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 It was an oversight that led to a 4 billion pound drop in Tesco's
market value and the suspension of four senior executives. The newly
installed CEO called in forensic accountants and lawyers to find out
what went wrong.
Whether conspiracy or cock-up, the scandal raises doubts over the
management and financial oversight at Britain's largest private
sector employer, now in the midst of the gravest crisis in its
95-year history.
"That whole finance organization must be in a world of hurt given
what has gone on. The rigor and analysis and the focus seems to have
fallen away a little bit," one former UK Tesco director told Reuters
on condition of anonymity due to the sensitivity of the subject.
Tesco had once appeared unstoppable, boasting two decades of
uninterrupted earnings growth as it bulldozed its way to dominance.
Things began to go wrong in 2011.
It has now issued three profit warnings in two months with the
latest causing the most alarm - the overstatement of its half-year
profit forecast by 250 million pounds due to the early recognition
of payments by suppliers and the pushing back of costs.
Investors, analysts and some former employees are questioning
whether an aggressive culture influenced the way the company handled
its finances - especially when trading slowed - and perhaps
prevented staff from coming forward to warn that the numbers no
longer stacked up.
Tesco has declined to comment on what may have happened until a
review has been completed but chairman Broadbent has described it as
"something completely out of the ordinary".
The revelation has also sparked scrutiny of the upper echelons of
the company. The senior executives who ran Tesco during its glory
years of the 1990s and 2000s have all left and the board lacks
retail experience.
"The chairman has been the leader of this organization that seems to
have failed at every turn," said David Herro of large Tescon
investor Harris Associates.
Four former senior Tesco executives have told Reuters that during
the 2011-2014 CEO tenure of Phil Clarke, he repeatedly clashed with
directors, who found him reluctant to take advice. During that time
four of the company's most senior executives quit, taking a combined
109 years of experience with them.
Clarke has declined to comment on his management style but defenders
of his record point out that he was battling the most difficult
market conditions in decades.
The company's head of digital told a conference this week Tesco was
too big and complex to be run by "one general".
WHO'S IN CHARGE?
People outside the company have many questions - not least who has
been signing off on profit forecasts in the last three months which
turned out, quickly, to be wrong.
By the time the group issued the second of its recent profit
warnings on August. 29, Clarke, a 40-year Tesco veteran, was
technically still CEO but was working his notice while Laurie
McIlwee, the firm's chief financial officer since 2009, had quit on
April 4. McIlwee declined to comment for this article.
"It seems unbelievable that a retailing colossus like Tesco should
not have a full-time finance director," said Adrian Bailey, head of
parliament's business committee.
Tesco's finance function had been further weakened in June when Mike
Iddon quit as Tesco's group finance director, planning, treasury and
tax.
Tesco says that after McIlwee's resignation on April 4 it set up a
group of senior finance personnel, reporting directly to Clarke.
However the company has declined to say who was in that group and
Clarke was himself working down his notice.
"What was the board's scrutiny of the (second) profit warning (on
Aug. 29) and numbers that they put out, because you would expect it
to be extreme?" asked one retail audit committee chairman, in
reference to the profit downgrade and 75 percent cut to Tesco's
interim dividend.
"If you're a non-executive director and you're being asked to put
out those kind of profound numbers and you've got no finance
director and you've got no CEO to stand beside them, how do you know
they're right?"
OVERLY AMBITIOUS
Tesco said the 250 million pound overstatement principally related
to its supplier contracts within the food business of its UK
division - its home market which generated 48.2 billion pounds of
revenue in 2013-14.
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People familiar with how Tesco operates said it had been overly
ambitious when predicting sales. As they then slowed, the cash
rebates paid out by suppliers as incentives also dropped.
Tesco has declined to comment but said it is investigating the
accounts. New CEO Dave Lewis has told staff the firm's culture needs
to change.
The former UK Tesco director believes the accounting mistake could
have come about due to the combination of a loss of experience in
the finance department and the fact that the business is now
shrinking. "You had a business that used to be growing and had
algorithms that worked," the former director said. "When the
business is flat to declining and you don't really know how much
you're declining by, you can get that wrong very quickly."
During two decades of uninterrupted growth Tesco had rarely made a
mistake with its numbers - it issued its first profit warning in
living memory in 2012 as the competition ramped up.
However, analysts and shareholders have more recently raised
concerns that Clarke and his colleagues had instilled a more
aggressive approach as pressure to revive the business increased.
Bernstein analyst Bruno Monteyne, who was previously a supply chain
director of Tesco Asia, said managers - possibly under pressure to
improve earnings - might have brought forward promotions and the
right to book supplier rebates. Tesco declined to comment.
 Cantor analyst Mike Dennis, who last year questioned how the company
could be maintaining its trading margin at a time of falling sales
and rising costs, noted that staff had been incentivized via share
schemes to maintain the measure.
PwC Tesco's auditors since 1983, had highlighted the rebate issue in
its 2013-14 report as an "area of focus" due to the "risk of
manipulation". Broadbent says Tesco's finance function was "working
well with considerable oversight".
THIN ON TOP
Analysts and investors have pointed out that the board is now very
thin on retail experience. Broadbent, chairman for almost three
years, was a former public official and banker.
Others on the board have experience in telecoms, media, finance and
cars, while Patrick Cescau, the board's senior independent director,
is a former chairman of Unilever, one of Tesco's biggest suppliers.
"In a situation such as this, the buck stops at the board," said Guy
Jubb, head of governance and stewardship at Tesco investor Standard
Life Investments. Having drafted in the replacements for Clarke
and McIlwee earlier than expected, the board now has two executive
directors in the form of new CEO Lewis from Unilever and CFO Alan
Stewart, formerly of Marks & Spencer. Stewart was appointed during
the time of former CEO Clarke.
Tesco declined to comment on the retail experience of its board, or
on who was involved in the planning of the Aug. 29 statement.
Trading statements do not have to be checked by an external
accounting firm.
But the numbers are now being pored over.
A swathe of managers have had to hand in their laptops and phones as
part of the internal probe and Britain's Serious Fraud Office has
said it is watching events closely.
The country's financial regulator, the Financial Conduct Authority,
has launched a full investigation and lawmakers are also considering
whether to grill past and present executives over the error.
 (1 US dollar = 0.6103 British pound)
(Additional reporting by Dominique Vidalon in Paris and Tom Bergin
in London; editing by Janet McBride)
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