also reiterated one of its long-standing themes, the importance of robust systems and controls, the regulator observes:

2.26.      The deterioration in CCS’s business during the Relevant Period, coupled with the pressure to meet very challenging financial targets, significantly increased the risk that overly aggressive contract accounting judgements would be applied in order to maintain its financial performance. To counter this risk, Carillion’s procedures, systems and controls in relation to CCS needed to be sufficiently robust to ensure that these judgements were made and reported appropriately. They were not, significantly increasing the risk that market announcements in relation to Carillion’s financial performance would not be accurate.

2.27.      The overly aggressive contract accounting judgements being applied to CCS’s major projects were not properly documented at Performance Review Meetings held by CCS (which [the Group CEO] chaired). This meant there was no clear record of the assessments being made, approved or reviewed. This contributed to a lack of rigour around these judgements and their approval and review.

2.28.      The management information relating to hard risks, MCSs and certain major projects produced and reported by CCS to (amongst others) [the Group CEO] highlighted large and increasing risks associated with the financial performance of CCS’s construction projects during the Relevant Period. This information was inconsistent with other reports . . .  that contained much more optimistic assessments of the financial performance of those projects, as reported to the Board and the Audit Committee.

2.29.      The Board and the Audit Committee were not made aware during the Relevant Period of the significant and increasing financial risks described above. This meant they were hampered in providing proper oversight of CCS’s financial performance and the overly aggressive contract accounting judgements being applied to its major projects.

Although the FCA’s conclusions are subject to appeal to the Upper Tribunal it already seems likely that there are some important lessons for NEDs arising from the collapse of Carillion Plc. Key lessons include the need for NEDs to be vigilant in relation to the quality and content of management information (MI). The FCA is clear in its view that the executives were not providing adequate, accurate and complete information to either the Board or the Audit Committee. NEDs need to make judgements not only in relation to the information they are seeing, but also as to the information they should be receiving from the executive. This will include challenging the executive where there are gaps or inconsistencies. Secondly the need to monitor, and where appropriate challenge, the effectiveness of internal systems and controls. NEDs need to understand what these are and how they are supposed to operate. If they are flawed or if they don’t seem to be working in practice, NEDs will be expected to call them out. In the case of Carillion, it would appear from the FCA’s findings that the regulator found clear failings in both areas which helped to contribute to the company’s demise. NEDs need to be aware of these risks and in some cases where there are material concerns, NEDs may need to consider whether they should have access to independent advice in order to make fully informed decisions. By heeding these lessons, NEDs can help to prevent similar situations from happening in the future.

Peter Snowdon is a legal and corporate governance expert, with a particular interest in issues affecting financial services firms, banks and investment firms. A former partner at Norton Rose, he also worked for the Financial Services Authority (FSA) prior to joining Bvalco.

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