Blaming the non-executives

Tesco has just reported terrible financial results. UK sales are down by 4.6%, half yearly UK profits are down 55.9% and previous financial reports have been shown to have included serious errors that breached accounting rules.

This misreporting is subject to an investigation by accountancy firm Deloitte and is separately being investigated by the regulator, the Financial Conduct Authority. Profits were over-stated in previous periods by £263m because revenues were recognised earlier than they should have been.

Financial misreporting is a serious matter and in some circumstances can constitute a criminal offence – so it would be wrong to do more than report the bare facts.

What we can say, though, is that eight senior executives have been suspended by Tesco while matters are investigated. The non-executive chairman, Sir Richard Broadbent, has announced that he will step down on the principle that the board has overall responsibility for performance.

This seems to me to be a reasonable approach for the company to take. Executives are responsible for operational matters, while non-executives have oversight of strategy. But non-executives can only work with the material they are presented with.

Yet the Myners review of the Co-operative Group seemed to take a different approach. Lord Myners appeared to take the view that the non-executives were responsible for most of the problems at the Group. I disagree.

True, with the benefit of hindsight, a number of wrong appointments were made. Directors probably wish now that Peter Marks had not been appointed chief executive of the Group, nor Neville Richardson chief executive of the Bank.

Similarly, many directors may feel that they would have been better served if Len Wardle had not been chair of the Group board and Paul Flowers had been overlooked as chair of the Bank board.

But I fear that prejudice was used to blame non-executives from non-City backgrounds on the board of the Group where the same approach has not been adopted elsewhere.

Let us look, for example, at who was on the board at Tesco. Sir Richard Broadbent is former chairman of HM Customs & Excise, a senior investment banker and was a non-executive director of Barclays and Arriva. In other words, very much a City insider.

Patrick Cescau is a senior independent director, Unilever’s group chief executive and is also a non-executive at Pearson. Deanna Oppenheimer founded a major US IT business and is a non-executive at AXA Insurance and NCR.

I could go on through the rest of the board, but I have made my point: they are all recognised senior City people. But their level of control over executives was limited – and their strategic oversight must be regarded as flawed, given the trouble Tesco is having competing with discount grocery retailers and online challengers on non-food items.

A recent blog by Nick Matthews, chair of Co-operatives UK, points out that the board that oversaw the troubled Co-operative Bank actually had a rather similar make-up of non-executives. Far from being filled with lay people without relevant qualifications and skills, it was actually stuffed with senior financial services people. Let us review the Bank’s financial report for 2010.

Yes, there were co-op movement people on the board. Paul Flowers was a movement time-server who rose to seniority through a plausible manner and apparent qualification through political and interpersonal skills. Peter Marks was also on the board, through his role as chief executive of the Group – which should have qualified him to have the rigour necessary to be on the board of the Bank.

Ben Reid is CEO of the very successful Midcounties society, so is qualified to be a non-executive. That leaves just Duncan Bowdler, a biochemist, as the only person on the board, bar Flowers, whose experience does not obviously meet Myners’ expectation of the City.

Rodney Baker-Bates was vice-chair of the board. He is a senior and experienced banker, who had been chair of the Britannia Building Society and was non-executive of a range of large companies, including the Stobart Group. David Davies was chair of Sun Life Assurance and of Nortel Networks Pension Scheme. Peter Harvey is a qualified insurance broker and an advisor to a large law firm. Paul Hewitt holds a range of directorships in medium sized and large companies, including a leading wealth management advisory firm.

Chris Jones is a lawyer, a credit manager and a business recovery specialist. He was non-executive of a number of companies. Stephen Kingsley was an accountant and consultant, who held a senior position at one of the accountancy firms and was then managing director of a consultancy firm. Bob Newton had been management resources director at Barclays Bank and was also non-executive of other financial services companies.

We can, by all means, discuss whether this board and its predecessors and successors made the correct strategic business decisions. But let us not say that it made flawed decisions because the directors did not have professional or City backgrounds: the evidence clearly refutes that.

What we can say is that, despite the board’s apparent collective skills and experience, the Bank performed badly and ultimately failed. Two new reports add to the criticisms of performance.

The Financial Reporting Council’s Corporate Reporting Review, just published, listed ten companies for criticism for failures in the quality of their financial reporting for 2013. The Co-operative Bank was on the list for not producing clear disclosures on capital management, the fair valuation of assets and the accounting treatment of software development costs. Ensuring that financial reports are clear is a responsibility of boards – though we must stress that in the case of the Co-operative Bank, that was the responsibility of a different and later board from the one listed above.

The quality of the Bank’s financial reporting has also been of concern to the House of Commons Treasury select committee, which has just published its report into Project Verde (the failed bid by the Co-operative Bank for Lloyds Bank branches, which have now been rebranded TSB).

The committee’s report concluded: “The Co-op Bank’s approach to recording its impairments in the years running up to 2013 was described by [regulator] Andrew Bailey as ‘looser’ than the rest of the industry. This should have been clear to Co-op Bank’s management – to all those responsible for risk and accounting, including the board, relevant executives and committees. It should also have been apparent to Co-op Bank’s auditor – KPMG – and to the regulator – for the period in question, the FSA.

“The Committee is surprised that, in spite of the evidence it has heard, Co-op Bank’s former auditors, KPMG, maintain that Co-op Bank was not an outlier in terms of its impairments.”

The chair of the Treasury select committee, Andrew Tyrie, seems clear where responsibility should lie in terms of the responsibility for the Bank’s problems.

“It could turn out [that] closer scrutiny by the auditor and regulator could and should have identified these problems before they became so severe. Nonetheless, the former management of Co-op Bank bears primary responsibility for the calamity that has befallen it.”

This is a fair verdict. Blame executives for their failings and blame non-executives for theirs. But there is no place for blaming ‘unqualified non-executives’ who were not even there.