An analysis of financial scandals: Deloitte’s implication in Bankia and Abengoa’s bankruptcy PDF

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In this case study we show the impact of two scandals in which Deloitte, the famous auditing and consulting company, has been involved. They are the two greatest Spanish bankruptcies ever, Bankia and Abengoa. In both cases, Deloitte was the auditor, so it was responsible for analysing the financial ...

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An analysis of financial scandals: Deloitte’s implication in Bankia and Abengoa’s bankruptcy

MODULE: Strategic marketing NAME: Ramón José Duarte León STUDENT NUMBER: 160612893 ACADEMIC YEAR: 2016-2017 UNIVERSITY: Newcastle University

EXECUTIVE SUMMARY In this case study we show the impact of two scandals in which Deloitte, the famous auditing and consulting company, has been involved. They are the two greatest Spanish bankruptcies ever, Bankia and Abengoa. In both cases, Deloitte was the auditor, so it was responsible for analysing the financial situation of the companies and therefore making sure that they weren’t being throughout financial distress. Those cases have implied sanctions for Deloitte as well as being the company involved in legal procedures to clarify its liabilities in the situation. All of this has caused a bad image of the company in the markets, not only in Spain but also in the rest of the world. Here we consider the reactions of Deloitte and suggest some strategic plans they can launch to face those situations.

LIST OF CONTENTS: 1. Company overview 2. Overview of the market background 3. Description of the events a. Bankia b. Abengoa

4. Critical analysis of both events a. Relevance of the image in the accounting sector b. Possible effects c. Deloitte’s reaction analysis

5. Consequences 6. Conclusion 7. List of references

1. Company overview Deloitte Touche Tohmatsu Limited, is an UK private company limited by guarantee (“DTTL”) (1). Founded in 1845 by a professional accountant called William Welch Deloitte, it operates in more than 150 countries using a network of professionals in independent firms which provide audit consulting, financial and risk advisory, tax and related services to their customers. With more than 244400 professionals, it is one of the named Big Four auditors, along with KPGM, EY and PWC. The revenues for fiscal year 2016 were US$36.8 billion, which put Deloitte in the leading position of the auditing and accounting firms at a global level. As it’s being considered two scandals that implies some of the greatest Spanish companies in the IBEX 35, the Spanish stock exchange, this implies that the member treated of DTTL will be Deloitte Spain, an independent firm with its own legal personality, but a part of the global network established by the DTTL group. Deloitte Spain has been traditionally the greatest company in the accounting and auditing sector, controlling a percentage of 43% of the market share of the IBEX 35 in 2015.

2. Overview of the market background Audits play a vital role in the functioning of capital markets. The demand for audit services by public companies also is inelastic in that these companies must obtain an audit due to regulation, with no substitution for such services available (2).

The trends of this market have been mainly the steadily concentration of most of the market share in the hands of a decreasing number of firms. Whilst in the 1980s the audit market of the largest companies was controlled by eight firms (the Big 8) there was a process of merging between them during the late 1980s and 1990s which has led to the monopolization of the market by the current Big 4. In 2013 the share of the global accountancy market by the Big Four audit firms was 67% (3). Another important evolution is the increasingly significance of the advisory and consulting sector. While the audit sector is still the most profitable one for the leading accounting firms, their relevance is now in clear downturn, in contrast with upward trends of the consulting services. However, is still important as most managers see a good audit service as a positive image to rely on the firm’s capability to give good and useful advisory service.

Big Four Global Network 3-Year Summary of Revenue (US $Millions) 120000

100000

80000

60000

40000

20000

0 2011 Assurance

2012 Tax

Advisory

2013 Total Revenue

source: Current Trends in the Audit Industry. International Forum of Independent Audit Regulators.

Those features, together with some measures taken by most governments, especially legal changes to enable the introduction of more competitors, make the accounting services market as a so competitive environment where firms must have a strong position, a considerable size and a consolidated brand image to be able to survive.

3. Description of the events Both Bankia and Abengoa had Deloitte Spain as their auditor. Hence, it was entrusted to check whether the companies’ accounts gave a true and fair view of their financial positions. As a summary, we can say that despite the fact that Deloitte reported a good situation of both firms, at last they went bankrupt, highlighting they had been involved in financial trouble. However, they are different cases so they should be considered separately.

a. Bankia Bankia was a bank created through the merger of seven smaller saving banks, to re-engine the Spanish financial system, in a context of economic crises and financial distress. After the creation, the company was going to be launched to the stock exchange in May 2011, so Deloitte was chosen as its auditor, responsible to assess its financial situation. But Deloitte wasn’t only the auditor, its professionals assumed consultancy advice function, something which wasn’t allowed by the Spanish regulatory framework. This lack of independence has been seen as one of the main reasons for the manipulation of the accounts which led Deloitte to be prosecuted by the Spanish judiciary. But what figures are we talking about? Bankia was formed by several financial institutions which were suffering serious financial problems. Nonetheless, this wasn´t an obstacle to achieve an important profit of €300 million just before its public launch in May 2011, according to the financial reports made by Deloitte’s professionals.

Taking into account that performance, about 360000 investors put their money into the company, to buy shares in the IPO. Another 238000 acquired shares, those ones called “preferentes” shares, a high-risk subordinate debt instrument which were sold as non-risk investments. However, the performance was not as good as it was reported. As a result, the great majority of the investors lost their money, and they have recovered only a part of it thanks to the bailout of Bankia, who cost roughly €22.5 billion to Spanish taxpayers. Even though the judicial process to determine pecuniary and criminal accountability is still to be finished, the ICAC, an entity dependant to the Economy department of the Spanish government, imposed a sanction to Deloitte Spain of €12.8 million, recently reduced to €10.4 million. Both Deloitte and its partner, Francisco Celma, the person entrusted to review Bankia’s financial position are now accused alleged offender for criminal offence in the judiciary process. Deloitte first approach to this scandal has been mainly until recent times to blame his partner for the potential legal consequences for the auditing of the company. However, a few months ago recognised that there could be some “errors” in its action.

b. Abengoa Deloitte is also facing a judicial process by its responsibility as Abengoa’s auditor, due to the action filed up by the minority shareholders of this company. On 13th November, 2015 Abengoa disclosed its accounts, foreseeing losses for €194 million. Up to that date, Deloitte professionals,

entrusted with the auditing of the company, didn’t report any fact that could worry to the Abengoa’s shareholders.

But there was somebody who really did realise about the underlying financial difficulties that Abengoa could end up facing. A 17-year-old student, called Pepe Baltá Aymar, who wasn’t even studying at any University analysed Abengoa’s accounts for a class project. He discovered the accounts were not as the common models of standard companies’ accounts, but at first he thought this could be because he was considering such a big company. But afterwards, he discovered that its debt rates were surprisingly high. As a result, he claimed that could make Abengoa go bankrupt.

4. Critical analysis a. Relevance of the image in the accounting sector As it was stated before, the accounting sector is a very competitive market with a great concentration of the market share under the control of a few amount of big multinational companies. Those companies are usually structured in a large network of independent firms who hire professionals to render the the most relevant services included in the accounting sector. Auditing, the most important, but also others like advisory, consulting and tax services. Due to that setting, the brand image of the global group for the firm have a key role to achieve success. The reason for that is a positive brand image permits not only have a better reputation to get more clients for the company, but also enable attracting more highly skilled professionals with the best capabilities and wider knowledge.

Those professionals will perform much better and the customer satisfaction will improve too.

b. Possible effects Taking all of this into account shows the devastating aftermath of a scandal such as the ones treated before. Those negative consequences not only implied the possible sanctions that faced Deloitte Spain, and the foreseeable losses in that particular market, but they have a global impact.

The whole image of the brand results damaged, and the competitors can take advantage of it and occupy the space that Deloitte Group leaves. In this point we must emphasize too that the US regulator have also started to investigate Deloitte Spain for possible criminal charges due to its participation in the Abengoa’s bankruptcy. This combined with the fact that a 17-year-old student with limited skills in accounting report foresaw the situation of the company could make this case even worse for Deloitte than its participation in Bankia. The US is, without any doubt, the largest market for the accounting leading firms and a scandal of such a dimension could even exclude Deloitte from there, reducing dramatically the revenues of the group.

c. Deloitte’s reaction analysis Despite the legal procedures that implies both cases, especially to clarify the accountability of the firm and its professionals, and the possible losses

that could entail, the future of the company depends mainly on how they face the scandals from a communication point of view.

In this connection, Deloitte first reactions to the Bankia scandal were less than appropriate. The company just denied its participation in the manipulation of the accounts, and blamed one of its professionals, Francisco Selma, for being the person responsible to give a fair view of them. Within a context of irresponsibility, and considering most minority investors lose great amounts of money (including lots of retired workers totally unaware of the financial risks of their investments) had a great adverse effect on most opinion makers all around the world. In the opinion of Lou Robin, general manager of Dprime Consulting, a division of Omnicom Group, the first rule is you can’t hide information. You must acknowledge the problem and your accountability. People want to forgive, and regret, unlike lies, is something accepted in our culture. If management concludes that the company is likely to be affected by a scandal, it should immediately acknowledge the problem, expressing concern for any parties harmed and outlining the steps the firm is taking to investigate and to prevent further damage (4). Response time is a crucial factor as well. Even though getting away from the public interest could be a good option in some cases in order to avoid suffering great periods of negative headlines in the news, if the scandal is too big and serious you must be quick in communicating your point of

view to the public. Hiding yourself will only be seen then as a way of escapement from your responsibility. If the bad practices that finally unleashed the problem were the action of a specific individual, it would be important to make it pay the price for them.

Regarding particularly the Bankia case, the auditor, Francisco Celma, is a partner of Deloitte yet. But nevertheless Deloitte approach has recently changed. Its partner Francisco Celma acknowledged in a letter sent to the judge of the case that it could be a “mistake” in its report for the very first time. He has admitted his negligence, but denied any type of wilful misconduct that could lead to criminal responsibility. This action, taken anyway a little late, might be the first step to recover the lost confidence of the market and create a positive footprint in the customers. In this point it should be declared that some crisis are not only negative events but also opportunities for the company to strengthen its position and bolster its brand image.

5. Consequences Both scandals have had significant implications not only for Deloitte, but for the entire accounting firm’s sector. And these consequences are not limited solely to sanctions for the firms. Legislation in most jurisdictions have changed to ensure that bad practices won’t repeat in the future.

Focusing on the Spanish market, Deloitte Spain is lately loosing part of its leading position. The new legislation has forced companies to change their auditor every 10 years so most of their customers have chosen PwC as their new auditor, refusing to choose Deloitte Spain. Huge firms as Grupo Santander, Telefónica and Repsol selected PwC as their new auditors. The loss of the reputation that has implied the Bankia and Abengoa case has also played a key role on this evolution of the market, according to some companies’ surveys.

Comparison between market share in Spain of each firm of the Big 4 by revenue in the year 2015 (Graphic A) and 2017 (Graphic B)

Graphic A

PWC

Deloitte

EY

KPGM

source: José Antonio Navas (26th September, 2016). Vuelco total en el mapa de las Big 4: PwC desbanca a

Deloitte

del

trono

del

Ibex.

El

Confidelcial.

Retrieved

http://www.elconfidencial.com/empresas/2016-09-26/vuelco-total-en-el-mapa-de-las-big-4-pwcdesbanca-a-deloitte-del-trono-del-ibex_1264491/

Graphic B

from

PWC

Deloitte

EY

KPGM

source: José Antonio Navas (26th September, 2016). Vuelco total en el mapa de las Big 4: PwC desbanca a

Deloitte

del

trono

del

Ibex.

El

Confidelcial.

Retrieved

from

http://www.elconfidencial.com/empresas/2016-09-26/vuelco-total-en-el-mapa-de-las-big-4-pwcdesbanca-a-deloitte-del-trono-del-ibex_1264491/

As we’ve seen before, trends in the global market also suggest that Deloitte is being reached by its competitors. The gap between it and the rest of the Big 4 have been decreasing in the past few years.

In spite of this, Deloitte continues to be the leading company in the accounting sector. It seems the scandals have not damaged enough its image to expel them from the market, as it occurs with Arthur Andersen and the Enron case. The strong position of its brand stays a powerful tool to maintain its reputation and therefore its privileged situation within the audit and accounting industry.

Revenue 2016 (US$ in billions) 40 35 30 25 20 15 10 5 0 Deloitte

PwC

KPGM

EY

source: EY 2016 Global Review, PwC 2016 Global Review, 2016 KPGM International Annual Review, About

Us:

About

Deloitte

(2016)

A

story

that

matters.

Retrieved

from

https://www2.deloitte.com/global/en/pages/about-deloitte/articles/about-deloitte.html

We can see that more clearly regarding the upward pattern of the Deloitte’s revenue at a global level during the last years. It is a common tendency in this industry the increase in income in recent years, even though the partial disrepute suffered by the accounting and auditing profession.

DTTL's Revenue (US$ in billions) 40 35 30 25 20 15 10 5 0 2011

source:

About

2012

Us:

About

2013

Deloitte

(2016)

2014

A

story

2015

that

matters.

2016

Retrieved

from

https://www2.deloitte.com/global/en/pages/about-deloitte/articles/about-deloitte.html

6. Conclusion Those scandals have been more common than what people usually think. Especially during the recent years, in a context of economic crises, there have been several events of financial fraud and great bankruptcies (Gowex, Madoff, Lehman Brothers). A sensation of impunity of the responsible people of such events is now widespread in the public opinion. This may

significate a disrepute for the accounting and auditing profession, a communication challenge which may be faced by most companies of this sector. The common reaction is usually the denial of any participation in them, something that might be even worse for their image. Perhaps deeper assumption of their accountability and repair of economic losses

caused will result in greater benefits from those firms, since they won’t lose the market share otherwise they will.

However, the sector is growing, and this doesn’t seem to change in the future. Deloitte is also following this trend, and it seems that the scandals which are being faced currently by the company haven’t had a great impact at a global level. Its prestige and reputation as a respectable and serious company may have prevented negative consequences for them. They continue working with the largest corporations in the world and having the leadership of the Big 4 companies of the accounting sector.

7. List of references (1) About Us: About Deloitte (2016) A story that matters. Retrieved from https://www2.deloitte.com/global/en/pages/aboutdeloitte/articles/about-deloitte.html (2) (3) (2013). Current Trends in the Audit Industry. International Forum of Independent Audit Regulators. (4) (5th October, 2005). La rehabilitación de una marca tras un escándalo empresarial. Wharton, University of Pennsylvania. Retrieved from http://www.knowledgeatwharton.com.es/article/la-rehabilitacion-deuna-marca-tras-un-escandalo-empresarial/

José Antonio Navas (26th September, 2016). Vuelco total en el mapa de las Big 4: PwC desbanca a Deloitte del trono del Ibex. El Confidelcial. Retrieved

from

http://www.elconfidencial.com/empresas/2016-09-

26/vuelco-total-en-el-mapa-de-las-big-4-pwc-desbanca-a-deloitte-deltrono-del-ibex_1264491/

Juande Portillo (26th October, 2016). Deloitte expone que en el peor caso hubo un “error” contable en Bankia pero nunca “conducta dolosa. Cinco Días.

Retrieved

from

http://cincodias.com/cincodias/2016/10/26/mercados/1477493668_5140 96.html

Don Quijones Spain & Mexico. (14th February, 2016). Deloitte About to Pay for

its

Spanish

Sins?

Wolf

Street.

Retrieved

from

http://wolfstreet.com/2016/02/14/deloitte-spain-to-pay-for-audit-sinsbankrupt-bankia-abengoa/

Luis Federico Florio (12th December, 2016). El estudiante de 17 años que predijo

la

caída

de

Abengoa.

La

Vanguardia.
...