They say that the standards – and in particular IAS 39 – contain “substantial legal flaws” which have resulted in distortions in the financial statements of banks from 2005 onwards. As a result, these no longer show a true and fair view – an accounting concept which is enshrined in UK law – so the dividends that the banks have been paying out on the basis of incorrect figures are illegal.
The group, which includes the Universities Superannuation Scheme, Threadneedle Asset Management, UK Shareholders Association and the Local Authority Pension Fund Forum (LAPFF), also believe that audit firms have been signing off banks’ accounts illegally as well.
And they have called for a review of the role of firms in setting “these defective standards”.
They are basing their view on a legal opinion which they commissioned from leading counsel George Bompas. In it, he concludes that since the true and fair view is paramount, company directors have a duty to override IFRS in order to comply with it.
He also takes issue with an earlier legal opinion on the issue which the UK Financial Reporting Council commissioned from another leading QC, Martin Moore, in 2008 following implementation of the 2006 Companies Act.
This confirmed the FRC’s approach which is that the true and fair requirement is integral to the preparation of financial statements in the UK, whether they are prepared in accordance with international or UK GAAP.
Moore also said that companies could depart from the relevant standard but only in “extremely rare” or “exceptional” circumstances.
In his opinion, Bompas goes on to argue that IFRS fail to include the capital maintenance purpose of accounts or to require prudence as a fundamental accounting principle. Furthermore, individual standards fail to follow statutory accounting principles.
He singles out IAS 39 for criticism for allowing unrealised mark to market “profits” and mark to model “profits” in valuations, “contrary to the requirement of prudence to include only realised profits” in the accounting directives.
He also slates IAS 39 for “not accounting for all foreseeable liabilities and likely losses irrespective of the time in which they arise”, again contrary to the prudence principle.
The investors are so convinced by Bompas’s conclusions that they are advising company directors to ignore the FRC’s legal opinion.
“Over the past two years, LAPFF has repeatedly made clear its view that that the IFRS framework is legally faulty,” said forum chairman Kieran Quinn.
“The FRC has consistently denied that. However, this opinion suggests that something has indeed gone very badly wrong in the standard-setting process, leading to the conclusion that IFRS should be overridden.
“These are extremely significant issues, given that they directly affect the accounting practices of systemically important financial institutions, and in turn affect the decisions made by those institutions, including the legitimacy of dividends paid since 2005. This also suggests that the accounts used for banks’ rights issues were in fact defective.”
An FRC spokesman said that the regulator was aware of the Bompas legal opinion and was considering it in detail but would not comment further.
If the investors are right, it could open up a route for shareholders pressurise banks’ boards to sue former bank directors and bank auditors for compensation.