Just imagine…you are an auditor.

You are going over the books of accounts and other records of the client. Then out of nowhere, a red flag arises. The numbers don’t marry up. The information is apparently deliberately obscured. All the while, the client acts more and more suspicious.

That is how it went for PwC when performing its 2016 audit for London Capital & Finance. Except here is the kicker: even though these suspicions were palpable, PwC failed to report their findings to the regulator. The result? A record £15m fine and a salutary lesson learned.

As PwC dived deeper into LCF’s books and records, what was initially a mere “that’s a bit strange” quickly escalated. It became a full-scale “good grief, this is a disaster in the making.” It decided to stonewall and not give PwC’s auditors with some very basic information; it would simply not cooperate.

Inside PwC, the audit team waved so frantically, they could have been mistaken for a parade. The PwC risk team termed it “an issue with multiple question marks.” They cautioned that they might want to withdraw as auditor. Alternatively, they might limit the scope of the audit.

Aftermath: Fast-track to 2019 and the house of cards that was LCF folded, leaving investors £237 million in the red. It turns out LCF ran a “Ponzi scheme” to finance its lavish spending. They spent on everything from diamond earrings to horses. They also had a membership in a really posh London nightclub. Talk about living it large off other people’s dimes!

There was a huge fallout in which the Financial Services Compensation Scheme  had to pay out £57.6 million to bondholders who were left in the lurch when LC&F went bust. If that turmoil were not enough, the government offered a one-off agreement to pay £115m to eligible bondholders. But, that particular lifeline has since been axed.

The moral of the story, to be perfectly frank: PwC remained silent. An auditor must go directly to the regulator if they suspect any wrongdoing in terms of regulations. End of story.

Was PwC not seeing a whole set of red flags? 

They had ample cause to suspect that LCF was up to something improper, perhaps even fraudulent. Well, what had they done about it? Amazingly-nothing. It simply did not come into their minds to mention this to the Financial Conduct Authority. It was almost as if they were playing a sort of Jekyll-and-Hyde-type “see no evil.” They were playing “hear no evil.” They were also playing “speak no evil.” This time, the “evil” was fraud and they chose to turn a blind eye.

The Fallout:

Besides, PwC violated some of the underlying fundamental principles of the code of ethics for professional accountants. These include integrity, professional behavior, and due care. They were also experiencing a threat of intimidation from LCF’s aggressive conduct. This conduct was capable of impairing their objectivity and professional skepticism.

PwC have just suffered their most severe regulatory defeat. It is the worst they have ever seen in the UK. It also dwarfs the £6.5m fine imposed by the Financial Reporting Council in 2018 for their botched audit of BHS. For clarity, that would mean about almost £15,000 for every partner. One wonders how on earth they would recover from this. Perhaps they will dig into the staff bonus pot, if such a thing exists. Alternatively, perhaps they will just hike their fees. Or, I dare say, cut even more corners on the audits.