Questions for EY over its handling of Anglo Irish Bank’s audits

A report for Chartered Accountants Ireland found serious failings in EY’s audit of Anglo

 

In December 2008, after more than a year of firefighting on a number of fronts, Anglo Irish Bank’s chairman, Sean FitzPatrick, and its chief executive, David Drumm, resigned from the bank, which was on the verge of collapse amid the worsening global financial crisis.

The following month, the bank, once a darling of the stock market, was nationalised, a move that would ultimately cost taxpayers in Ireland about €29 billion.

Drumm is serving six years in prison for his role in a conspiracy to defraud and for false accounting for a €7.2 billion transaction he “directed” connected with Irish Life & Permanent.

FitzPatrick was declared bankrupt and successfully defended himself in criminal trials connected with his time at the bank.

A decade on, Chartered Accountants Ireland (CAI), one of the main professional bodies for accountants here, is considering resuming disciplinary proceedings around the conduct of Ernst & Young, now known simply as EY, as auditors of Anglo Irish Bank.

In 2009, it appointed former comptroller & auditor general John Purcell to produce a report into EY’s work as auditors under five headings. Purcell was assisted in his work by forensic accountants at consultancy FTI and, after a few missed deadlines, produced a report in 2011, which was to be used as part of the CAI’s investigation, which was being undertaken for it by the Chartered Accountants Regulatory Board.

Purcell’s report found there was a prima facie case that EY was liable to disciplinary action in connection with certain aspects of its Anglo audits. It was cleared in relation to other elements of its work as auditors to the controversial failed bank.

EY has rejected the findings of the report and failed in 2011 in a High Court bid to halt the CAI’s disciplinary investigation. EY declined to comment to The Irish Times on the findings of this report.

Purcell’s report was placed in cold storage in 2011 and never published in full, as the Director of Public Prosecutions wanted to allow the now-concluded criminal trials to work their way through the courts. Elements of the report emerged in various Anglo-related court hearings.

The Irish Times has seen a copy of the full report, which lays bare Purcell’s view on the failings in EY’s audits.

The areas he was asked to cover included Fitzpatrick’s “warehousing” of his loans from the bank with Irish Nationwide Building Society; the nature of a €8.2 million loan to Anglo finance director William McAteer; and transactions between Anglo and Irish Life & Permanent, which gave the impression deposits in Anglo were €7.2 billion larger than they were in 2008.

Charges of conspiracy

In June, Drumm was jailed on charges of conspiracy to defraud and of false accounting, over the transaction with IL&P.

His former Anglo colleague John Bowe, and ex-Irish Life & Permanent chief executive Denis Casey also received prison sentences in 2016 in relation to the same fraudulent scheme.

With the various Anglo-related criminal trials now concluded, the CAI’s disciplinary inquiry is expected to resume. EY audited Anglo throughout the 2000s, for an annual fee of €1 million.

The 242-page report detailed a series of failings in EY’s work on Anglo’s 2008 financial accounts. Most of the financial practices related to Anglo’s efforts to make the bank’s end-of-year financial accounts, dated September 30th, 2008, look healthier than they were in reality.

According to Purcell, there was a lack of both “proper examination” and “auditor scepticism” in relation to the transactions between Anglo and Irish Life & Permanent in 2008.

The purpose of this scheme in September 2008, during a period of increasing turmoil across the banking sector, was to bump up reported customer deposits in Anglo.

In what was dubbed the “green jersey agenda”, Anglo would transfer funds to Irish Life & Permanent, which would then reroute the same amount back to the bank through a unit called Irish Life Assurance.

On September 29th, 2008, the day the government’s bank guarantee was announced, at 10.31am Anglo made a payment of €1 billion to Irish Life & Permanent.

By 12.42pm the bank received a corresponding deposit for the same amount. Four minutes later, Anglo made another €1 billion payment to Irish Life & Permanent, and over two days alone six payments of €1 billion were made by Anglo, and identical deposits were accounted for from Irish Life Assurance.

Overall, €7.2 billion was routed into Anglo’s deposit accounts shortly before the end of its annual financial reporting period. The loans then matured three days after the end of the financial year.

Several characteristics of the transactions should have raised red flags for auditors, such as the back-to-back and short-term nature of the payments, and their timing just days before the financial year-end, Purcell’s report says.

‘No disclosure’

“There was no disclosure in the 2008A financial statements indicating the linked nature of the transactions, or the concentration of Anglo’s exposure with ILP [Irish Life & Permanent] or deposits from ILA [Irish Life Assurance],” the report states.

Despite the fact the deposits matured a number of days after the financial year end, “the shortest maturity period disclosure was ‘not more than three months’,” on the bank’s financial statements, according to the report .

“EY in the person of the audit engagement partner, Vincent Bergin, were aware of the September 2008 transactions before 2nd December, 2008,” the report states.

In an interview for the Purcell report, Bergin stated he understood “to some extent” that the reason for the transaction “was to demonstrate that another institution was willing to take on Anglo’s credit risk and . . . deposit money with Anglo”.

The report said the transactions were discussed at an impromptu meeting between Bergin and senior Anglo figures Colin Golden and Kevin Kelly on October 23rd.

“At no stage did I have a concern about the transaction. I mulled it over in my mind whether it might be misleading for a reader [of the financial statements] but concluded that in the context of the government guarantee that was not the case,” Bergin said.

Assessing the auditing work in relation to the €7.2 billion transactions, Purcell concluded the “failure to establish the full facts relating to the September 2008 transactions with ILP prior to the sign-off on the 2008A audit could represent a serious deficiency in EY’s performance”.

“In my opinion, these failures represent professional incompetency on the part of Ernst & Young . . . the deficiencies in the audit of the transaction and its disclosure must be regarded as serious,” Purcell states.

In December 2008, FitzPatrick’s resignation as chairman of Anglo, over his concealment of loans he had taken out from the bank, was one of the first loose threads in the unravelling of the boom-time lender.

The practice was to reduce the reported amount FitzPatrick owed Anglo in the bank’s end-of-year financial accounts, by taking out a new loan from Irish Nationwide Building Society to cover his debts with Anglo for a number of days, before the accounting year-end.

Loan ‘warehousing’

It was dubbed “warehousing” as FitzPatrick’s loans were effectively taken off the books and put into storage for a number of days, hidden from the bank’s auditors. They would then be transferred back to Anglo.

The question Purcell examined was despite FitzPatrick’s efforts to conceal these loans, should EY have uncovered the practice in their audits?

According to Purcell’s analysis, FitzPatrick had 29 loan facilities across three currencies – euro, sterling and dollars – and more than 230 individual accounts with Anglo. The loan balances rose substantially after FitzPatrick became chairman in 2005, peaking at €122 million in December 2007, Purcell found.

In an interview with Purcell, the former head of group finance at Anglo, Colin Golden, said he was “fairly sure” he told EY’s auditor Bergin that FitzPatrick was systematically refinancing his loans.

Golden is recorded as saying he “mentioned the refinancing element to Vincent Bergin prior to him signing the audit report on December 2nd in a telephone conversation”.

Later that month, FitzPatrick declared he had concealed the loans in a statement announcing his resignation from Anglo. Golden said he called Bergin shortly before the statement about the loans went public, and said he recalled Bergin saying “oh, I remember you telling me that”, in relation to the refinancing.

In Bergin’s interview, he said he was not concerned at the time over FitzPatrick’s refinancing of Anglo loans. “I didn’t get a picture that there had been systemic refinancing at year-ends going on,” he said.

FTI identified several pieces of information the auditors had come across “which might reasonably be expected to have led to an identification of Mr FitzPatrick’s ‘warehousing’ practices in respect of his Anglo loans”.

Inconsistencies that should have led auditors to uncover the “warehousing” practice, which FitzPatrick carried out over eight years, were present as early as 2006, the Purcell report said.

FTI found a statement provided to auditors from FitzPatrick on the loans he had with Anglo in 2006 amounted to €63 million. But the total amount of disclosed loans to all directors at the end of the 2006 financial year was €25 million.

Purcell concluded it was likely any follow-up from the auditors of this inconsistency “would have brought the refinancing practices to light” and that EY’s work was “not sufficiently robust to detect” the practice.

Had the auditors studied quarterly exposure reports from Anglo, the refinancing “would have been apparent”, FTI said.

In June 2004, Anglo reported it had €25.8 million in loan exposure to FitzPatrick. This dropped to less than a €1 million at the financial year-end in September, before rising to €28 million in December.

“These returns indicate that Sean FitzPatrick’s Anglo borrowings were significantly higher throughout the year compared to the outstanding amounts at year-end which were disclosed in Anglo’s financial statements. Despite being in possession of these returns, EY do not appear to have identified this,” Purcell said.

‘Audit junior’

“Had EY reviewed a list of transactions between Anglo and its directors, in accordance with its own planned procedures, assuming an accurate list was supplied by Anglo, Mr FitzPatrick’s periodic refinancing at the year-end would have been apparent,” the FTI report said.

The “substantive” audit work in relation to directors’ borrowings was carried out by an “audit junior”, who was “not given specific direction” on how the work should be carried out, the Purcell report found.

Notwithstanding the fact Anglo had withheld several pieces of information that contributed to the auditors’ lack of knowledge about the practices, Purcell concluded there was a reasonable case to take disciplinary proceedings against EY over its failure to uncover FitzPatrick’s loans.

The third and final element on which the Purcell report recommended EY had seriously failed in its role as auditors to Anglo related to an €8.2 million loan granted to the bank’s finance director, William McAteer.

McAteer had taken an €8.2 million loan with Bank of Ireland to purchase 3.3 million shares in Anglo. Under the terms of the loan, if Anglo’s share price dropped below a certain value it would trigger an option for Bank of Ireland to sell the shares, without requiring McAteer’s approval.

In 2008, Anglo’s shares had nosedived, as the global financial crash was unfolding. In September, McAteer feared that Bank of Ireland was planning to sell off his shares, which would have triggered a further loss of confidence in Anglo.

McAteer’s loan with Bank of Ireland had been a recourse loan, meaning he was personally liable if he defaulted on the repayments. However, the €8.2 million loan he received from Anglo to pay off Bank of Ireland, was non-recourse, secured only against his shares with the bank. Meaning it was on much more favourable terms to McAteer than the original loan.

The loan was formulated on September 29th, 2008, the day of the government’s bank guarantee.

Fraudulent scheme

In January of this year, McAteer received a 2½-year sentence over the fraudulent loan. He had previously received a 3½-year sentence over the €7.2 billion Irish Life & Permanent fraudulent scheme, and the sentences will run alongside each other.

The favourable terms of the loan were not disclosed in Anglo’s financial statements. EY was aware of the loan when auditing the accounts, as it was selected at random to confirm it had been correctly authorised.

“Despite the size and timing of the payments and the beneficiary being the group finance director [McAteer] . . . the payment was not highlighted for further examination,” Purcell’s report stated.

“No tests were carried out on the 2008A audit to establish if the loan to William McAteer was on normal commercial terms,” the report said, adding a person “of the same financial standing but unconnected with the bank”, would not have been given such a loan in September 2008.

When asked about the lack of follow-up checks on the loan in an interview, Bergin said the loan was “somewhat unusual”.

“I think that [it] would have been better if it had been raised as an issue requiring a further look,” he added.

In conclusion, Purcell said “there is no doubt in my mind that this was a very unusual transaction and as such merited close scrutiny by the auditors . . . Ernst & Young’s failure to ensure that the statutory and/or accounting disclosure requirements were met must therefore be regarded as serious.”

In relation to loans provided by Anglo to 10 customers for the purchase of shares controlled by Northern Ireland businessman Sean Quinn, Purcell found that EY’s failure to identify the loans in its audit was not “attributable to serious shortcomings” in its performance, and it did not have a prima facie case to answer.

Similarly, in relation to certain loans provided by Anglo to four key management personnel, Purcell found that EY was not liable to disciplinary action.

The allegations in Purcell’s report are expected to form part of the CAI’s disciplinary case against EY, along with the firm’s response.