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True and fair remains at heart of battle over bank accounting rules

LAWYERS – who needs them? Apparently, the Financial Reporting Council (FRC) does. And that, it seems, is due to the concerted efforts of the Local Authority Pension Fund Forum (LAPFF) and such major long-term investors as Threadneedle Asset Management.

Back in April 2013, George Bompas QC, a highly regarded commercial silk, delivered the first of his two opinions on the legality of distributions made on the basis of financial statements prepared under International Financial Reporting Standards (IFRS).

The starting point for the opinion was the requirement under Section 393 of the Companies Act 2006 for company directors to approve only those accounts that present a true and fair view of a business’s assets, liabilities, financial position and profit or loss.

Section 495(3) imposes a similar obligation on auditor sign-offs. Also under the Bompas microscope were the Fourth and Seventh Directives and the so-called IAS Regulation, which together give effect to IFRS across the EU.

The first Bompas opinion looked at whether IFRS accounts deliver on that true and fair view requirement and whether that requirement itself takes precedence over those of IFRS. Bompas concluded that IFRS fails to meet the true and fair view requirement because it lacks a capital maintenance requirement, omits prudence as a fundamental accounting principle, and does not follow statutory accounting principles. He also argued that the true and fair view does indeed take precedence.

Apple of discord

The roots of investor dissatisfaction with IFRS broadly lie with the impairment model in International Accounting Standard 39, Financial Instruments: Recognition and Measurement.

LAPFF and its long-term investor allies argue that this standard opened the door to banks taking unrealised profits through illusory mark-to-market and mark-to-model valuations. In a bid to remedy the too-little-too-late problem, the IASB embarked on its flagship project to develop IFRS 9, Financial Instruments, as a replacement for IAS 39.

Back with the lawyers, the FRC sought a fresh opinion from its QC of choice, Michael Moore. Bompas, he said, is wrong. First, he said, usefulness, the financial reporting objective in the post-2010 iteration of the IASB’s conceptual framework, and true and fair are “inseparable” because “for financial statements to be useful, they must present a true and fair view”.

He added that paragraph 24 of IAS 1 does indeed cater to a departure from IFRS’s requirements where that is necessary to arrive at a faithful representation of transactions, events or conditions. Finally, he pointed to the requirement in IAS 1 to disclosure of any use of the override.

This was not Moore’s first foray into such territory. He authored his first opinion on true and fair view for the FRC back in 2008. The FRC itself had followed this up in 2011 with a paper on the issue, followed by a further paper in 2014.

The instruction from the FRC was clear enough: stand back and ask yourself if the accounts give a true and fair view; if not, use the override and disclose. Nonetheless, there remains one nagging question: if the requirements of UK and EU law are clear, why were the lawyers finding so much to argue about?

However, it is this approach of standing back from the accounts that is wrong, says LAPFF spokesman Tim Bush: “Mr Bompas also identifies that the legislation applies the true and fair view test to specified numbers in the accounts, not the accounts as a whole. But the defective FRC position applies the ‘true and fair view’ objective to the accounts as a whole by its words: ‘standing back’, as if looking at a Jackson Pollock painting.”

European fight

Investors, meanwhile, took the fight to Europe. Here, they found a willing audience among IFRS-sceptic MEPs, among them German Green Party member Sven Giegold and London Conservative Syed Kamall.

The timing could not have been more awkward for the IFRS Foundation, which had been rocked by an HMRC investigation into its treatment of PAYE and National Insurance, as well as the tale of woe surrounding its corporate filings at Companies House.

In response to the revelations, MEPs issued a strings-attached five-year funding package for the IFRS Foundation and the EU’s own accounting advisory body. Under Article 9 (3) of the Regulation approving that funding, the commission agreed to prepare an annual report on the activities of the IFRS Foundation, the Public Interest Oversight Board and the European Financial Reporting Advisory Group (EFRAG).

The first commission report emerged largely unnoticed on 17 September. In relation to the true and fair view concern, which it labels ‘fair presentation’, the report notes: “Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Conceptual Framework.”

But in September, the LAPFF published a second Bompas opinion. This reiterated the claim that company accounts prepared using IFRS fail to provide a true and fair view of a company’s financial position. Nor, Bompas argued, do IFRS accounts allow companies to assess how much of their profit each year is available for distribution to shareholders.

This second opinion snared the ICAEW. Bompas now argued that Martin Moore QC had relied on “defective” advice produced by the ICAEW and the Institute of Chartered Accountants of Scotland dating back to 1982. This situation, LAPFF chairman councillor Kieran Quinn said, means that accountancy has effectively become “a state within a state”.

Financial Director invited both the FRC and the ICAEW to comment on the allegation and to confirm whether either had sought further advice from counsel. In a statement, the FRC said: “UK government and the FRC have previously carefully considered the issues raised by LAPFF and discussed in the Bompas opinions. The FRC has published the legal opinions it has obtained. In reaching its conclusions the FRC has not relied on the ICAEW.”

The ICAEW said it has “not sought a recent legal opinion on this and stands by the 1982 guidance”.

Meanwhile, developments in Brussels continue apace. A leaked letter from Sven Giegold and Syed Kamall to the commission called for it to explain why it has failed to produce clear guidelines on the meaning of ‘the public good’ and ‘the true and fair view principle’.

The MEPs are concerned the commission has no apparent plan to carry out a thorough impact assessment on either the measurement or impairment requirements of IFRS 9. Then, on 23 September, the LAPFF accused EFRAG of having misread EU legislation in its broadly positive endorsement advice to the commission on IFRS 9.

Friendly disposition

Despite this opposition to IFRS 9, which is viewed as offering more bank-friendly upfront provisioning, the likelihood is that the EU will endorse IFRS 9. Given its status as delegated legislation, the European Parliament is unlikely to invoke its nuclear option of veto. In any event, a veto requires an absolute majority.
Tim Bush says he is sanguine about the situation: “Given that the faults with IFRS 9 are already apparent, and the Americans have gone for a more robust expected-loss model, rejection of IFRS 9 would in the long run do the IASB a favour. If IFRS 9 is used widely, it won’t take long to be revealed as defective compared to the American model.” ?

 

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