Risk Management and Crisis Response Blog

Nearly three years later, Tesco continues to deal with the fallout from its accounting scandal

May 19, 2017 4 MIN READ
Alexander Cobb

Partner, Disputes, Toronto

In September 2014, prominent British retailer Tesco PLC found itself in crisis following its announcement that it had overstated its profit expectations by £250-million. The company later adjusted this amount to £326-million. Nearly three years later, Tesco continues to deal with the consequences of the accounting irregularities. In April 2017, Tesco subsidiary Tesco Stores Limited reached a deferred prosecution agreement (DPA) with the UK Serious Fraud Office, under which Tesco agreed to pay a penalty of £129-million. While the DPA settles Tesco’s criminal liability in Britain, other criminal proceedings continue against its former employees, and the prospect of further significant payouts in ongoing civil proceedings continues to loom.

The scandal

The overstatement of Tesco’s expected earnings arose as a result of the alleged practice of some of Tesco’s senior management to book profits prematurely and delay logging expenses in order to pad results. When Tesco first announced that it had identified the irregularities, it stated that it had suspended four executives who were implicated in the allegations.  

The bombshell announcement has had far-reaching consequences for the company, its directors and officers, and its stakeholders. In addition to the £129-million DPA that Tesco reached with the Serious Fraud Office, Tesco also last month agreed to pay £85-million to the Financial Conduct Authority, Britain’s financial regulatory body, in order to compensate investors who suffered losses as a result of the scandal.   

The deals with the U.K. criminal and regulatory authorities do not bring an end to Tesco’s troubles, or those of its former employees. Tesco still faces a £100-million class action brought by 125 institutional investors, after having settled a separate class action for £12-million with a group of plaintiffs who held Tesco’s American depository receipts. In addition, in September 2016, the Serious Fraud Office charged the former head of Tesco’s British business, and two former executives in that unit, with fraud by abuse of position and false accounting. The so-called “Tesco trio” are schedule to face these criminal charges at a hearing in September 2017. In 2015, Tesco reported a £6.4-billion loss. Its market capitalization has shrunk by nearly 50%.

Deferred prosecution agreements

Deferred prosecution agreements allow for criminal settlements that subject the company to sanctions without the need for a formal conviction or guilty plea. In addition to monetary penalties, non-prosecution agreements provide law enforcement with the additional flexibility to impose mandates on companies to reform their behaviour and improve their internal governance systems, and to obtain important cooperation from companies to assist future prosecutions. Generally speaking, these types of compliance-based results are not available in conventional criminal prosecutions.

As we have previously written, deferred prosecution agreements have proven to be useful tools in the U.S., with many prominent settlements having been reached with corporations accused of criminal conduct. The U.K. adopted its deferred prosecution program in 2014. While the model in the U.K. is similar to the U.S. approach, deferred prosecution agreements in the U.K. must be approved by the courts, whereas in the U.S. the SEC or the DOJ has the authority to enter into such agreements of their own accord. The Tesco deferred prosecution agreement is the fourth such DPA that the U.K. Serious Fraud Office has entered into since it was granted that power in February 2014, including a recent DPA with Rolls Royce for £671-million earlier this year. The Director of the Serious Fraud Office in the U.K. has made clear that the adoption of a deferred prosecution regime does not mean that corporations who run afoul of the law can count on a DPA-based resolution. Full cooperation with law enforcement throughout the process is a prerequisite to the availability of DPAs.

While DPAs are not currently a feature of the Canadian enforcement landscape, as the use of DPAs increases elsewhere, there is mounting pressure on the Canadian government to consider DPAs as an alternative means of resolving criminal allegations. They allow law enforcement to quickly and efficiently secure deals with companies, which can and often do include very steep penalties and remedial orders, as the Tesco case demonstrates.