THE long-running row over the legality of international accounting rules flared up again in August, with online bookmakers Betfair dragged into the dispute after it admitted to paying illegal dividends out of capital between 2011 and 2013.
Investors are unhappy that international reporting standards (IFRS) are riven by fault lines and are disconnected from the requirements for true and fair accounts as set out in EU company law. Betfair has become embroiled in the battle between investors and standard setters.
The gambling website’s annual accounts revealed £30m in dividends and £50m in share buy backs were issued over three financial years, contrary to ICAEW guidance and conditions of realised profits and distributable reserves, the rules of which were amended in 2010
Betfair said in its report: “As a result of certain changes to the technical guidance issued by the … ICAEW in October 2010, the company did not have sufficient distributable reserves to make those distributions and so they should not have been paid by the company to its shareholders.”
Shareholder governance group Pirc subsequently recommended that investors reject the bookie’s accounts at its annual general meeting and oppose the reappointment of auditors KPMG for failing to spot that it had paid dividends to shareholders without having “sufficient distributable reserves to make those distributions”.
“Shareholders have been asked in prior years to vote on the payment of dividends that in fact were illegal due to defective accounts. That makes the validity of the company’s accounts themselves questionable,” said Pirc managing director Alan McDougall.
Betfair has hit back and accused Pirc of materially misrepresenting the facts in a number of ways. “Its most serious error is to claim that Betfair’s profits are overstated,” it said in a statement.
Despite reporting under UK GAAP rather than IFRS, Betfair’s accounting error is used as an example of the disconnect between accounting standards and company law.
In August, a group of institutional investors raised “grave concerns” that IFRS – with its emphasis on neutrality over prudence – has “dangerously weakened” the true and fair accounting concept and claimed that businesses are at risk of paying dividends out of capital as long as IFRS does not require companies to disclose underlying capital reserves, and which part is available for distribution.
The group, which includes Threadneedle Investments, Royal London Asset Management and the London Pensions Fund Authority, said Betfair’s failure to meet the conditions of realised profits and distributable reserves “highlighted the importance of the matter” despite Betfair reporting under UK GAAP.
The problem, the investors claim, was “most pernicious” in the case of banks in the run-up to the financial crisis. “The Bank of England has long maintained that the underlying problem was one of solvency, not liquidity, and yet investors could not have gleaned this by looking at banks’ report and accounts. Instead shareholders and taxpayers found out the hard way as share prices nose-dived and capital was destroyed,” the group said.
The concept of true and fair – whereby directors must consider whether, taken in the round, the financial statements that they approve are appropriate – is enshrined in UK law and came into conflict with international accounting rules last year when a group of investors questioned the legality of IFRS.
Doubts were raised by Lincoln’s Inn counsel George Bompas QC, who identified inconsistencies between IFRS and existing company law, suggesting that company directors must override the standards in order to comply with competing legislation.
In October 2013, the FRC and BIS dismissed the claims as “misguided” and published a legal opinion from Martin Moore QC that found that IFRS is legally binding and achieves a true and fair view in financial statements and could, in most instances, be achieved by complying with the rules.
The FRC has since confirmed that the presentation of a true and fair view remains a fundamental requirement of financial reporting and said that, in the “vast majority” of cases, a true and fair view will be achieved by compliance with accounting standards. However, the standard should be overridden where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the reporting watchdog said.
But the statement fails to respond the problems outlined in the Bompas legal opinion, the investors said. According to the group of investors, the FRC paper fails to clarify what “true and fair view” means, what is the availability of the true and fair “override” in the case where accounts do not reveal distributable reserves, or what are the key features of prudence in company law.
“We remain concerned that a faulty accounting framework, which has contributed to market instability and economic hardship in recent years, has not been properly addressed,” the group said.
“We recognise that the International Accounting Standards Board is reluctant to set standards according to any particular legal construct, but would welcome efforts on its part to take account of the incompatibility that we identify for the EU. If the IASB and the FRC cannot resolve the matter, there is an urgent need for a robust independent review.”