Explaining its $450 million settlement with U.S. and U.K. regulators, Barclays said it had "inadequate" controls and "had not anticipated the increased risk around the Libor process." Auditor PricewaterhouseCoopers has been negligent in its duties as well.
PwC agreed to the most minimal disclosure of Barclays' potential settlement in the annual report released in March. Barclays "attempted to manipulate and made false reports concerning both benchmark interest rates to benefit the bank's derivatives trading positions by either increasing its profits or minimizing its losses," according to the Commodity Futures Trading Commission. PricewaterhouseCoopers missed, or maybe looked the other way at conduct that was "regular and pervasive."
The CFTC enforcement order says Barclays based its Libor submissions on the requests of Barclays' swaps traders, who were attempting to influence the official published London interbank offered rate and the profitability of their own trades. In addition, certain Barclays swaps traders "coordinated with, and aided and abetted traders at certain other banks to influence the Euribor submissions of multiple banks, including Barclays." Barclays also systematically suppressed its submissions to the Libor committee regarding its borrowing costs to mitigate perceptions of its weakness during the 2008 crisis.
PwC could have caught the faults twice. The auditor should have identified and warned shareholders and the public about increased risk at Barclays. An audit firm has an obligation, according to standards enforced by the Public Company Accounting Oversight Board, the profession's U.S. regulator, to audit disclosures. Generally Accepted Accounting Principles and International Financial Reporting Standards require disclosure of information about risk. (Barclays is subject to the latter set of rules.) If disclosures are materially incomplete or inaccurate, an auditor should not issue a clean opinion.
The "management discussion and analysis" of results for a financial institution must include discussion of: liquidity; capital resources; results of operations; off-balance sheet arrangements; and contractual obligations. Although auditors' obligations are more limited here, the auditor should read this information and consider whether it, or the manner of its presentation, is materially inconsistent with information appearing in the financial statements.
Second, when a bank must comply with Section 404 of the Sarbanes-Oxley Act (and Barclays must, despite being a foreign entity, since its American Depository Receipts trade on the New York Stock Exchange), the auditor expresses an opinion on the effectiveness of the company's internal control over financial reporting. PCAOB's Auditing Standard No. 5 says, "When auditing internal controls over financial reporting, the auditor may become aware of fraud or possible illegal acts. In such circumstances, the auditor must determine his or her responsibilities."
Controls over values created using models, third-party pricing services, and use of market inputs are supposedly supported by elaborate compliance systems to make sure valuations meet accounting standards. Basic assumptions used to assign values such as benchmark interest rates should not be vulnerable to manipulation or collusion. Banks must comply with legal and regulatory requirements to ensure the integrity of data critical to the functioning of the capital markets.
According to the regulators, Barclays had no specific internal controls or procedures, written or otherwise, regarding how Libor submissions should be determined or monitored, and Barclays also did not require documentation of the submitters' Libor determinations.
The CFTC order requires Barclays not only to beef up its compliance processes but to "take on a role as an advocate for increased oversight for the industry," according to the Financial Times. Auditor PwC gave Barclays – along with JPMorgan Chase and MF Global – clean opinions on internal controls over financial reporting while we know now, from regulators' disclosures, that those controls were seriously deficient.
More than a dozen other banks are under investigation by U.S., Asian and European regulators for collusion in setting interbank lending rates. It will be interesting to see if KPMG, Ernst & Young and Deloitte's banking clients also manipulated Libor – as Barclays suspected – and if those banks also allowed derivatives desks to set the rates.
If so, Barclays has a big job ahead as industry advocate for being good.
Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.