CATTLES’ former auditor PricewaterhouseCoopers faces claims it was “grossly inadequate” because it failed to warn about the sub-prime lender’s accounting alchemy or apply “proper professional scepticism” to its ballooning loan book.
Fresh details of the failed lender’s £1.6bn damages claim against PwC emerged in papers lodged with the High Court in London.
Once a member of the FTSE 250 with a market capitalisation of more than £1bn, Batley-based Cattles was felled by a long-running accountancy scandal which surfaced in early 2009 after warnings from a whistleblower. It is now being wound down.
But Cattles argues PwC should have raised the alarm at least two years earlier. Instead its “negligence” saw Cattles continue growing in 2006 and 2007 despite being fundamentally unsound.
Cattles sold high-interest loans to people with poor credit ratings. It grew from more than 400,000 customers and a £2.1bn loan book in late 2006 to 500,000 customers and £2.8bn of loans by December 2007. PwC was Cattles’ auditor from 1995 until 2009, when it was asked to resign.
“Any reasonably competent auditor would have concluded from proper audit work and reported to the audit committee that the loan loss provision in the accounts for 2006 and 2007 did not give a true and fair view of WFSL’s (Welcome Financial Services) financial position, and that a very substantial increase in the level of loan loss provision was required in each of 2006 and 2007,” alleges the claim.
Cattles says its main trading arm Welcome Financial Services used “deferments” and “rewrites” extensively to hide the fact that loans had soured, when they should have been classed as impaired.
Welcome should have admitted loans were impaired after a limit of 120 days in arrears – four missed monthly payments. But instead it used “deferments” to delay when a loan was classed as impaired, or used “rewrites” to revise its terms – resetting the clock when it soured.
“PwC failed to detect and report on these matters because its audits of the 2006 and 2007 accounts were grossly inadequate,” Cattles claims.
The papers reveal the extent to which Welcome’s loan book was manipulated.
By the end of 2006, £251.3m of the book had been subject to six or more deferments, while £426.9m had been deferred four or more times. A year later, £466.7m of loans had been deferred six or more times, and £689m had been deferred four or more times.
“There was no basis for believing that debt which had been subject to one or more deferments or rewrites... was more collectable than a debt which had not been,” says the claim.
Cattles later reported restated losses of £97m for 2007, £765m for 2008 and £685m for 2009.
Documents filed with the High Court allege PwC:
Failed to investigate the nature of Welcome’s whole loan book
Failed to bring an attitude of “proper professional scepticism”
Failed to take proper account of the risk of deliberate mis-statement by management
Failed to ensure proper disclosure in financial statements
Failed to communicate properly with Cattles’ audit committee
Failed to consider the appropriateness of a 120-day “deferred contractual arrears impairment trigger”
Failed to probe the use of “deferments” and “rewrites”.
Cattles claims PwC should have alerted the audit committee to these issues by December 2006, which would have triggered a wind-down of the business.
“In pre-action correspondence, PwC have suggested that even if they had given this or similar advice, the companies would not have accepted it,” states the claim.
“This contention is denied... The audit committee consisted entirely of independent non-executive directors, who were not privy to any of the practices.”
PwC said it was an “inflated and misguided claim” and it would “vigorously” defend its work. “We are disappointed that this claim has been issued given the FSA’s censure of the company for market abuse as well as the FSA’s conclusion that certain directors of Cattles plc were found to have acted without integrity in discharging their responsibilities,” it said.
The Financial Services Authority last year censured Cattles and Welcome and fined three former directors.
However, the looming court case threatens PwC at a time when the big four auditors are under fire from the Competition Commission for their “cosy” relationship with clients.
The regulator is looking at ways to encourage greater competition, including mandatory tendering and rotation of audit contracts.
The claim by Cattles and Welcome is being pursued by restructuring firms Zolfo Cooper and Rollings Oliver, which are supervising its wind-down to recoup cash for banks, bondholders and some shareholders.
A case is not expected to begin until late 2014, and could last six to eight weeks. Law ﬁrm Ashurst is acting for Cattles.
Cattles claims PwC’s alleged failings cost it £1.642bn because it carried on lending for two years. The claim includes the cost of overheads, loans, commission, bonuses, dividends and professional fees. Cattles admits the court will deduct from its claim for “contributory negligence”.