Counterfactual: the FRC Code and @IRLSR S4.12 together prevent the collapse of Carillion

Carillion is in the news again. Not that it ever was, or ever will be, fully out of the news because it will never be forgotten.

It’s in the news because:

The UK’s financial regulator has said it is planning to take action against former directors of Carillion, almost three years after the government contractor collapsed under £7bn of liabilities, leaving taxpayers to pick up the pieces.

On Friday, the Financial Conduct Authority announced that it had issued warning notices to the company itself and to “certain previous executive directors” over a series of breaches of financial rules before the business failed. 

These include giving “false or misleading signals as to the value of its shares”, “failing to take reasonable care to ensure that its announcements were not misleading, false or deceptive”, and “failing to take reasonable steps to establish and maintain adequate procedures, systems and controls”.

Financial Times 13 November 2020

It will never be forgotten in the history of corporate collapses because its demise was wholly a function of conduct – behaviour over time:

Carillion’s rise and spectacular fall was a story of recklessness, hubris and greed. Its business model was a relentless dash for cash, driven by acquisitions, rising debt, expansion into new markets and exploitation of suppliers. It presented accounts that misrepresented the reality of the business, and increased its dividend every year, come what may. Long term obligations, such as adequately funding its pension schemes, were treated with contempt. Even as the company very publicly began to unravel, the board was concerned with increasing and protecting generous executive bonuses. Carillion was unsustainable. The mystery is not that it collapsed, but that it lasted so long.

House of Commons Joint Committee Report 9 May 2018

In July 2018 the FRC published its updated Corporate Governance Code, the first three Principles are set out as follows:

Principles
Financial Reporting Council
A. A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society.
B. The board should establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and
promote the desired culture.
C. The board should ensure that the necessary resources are in place for the company to meet its objectives and measure performance against them. The board should also establish a framework of prudent and effective controls, which enable risk to be assessed and managed.

FRC Corporate Governance Code July 2018 (the Code)

In June 2020 The Centre for Ethics & Law, University College London published its Final Report of the Independent Review of Legal Services Regulation written by Professor Stephen Mayson in which he recommended:

Recommendation 20 (page 151): An in-house legal department should be capable, for regulatory purposes, of being registered as a distinct business unit, so that the department’s delivery of legal services would be subject to the same regulatory obligations as any other registered provider. Individuals within such a registered in-house unit should also be registered personally if they carry on activities for which before-the-event authorisation or personal accreditation would otherwise be required.

Final Report of the Independent Review of Legal Services Regulation June 2020

Professor Mayson set out his reasons for this Recommendation as follows:

There is little doubt that a tension is inherent in this relationship when the client for legal services is also the adviser’s employer. The usual expectation of ‘independent’ legal advice is often stretched … arguable that those with professional obligations might benefit from further regulatory support… In principle, they should not be at risk of dismissal or disadvantage simply for observing their professional obligations … This might entail express conditions in their employment contract, and a direct reporting line to the Board … As we have seen in recent years, corporate failures can lead to consumer and societal detriment. In-house lawyers have to be able to sound alarm bells without the chilling effect of potential reprisal.

Section 4.12

Furthermore, and of particular relevance to the Carillion case, he goes on to point out that:

…I agree with a submission in response to the interim report that we should not presume that “corporate governance alone is sufficient to address the public interest – there will be times when general counsel need recourse beyond their board, to their regulator (e.g. when the concerns derive from, or are perpetuated by, behaviour at board level)”.

Section 4.12

What if the the Code and Recommendation 20 of the IRLSR had been in force and enforced, with criminal prosecution consequences for breach, over many years prior to the collapse of Carillion? Here’s my guess:

  • Fear of prosecution relating to breaches of the Code would have prevented the creation of a decision-making culture that led to the more reckless conduct of the Board
  • Carillion’s in-house lawyers (in respect of whom the HOC Report is silent) would have been in a position when the early signs of reckless conduct presented themselves to reach “beyond their board and, to their regulator (e.g. when the concerns derive from, or are perpetuated by, behaviour at board level)” and which recourse would have acted as a brake on that behaviour. I don’t accept the point, often made, that this would mean that all companies would stop employing in-house lawyers. If some did , would that not be a statement about them?
  • The lives and pensions of thousands would have been protected, the taxpayer saved millions, and trust in boards, lawyers, regulators and politicians to protect wider society would not have been tarnished so irreparably.

But that’s the counterfactual.

The current reality is that the Code is an excellent framework, but without criminal sanction to back it up, it won’t prevent another Carillion. Nor, even worse, will the current regulatory framework under which in-house lawyers function.

Sadly, there appears to be little appetite in parliament, boards, the legal profession and the SRA to grasp this nettle.

I have written extensively on this subject in the current edition of the Modern Lawyer quarterly journal, edited by Catherine McGregor and published by Globe Law & Business, in a long read entitled: Inherent tension in-house: defusing the law department time bomb at a time of pandemic. I have spare copies. Email me at cfenton@ciaranfenton.com with your postal address if you would like a copy.

Meanwhile, there is light at the end of this bleak tunnel: the pandemic and the ESG movement will create an environment in which parliament, boards, the legal profession and regulators will be forced by society, including employees, customers and suppliers through social media, to prevent another Carillion because the price of the furlough schemes and COVID-19 Financing will be much better conduct.

Much better, or else.

Ciarán Fenton

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