Redcentric (RCN) Campaign: Important Developments

There have been important developments in our campaign regarding the accounting scandal at IT service group, Redcentric.

Firstly the FRC have moved at “lightning speed” (by their usually interminable standards), and published their findings in little more than two years after the matter was brought to their attention. And secondly there is news on the parallel FCA investigation in Redcentric’s recently published annual results for 2018/19.

FRC Report

The FRC concluded that Redcentric’s auditors, PwC, did not meet expected professional standards in their audits of Redcentric’s FY15 and FY16 accounts and have levied a £4.5m fine as a sanction. The FRC’s announcement and details of sanctions can be found here: https://www.frc.org.uk/news/june-2019/sanctions-against-pwc-and-partners-in-relation-to

Of greatest interest to me is the FRC report on their investigation: https://www.frc.org.uk/getattachment/8affbe3a-e3f8-4ffa-9b73-4ed7808e68b1/2019-05-22-Rule-18-Decision-Notice-(Signed)-Final.pdf This contains details of an astonishing catalogue of failings by PwC. I would like to congratulate the FRC on a comprehensive and thorough report delivered in a reasonable timescale.

Most glaring, to me, is an explanation of how PwC could have failed to spot inaccurate reporting of net debt. The report reveals:

The summary of reconciliations at the year end indicated a very high level of deposits in transit, resulting in a significantly higher reported balance for cash compared to the bank balance at 31 March 2015: £6.5m in transit vs. £446,141 bank balance. The value of deposits in transit at the year end was much higher than in the other month where bank reconciliations were tested by the audit team. There is no indication on the audit file that
these matters were noted or the implications for audit testing considered. Whilst reconciling items were tested during the FY2015 audit, in the above circumstances, strong external evidence (e.g. bank statements) should have been obtained by the audit team. There is no evidence this was done, and the audit team relied upon Redcentric generated excel spreadsheets listing reconciling items.

It is quite incredible to me that PwC’s audit team could have failed to independently reconcile accounting entries with bank statements: this is audit 101!

The report also confirms a number of suspicions that I and  senior campaign members (with audit experience) have had. Firstly, it confirms that a significant amount of the audit work was conducted by trainee, and even undergraduate, audit staff. Clearly such staff would find it difficult to challenge statements made by highly experienced accounting staff at the firm being audited and would not be able to distinguish fair comment from attempts to mislead. Part of the sanctions applied to responsible PwC partners include:

In addition, and as a condition of Executive Counsel accepting the Respondent’s agreement to the Decision Notice, additional training has been performed by [the partner] in relation to:

1. compliance with the requirements of paragraph 15 of ISA 220, as it relates to supervision of the engagement team; and

2. the application of professional scepticism in accordance with ISA 200.

Secondly, it confirms a point that I have previously made to Redcentric’s board:

The FRC criticises PwC for not classifying the audit as “higher risk”, with one of the reasons for that classification being:

the structure of certain of Redcentric’s management incentives, the vesting of which were directly linked to current year financial performance, rather than longer term measures such as share price growth.

The board has previously said to me that they did not know what motivated the false accounting entries that were made and denied that it might have something to do with management incentives.

FCA Investigation

Unfortunately, the FCA have been slower in reaching a conclusion and, indeed it is only because of Redcentric’s recently released annual results, that it became clear that their investigation remains ongoing:

Unfortunately, the business continues to experience the effect of the FCA investigation. As well as diverting management time, significant costs are still being incurred (£0.6m in FY19 and £2.5m since November 2016), we are constrained in the markets into which we can sell, and strategic options are limited.

The FCA investigation is still ongoing and has not yet reached its conclusion. At this time, the FCA has not communicated how it intends to proceed and what, if any, action it might bring against the Company. Until such stage as the FCA’s intention becomes clear, the Directors are not able to judge whether a fine will be likely and therefore whether we would need to make a relevant provision in the accounts. We continue to cooperate as fully as we can with the investigation and whilst the overall timing is out of our control, we are seeking to expedite it as soon as practicably possible.

This is wholly unacceptable, in a number of respects: Firstly, it is only because of this statement from the company that we know that an investigation is ongoing. The FCA has refused to update complainants with any information whatsoever on whether an investigation was launched and any progress of the investigation. Secondly, who is being punished by this investigation? The costs and business damage the company reports impact long-suffering shareholders rather than any guilty parties, so far. How is this fair? Thirdly, why has the company found it necessary to expend vast sums in relation to the investigation? Who is being defended? I intend to ask the company about this at its forthcoming AGM.

If the company were fined as a result of the investigation this would only add insult to the injury shareholders have already suffered.

Redress

All these revelations increase my determination to seek redress for shareholders – in some way. It is not good enough that fines and sanctions are levied against various parties, but that shareholders who invested based on false accounts should continue to suffer substantial financial losses.

I have therefore put all the evidence I can gather in front of a legal adviser who has expressed an interest in the case. It is notable that Assetco recently secured a substantial claim against their auditors, who were similarly sanctioned by the FRC. In this case ISTM that there are other parties that could also be pursued and I await our adviser’s response with interest. However, the UK’s legislative environment does make it very difficult to obtain redress in cases like this.

ShareSoc will continue to fight for law reform, making it easier for shareholders to take action against parties that maliciously or negligently act against shareholders’ interests, as is the case in the US, for example.

Mark Bentley