This week Tesco finally agreed to a £129 million fine for overstating its profits in 2014, thus avoiding prosecution. This agreement, made by Tesco Stores Ltd. Follows a two-year probe from the SFO. Not only did Tesco suffer majorly from share price hits, but is now also facing a huge fine for its errors. Alex Ktorides, Head of Ethics and Risk Management at Gordon Dadds LLP, here provides Finance Monthly with a specialist overview of the matter, and hints at potential implications for any business missing the mark when it comes to such critical internal vulnerabilities.

Tesco appears this week to have reached a key stage in the financial misstatement scandal that so badly hit its share price and reputation in 2014.

A brief recap. The retailer, in or about September 2014, shocked the financial world when it admitted that it had identified an apparent £250 million overstatement of its profits. The central problem was that it was alleged that Tesco had significantly overstated its profits by supposedly booking rebates (receipts) from suppliers that it had not yet received. A range of regulators became involved as the Tesco share price took a serious hit in the wake of the revelations.

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Misstating profits, as in the Tesco case, can give rise to a number of concurrent investigations in the UK, all involving different investigating and prosecuting authorities with differently sized sticks with which to beat the offending corporate entity and singled out individuals.

First in the firing line (though there is no magical order in reality) are the internal financial directors and external auditors who will likely face serious scrutiny from the Financial Reporting Council (FRC), which has in the past brought investigations in relation to past scandals such as Torex, Cattles and car manufacturer, Rover.

The FRC has a range of powers including fines and sanctions against individuals and the auditing firms.  This will not be a cheap case to defend (FRC investigators invariably outsource forensic accounting investigatory aspects, the costs of which it will seek to recoup) and which may or may not be covered by the terms of professional indemnity insurance depending on the programme carried by the auditor in question.

Secondly will be the SFO investigation. The SFO will not be shy in seeking information and this will include amongst other things extensive disclosure of documents, countless recorded meetings and a range of witness statements and experts’ reports. Not a short process, nor one which is stress free.

The FCA will also be interested in protecting the public. In the instance of alleged misstatement of profits, as in the Tesco case, the ‘public’ are the investors and shareholders buying shares in a listed entity in a major regulated market such as the FTSE 100.

Similar to the ‘soft dollar’ settlements propounded by the SEC in the US, the FCA will look to quickly assess the period during which the share price may have been artificially inflated (or indeed in some cases, deflated) and look to impose or agree a settlement scheme as swiftly as possible. There is precedent to this, as well as the Tesco scheme announced very recently.  In the mid-2000’s the FSA (now FCA) put huge pressure on the IFA sector to agree with Aberdeen Asset Management and others a financial compensation scheme for individual investors miss-sold so-called ‘split-cap’ investment trusts. This was no easy feat for the then Chief of the FSA John Tiner who was (anecdotally) personally calling up the professional indemnity insurers of those advisors involved in a bid to speed up the implementation of the compensation scheme. One imagines that Tesco and its management/insurers will be receiving similar pressure to agree the £85m scheme it has just announced.

Tesco’s Deferred Prosecution Agreement (DPA) – if it is sanctioned in the Southwark Crown Court next week – will be the fourth reached by the SFO. All of the DPAs reached so far have involved very different allegations and conduct (see Rolls Royce for example). The allegations involving Tesco relate to relatively short periods of time and very specific behaviour of alleged accounting errors involving the early booking of receipts from suppliers.

There is one common feature to the DPAs reached so far, and that is that each of the corporates under investigation that have successfully reached DPAs with the SFO have been seen to be cooperating with the investigation. That does appear to be a crucial aspect of the potential for reaching a DPA with the SFO.

So, what to do if an investigation occurs? The first thing is to obtain advice speedily. It may be necessary for legal advice to be obtained by different advisors and professional firms, with individuals quite often having to be separately advised to the corporate entities. A DPA may be the obvious and best solution and these are always predicated on cooperation. Very often in the case of enforcement proceedings or criminal investigations, cooperation is a vital component of reaching agreement and this is only increased significantly with the advent of DPAs. Indeed, in a recent speech, the director of the SFO stated that DPAs are not the ‘new normal’ but rather will only be available where there has been significant cooperation which is meaningful evidence by the corporation in question.

Cooperation can take many forms including but not limited to, the provision of documents (this sounds simple but often in reality these are frequently requested in huge volumes and under tight timescales and in a format that the SFO’s computing experts can easily handle). In the Polly Peck case, revisited on the return of Asil Nadir after some 19 years in the sun of Northern Cyprus, the SFO had recourse to review thousands of documents which were in some cases 20 years old and it was fortunate indeed that they had been retained at all.

DPAs can lead to a swifter conclusion of investigations (which are of course very damaging) and discounts on any penalties. Also, receiving reduced sentencing for those cooperating with the prosecutors may be on the table.

In summary, financial accounting methods and over or understating profit is a business critical issue. The implications – financial penalty, share price collapse, civil compensation schemes, expensive regulatory and criminal investigations, loss of income and in some cases, prison – are as serious as it gets in the corporate world. As Tesco has shown us (and a glance at current cases with both the SFO and FCA shows us that there are many more to come, not least of all such big brands as Barclays, Airbus Group and GlaxoSmithKline) misstating profits is a short term boost towards long term pain. The settlements with the FCA and SFO as a special offer that Tesco will not be looking to repeat.

The Financial Conduct Authority (FCA) has imposed a financial penalty of £284,432,000 (€400 million) on Barclays Bank Plc (Barclays) for failing to control business practices in its foreign exchange (FX) business in London. This is the largest financial penalty ever imposed by the FCA, or its predecessor the Financial Services Authority (FSA).

Barclays’ failure to adequately control its FX business is particularly serious in light of its potential impact on the systemically important spot FX market. The failings occurred throughout Barclays’ London voice trading FX business, extending beyond G10 spot FX trading into EM spot FX trading, options and sales, undermining confidence in the UK financial system and putting its integrity at risk.

Georgina Philippou, the FCA’s acting director of enforcement and market oversight said: “This is another example of a firm allowing unacceptable practices to flourish on the trading floor. Instead of addressing the obvious risks associated with its business Barclays allowed a culture to develop which put the firm’s interests ahead of those of its clients and which undermined the reputation and integrity of the UK financial system.  Firms should scrutinise their own systems and cultures to ensure that they make good on their promises to deliver change.”

Between 1 January 2008 and 15 October 2013, Barclays’ systems and controls over its FX business were inadequate. These behaviours included inappropriately sharing information about clients’ activities and attempting to manipulate spot FX currency rates, including in collusion with traders at other firms, in a way that could disadvantage those clients and the market.

Barclays and other firms are already participating in an industry-wide remediation programme to ensure that they address the root causes of the failings in their FX businesses and that they drive up standards.

The Financial Conduct Authority (FCA) has handed Deutsche Bank AG a £227 million (€315 million) fine, its largest ever for LIBOR and EURIBOR-related (collectively known as IBOR) misconduct. The fine is so large because Deutsche Bank also misled the regulator, which could have hampered its investigation.

Georgina Philippou, acting Director of Enforcement and Market Oversight, said: “This case stands out for the seriousness and duration of the breaches by Deutsche Bank – something reflected in the size of today’s fine. One division at Deutsche Bank had a culture of generating profits without proper regard to the integrity of the market. This wasn’t limited to a few individuals but, on certain desks, it appeared deeply ingrained.

“Deutsche Bank’s failings were compounded by them repeatedly misleading us. The bank took far too long to produce vital documents and it moved far too slowly to fix relevant systems and controls.

“This case shows how seriously we view a failure to cooperate with our investigations and our determination to take action against firms where we see wrongdoing.”

Between January 2005 and December 2010, trading desks at Deutsche Bank manipulated its IBOR submissions across all major currencies. This misconduct involved at least 29 Deutsche Bank individuals including managers, traders and submitters, primarily based in London but also in Frankfurt, Tokyo and New York.

The Financial Conduct Authority (FCA) has fined Aviva Investors Global Services Limited (Aviva Investors) £17,607,000 (€24 million) for systems and controls failings that meant it failed to manage conflicts of interest fairly. These weaknesses led to compensation of £132 million (€180 million) being paid to ensure that none of the funds Aviva Investors managed was adversely impacted.

“Ensuring that conflicts of interest are properly managed is central to the relationship of trust that must exist between asset managers and their customers. It is also a fundamental regulatory requirement. This case serves as an important reminder to firms of the importance of managing conflicts of interest effectively by implementing a robust control environment with effective systems to manage the risks. Not doing so risks customers’ interests being overlooked in favour of commercial or personal interests,” said Georgina Philippou, Acting Director of Enforcement and Market Oversight at the FCA.

“While Aviva Investors’ failings were serious, the FCA has recognised that its actions since reporting its failings were exceptional. The level of co-operation during the investigation and commitment to ensuring no customers were adversely impacted meant it qualified for a substantial reduction in the penalty.”

From 20 August 2005 to 30 June 2013, Aviva Investors employed a side-by-side management strategy on certain desks within its Fixed Income area whereby funds that paid differing levels of performance fees were managed by the same desk.

A proportion of these performance fees were paid to traders in Aviva Investors Fixed Income area who managed funds on a side-by-side basis. This type of incentive structure created conflicts of interest as these traders had an incentive to favour one fund over another. This risk was particularly acute on desks where funds traded in the same instruments.

Aviva Investors agreed to settle at an early stage of the FCA’s investigation and therefore qualified for a 30% (Stage 1) discount under the FCA's executive settlement procedure. Were it not for this discount, the FCA would have imposed a financial penalty of £25.2 million (€34.2 million) on Aviva Investors.