Public Interest Report

Icelandic Bank

Investments –

Public Interest

Report

North East Lincolnshire Council

Audit 2008/09

24 June 2009

The Statement of Responsibilities of Auditors and Audited Bodies issued by the Audit

Commission explains the respective responsibilities of auditors and of the audited

body. Reports prepared by appointed auditors are addressed to non-executive

directors/members or officers. They are prepared for the sole use of the audited body.

Auditors accept no responsibility to:

• any director/member or officer in their individual capacity; or

• any third party.

Contents

Summary report 3

Detailed report 7

Summary report

3 North East Lincolnshire Council

Summary report

Introduction

1 I am the external auditor appointed by the Audit Commission to audit the accounts of

North East Lincolnshire Council (the Council).This report is issued in the public interest

under section 8 of the Audit Commission Act 1998. This section of the 1998 Act

requires me to consider whether, in the public interest, I should make a report on any

significant matter coming to my attention to bring it to the notice of the audited body

and the public.

2 This report sets out what I consider to be significant shortcomings in the way the

Council managed its investments and failed to protect the interests of taxpayers. The

Council has deposits to the value of £7 million with Icelandic banks. At the time this

report was written the investments were at risk following the collapse of the banking

sector in Iceland.

3 The consequences of the collapse and the arrangements local authorities make for

placing and managing cash on deposit were reported by the Audit Commission in the

national report, ‘Risk and Return’.

4 My report examines in detail the management of investments during 2008 focusing on

the Council’s control and supervision arrangements which failed to ensure compliance

with the expected standards of professional practice and the Council’s own strategy

and which were not effective in managing the risk of loss of public funds. The report

also comments on the investigations carried out by the Council following the collapse

of the Icelandic banks in October 2008.

Background

5 In early October 2008, Iceland’s three largest commercial banks, Glitnir Bank hf,

Kaupthing Bank hf and Landsbanki Islands hf, went into administration. The Council

was the last local authority in the country to invest in Icelandic banks and their

UK-owned subsidiaries: £3 million in Kaupthing Singer and Friedlander on

2 October 2008 and £1.5 million in Landsbanki on 3 October 2008. In addition, the

Council had invested £2.5 million in August 2008, so the total amount put at risk is

£7 million.

6 After the potential loss became known the Chief Executive asked Internal Audit to

carry out an investigation. Internal Audit found that many of the controls they expected

to find were not in place or operating properly and their findings were reported to the

Audit Committee in January 2009 when the report was made available to the public. In

response, the Council agreed Internal Audit’s recommendations and carried out a

further investigation under the disciplinary procedure which was completed in February

2009.

Summary report

North East Lincolnshire Council 4

7 In testing the effectiveness of the Council’s response, my team has reviewed the

detailed transcripts of the investigation and spoken to the officers involved in the

investigation, finance officers and leading Members. In my view, there are a number of

matters that still need to be raised more widely about the failures in internal control

which led to the potential loss and the scope and conclusions of the subsequent

disciplinary investigation.

Overall conclusion

8 The Council has £7 million at risk because it invested in Icelandic banks. The Council’s

Annual Investment Strategy was set by the Council in February 2008, prioritising

security of capital and optimising return. If officers had followed this strategy and

followed the professional advice they were given, the Icelandic investments would not

have been made by the Council during 2008. It is not clear why officers believed the

Icelandic investments they made would deliver the Council’s strategy. In my view, in

failing to respond appropriately to information received from the Council’s specialist

advisers and in continuing to invest in Icelandic banks, officers acted without the

expected levels of care.

9 Officers did not apply proper assurance systems and control arrangements to ensure

the Council followed its investment strategy. From a detailed transaction level up to the

key decisions made by senior officers, controls were routinely avoided or they failed

during a period of increasing risk and uncertainty in the financial markets when greater

vigilance was required. There was no effective system for identifying and reporting

these control failures to senior management. Weak governance meant officers did not

give specific assurance to Members about the operation of controls or compliance with

the Annual Investment Strategy.

10 The two senior finance officers, the Executive Director Corporate Services who held a

statutory responsibility under section 151 of the Local Government Act 1972 for

ensuring proper financial arrangements were in place, and the Deputy Director of

Finance (and Deputy Section 151 Officer), in my view failed to discharge their

professional duties to the Council and taxpayers. In particular, they did not take steps

to ensure a proper framework of financial control was in place and operating

effectively. If these officers believed that arrangements were in place, then their

judgement was based on untested assumptions and they therefore failed to exercise

the professional care that the Council and taxpayers have a right to expect. Weak

oversight and insufficient scrutiny by Members meant the Council was not aware of

deficiencies in the Council’s control framework.

Summary report

5 North East Lincolnshire Council

11 Controls were not treated as important tools to manage the risks of error and fraud.

The poor attitude towards controls by the most senior finance officers employed by the

Council was illustrated on 1 October 2008 when a revised counterparty list of approved

banks, including Icelandic banks, was signed by the Deputy Director of Finance

without any check or challenge. This was one day after the main credit rating agencies

reduced the credit worthiness of the Icelandic banks below an acceptable standard.

According to the Audit Commission Report ‘Risk and Return’, North East Lincolnshire

was the last Council in the country to invest in the Icelandic banks, having invested

£4.5 million in October 2008. The report was highly critical of authorities that invested

after 30 September 2008.

12 The Council initially responded appropriately to the failings identified by Internal Audit

and the subsequent investigation under the Council’s disciplinary procedure found that

effective management and supervision were not in place. The Chief Executive

accepted the recommendation for a whole service review of finance and disciplinary

action against the most junior manager but not the Executive Director Corporate

Services or Deputy Director of Finance who held overall responsibility. It is a concern

to me that the follow-up investigation failed to draw the conclusions implied by its

detailed findings.

13 The Executive Director Corporate Services, effectively the strategic director of the

Council’s financial services, left the Council in February 2009 to take up a similar post

at another local authority. He has, after a competitive recruitment process, been

replaced by the Council’s most senior legal officer in a new post – the Executive

Director Business Services. After Internal Audit had reported such serious flaws in the

Council’s financial management arrangements, I do not see how the new arrangement,

which involves even less capacity in finance, will improve strategic financial leadership.

14 The former Deputy Director of Finance, having failed to discharge his responsibilities

for ensuring a properly designed control environment was in place and working

effectively, was promoted on an acting basis to the new post of Chief Finance Officer

on 2 March 2009. He now has full statutory responsibility for ensuring the Council has

proper arrangements in place to manage its financial affairs. The evidence I have

considered in investigating this issue does not suggest this will lead to an improvement

in financial management.

Summary report

North East Lincolnshire Council 6

Recommendations

R1 The Council needs urgently to undertake an overall review of financial services and

evaluate the level and effectiveness of financial management capacity.

R2 A system should be introduced to monitor compliance with the Council’s investment

strategy on an ongoing basis.

R3 All controls and processes across the whole finance service, including investment

management, should be fully documented.

R4 The Council should review all of its control and assurance arrangements to

establish that there are proper arrangements for ensuring compliance with key

Council strategies, policies and plans. An assurance system based upon positive

evidence that controls are working rather than assumptions should be developed.

R5 A system of formal management and supervision should be developed to clarify

accountability and build an assurance framework.

R6 The Council should consider fully the findings of this report and the Audit

Commission’s national report, ‘Risk and Return’.

Detailed report

7 North East Lincolnshire Council

Detailed report

Investment of cash by the Council

15 North East Lincolnshire Council, like most local authorities, has at various times

significant balances of spare cash to invest. These can be short-term surpluses that

arise before the payment of a significant sum, such as the monthly salary payments or

for capital payments. The Council also holds longer-term cash-backed reserves that

act as a contingency. Prudent investment of spare cash helps provide income that

reduces the burden on council taxpayers.

16 In recent years the level of cash held by the Council has increased as it has taken a

longer-term view of borrowing to support the capital programme. The Council has

increased its level of reserves as illustrated in Table 1 below.

Table 1 Year-end Investment Balances

Year Year-end

Investment Balance

£000

Investment

Receipts

£000

31 March 2005 36 260

31 March 2006 24,036 1,086

31 March 2007 51,036 3,050

31 March 2008 40,003 3,557

17 Cash is invested over fixed periods ranging from a number of days to months. In

2007/08 the Council made 104 investments totalling £259 million. In 2008/09 until the 3

October 2008, the Council made 65 investments totalling £161.5 million using

20 different institutions. This included 20 separate investments totalling £32.5 million

with the two Icelandic-owned banks, Kaupthing Singer and Friedlander and

Landsbanki. Table 2 shows the Icelandic-owned bank investments when they failed in

early October 2008.

Detailed report

North East Lincolnshire Council 8

Table 2 Investments with Icelandic banks

Institution Principal

£000

Date of investment

Kaupthing Singer and Friedlander 1,500 5 August 2008

Landsbanki 1,000 15 August 2008

Kaupthing Singer and Friedlander 3,000 2 October 2008

Landsbanki 1,500 3 October 2008

Total 7,000

Treasury Management Strategy

18 In accordance with the professional guidance issued by the Chartered Institute of

Public Finance and Accounting (CIPFA), the Council adopts an annual Treasury

Management Strategy and a separate Annual Investment Strategy which includes an

agreed approach for managing investment risks. In February 2008 the strategies were

approved by the Council, setting out how investments and loans were to be managed

to support major capital and revenue payments, whilst minimising the cost of loans and

generating reasonable levels of investment interest.

19 The Council’s investment priorities were set out in the Annual Investment Strategy

which focused on low risk and reasonable return. The main priority was the security of

capital and liquidity of investments, whilst achieving the optimum return on investments

commensurate with the proper levels of security and liquidity.

20 The Annual Investment Strategy sets out:

• the types of institutions for investment to be included on the counterparty listing,

including UK clearing banks, building societies, foreign banks and the appropriate

credit ratings;

• the Executive Director Corporate Services’ overall responsibility for maintaining

and reviewing a counterparty list of approved institutions that the Council could

invest with in accordance with its strategy;

• the need to monitor credit ratings of the counterparties for existing deposits weekly,

using information from the Council’s investment advisers, with any counterparty

removed from the list immediately if it failed to meet the criteria; and

• delegated powers to the Executive Director Corporate Services to undertake the

most appropriate form of investments taking into account the interest rate and risk.

Detailed report

9 North East Lincolnshire Council

Operational staffing and management structure

21 The Council has a team of officers responsible for the day-to-day management of the

Investment Strategy. The Council also employs specialist treasury management

advisers to support these officers and to provide up-to-date information on investment

options and risks. The key Council officers and their responsibilities are identified in

Table 3 below.

Table 3 Key officers

Post Responsibility

Executive Director

Corporate Services

Statutory responsibility for the Council’s control framework

and, under section 151 of the Local Government Act 1972, to

ensure the proper administration of the financial affairs of the

Council.

Overall responsibility for strategic financial management and

financial services, including revenue collection and payment

services, and for treasury management as set out in the

Annual Investment Strategy approved by the Council.

Deputy Director of

Finance

Head of Finance (and deputy section 151 Officer), including

accounting, treasury management and investments,

revenues, benefits and payroll.

Responsible for:

• establishing an effective system of monitoring and

managing operational performance;

• ensuring the operation of financial services complies with

the regulations of the Council at all times; and

• maintenance of the highest standards of professional

practice.

Chief Accountant Line manages accountancy staff with overall responsibility for

the ledger and the Annual Accounts. Supported by 12 staff,

including the treasury management team.

Principal Accountant Responsible for treasury management, including the overall

bank/cash reconciliations, investments, loans and capital

programme monitoring with a team of four staff.

Detailed report

North East Lincolnshire Council 10

22 The Council’s investment advisers were required to:

• interpret the Council’s Investment Strategy and prepare a list of approved

institutions known as the counterparty listing;

• inform the Council about the market and provide specific advice about the bodies

on the counterparty list;

• update the Council on investment matters via a weekly investment monitor; and

• attend quarterly meetings with key Council officers.

Control framework

23 Arrangements for managing investment risk should involve a documented series of

controls, checks and balances to ensure that the investment strategy is delivered and

that the assets of the Council and taxpayers are protected. With multi-million pound

investments, control arrangements need to be robust at all levels, particularly during

the difficulties in financial markets seen during the summer of 2008. There should be,

as a minimum:

• a culture of internal check for all major transactions, which should be scrutinised by

a second, more senior, officer;

• documented procedures and controls so staff at all levels are clear on the checking

and control arrangements;

• management controls with a clear chain of command, roles, responsibilities,

accountabilities and proper supervision and review; and

• a system of assurances to ensure controls are operating as defined and to monitor

compliance with the investment strategy.

24 Internal Audit identified serious control weaknesses and a weak control environment,

and my audit work has confirmed that most of the expected controls were not properly

in place to manage investments. Internal Audit’s report highlighted the difference in the

counterparty listing as the critical factor in the potential loss. In my view, this was

symptomatic of a wider systemic failure in internal control. Key weaknesses in respect

of the Council’s investment management function were that:

• there was little evidence that senior officers placed appropriate emphasis on the

importance of internal controls;

• senior managers did not treat controls as important tools to manage the risk of

error and fraud. This poor attitude to control led to inadequate attention by other

officers so there were no up-to-date definitions of control arrangements and a poor

audit trail was maintained; and

• formal management processes that should be used as the basis of assurance for

the Council and the assertions in the Council’s accounts were not established.

Detailed report

11 North East Lincolnshire Council

25 This wider failure in internal control, in my view, significantly increased the risk of a

potential loss of investments during the period of instability in the financial markets. In

my 2007/08 Annual Audit Letter, I referred to an issue concerning the Council’s control

arrangements that should have led to closer attention by officers. The Council invested

£5 million with Northern Rock on 4 September 2007 in breach of the Council’s

counterparty list. Northern Rock’s financial difficulties were made public on

15 September 2007.

26 Responsibilities to lead the Council’s financial services and to ensure that control

arrangements were in place, rested with two officers.

• The Executive Director Corporate Services during 2008 was the most senior

qualified accountant and finance officer working for the Council. As well as his

duties set out in the investment strategy, he had a specific statutory responsibility

under section 151 of the Local Government Act 1972, to ensure the proper

administration of the financial affairs of the Council. The CIPFA statement on the

role of the most senior finance officer highlights the maintenance of strong financial

management underpinned by effective financial controls as a key role.

• The Deputy Director of Finance had overall operational responsibility for the

Finance Department and was the deputy section 151 officer. He describes his role

as being responsible for ensuring that the ‘control environments within finance are

in place and are as robust as possible across all areas’.

His job description sets out the following responsibilities.

− To provide strong leadership and clear direction to the Finance Services

management team and to co-ordinate the effective delivery of Finance

Services.

− To ensure the operation of the Finance Service complies with the regulations of

the Council at all times, particularly in respect of personnel and financial

administration.

− To promote the development and maintenance of the highest standards of

professional practice within the work of the Finance Service.

27 In my work I could not find evidence that these officers properly discharged their duties

in respect of investment management.

Detailed report

North East Lincolnshire Council 12

Operation of the control arrangements during 2008

Counterparty list

28 The list of institutions deemed as suitable for investment in line with the Council’s

Investment Strategy is known as the counterparty list. The list used by officers included

institutions that were outside the requirements of the Council’s Strategy because

information received from the Council’s investment advisers was ignored and so the list

was not updated for changes in the credit worthiness of the Icelandic banks. As a

consequence, investments were made with institutions that had not been deemed as

suitable.

29 Internal Audit found that in February 2008, the Council’s then new investment advisers

had informed the Council that, in their view, the Icelandic banks did not satisfy the

Council’s Investment Strategy. They issued two counterparty lists to the Council: one

without the Icelandic banks, consistent with the Council’s approved Investment

Strategy; and a second longer list including the Icelandic banks, which was suggested

by the Council’s investment advisers if the Investment Strategy was changed. The

Investment Strategy was not changed.

30 The Principal Accountant and Chief Accountant were aware of the differences but

chose not to follow the advice of the Council’s investment advisers and continued with

the previous list prepared in December 2007 which was based on the guidance of the

previous advisers. I have been informed officers believed this was necessary because

of the limited number of banks on the shorter list that were willing to take the Council’s

relatively low value individual investments for short periods. Evidence collected during

the disciplinary investigation suggests the Deputy Director of Finance agreed the

advice should be ignored. The Principal Accountant has said that he had several

conversations with the Chief Accountant and that the Deputy Director of Finance was

present on at least one occasion. The Chief Accountant has told me he discussed in

February 2008 the two lists with the Deputy Director of Finance, who agreed the longer

and incorrect list should be used. The Deputy Director of Finance has said he has no

recollection of the meetings to which the Principal Accountant and Chief Accountant

have referred. I am informed no record was made of the decision to ignore the advice

of the Council’s specialist advisers. On this matter, the disciplinary investigation report

concludes that the Principal Accountant and Chief Accountant, and arguably the

Deputy Director of Finance, knew investments were not being managed in accordance

with the Council’s Strategy. I am informed that officers were operating on the basis that

there had been a joint conclusion on which list to follow.

31 The Council’s investment advisers informed the Council of changes to ratings on the

shorter list and so did not send direct notifications about the Icelandic banks. However,

weekly investment monitors received from the advisers were not acted upon by

Council officers. These highlighted downgrading of the ratings of Icelandic banks in

March and May 2008 but the banks were not removed from the Council’s counterparty

list. The information was filed by the Principal Accountant without comprehensive

review, contrary to the Investment Strategy which required an immediate amendment

to the list in these circumstances.

Detailed report

13 North East Lincolnshire Council

32 Investments continued to be made in the Icelandic banks between February and the

beginning of October 2008. These constituted a total of 20 individual investments with

the two Icelandic banks totalling £32.5 million (19 per cent of all investments), which

were not in accordance with the Council’s Investment Strategy. At the time the

Icelandic banks went into administration, the Council had outstanding investments of

£7 million with Kaupthing and Landsbanki.

33 The counterparty list specified maximum periods for some investments to spread the

risk and ensure diversification but these were not followed routinely. The Council

focused investments on a relatively small number of banks. From 1 April 2008 until

3 October 2008, the Council:

• used 20 different institutions out of a counterparty list of 78 institutions; and

• 40 per cent of investments (£67 million out of £161.5 million) were concentrated in

four banks including the two Icelandic-owned banks.

34 Internal Audit found four investments totalling £23 million that were for longer periods

than allowed by the counterparty list without the specific authorisation of the Executive

Director Corporate Services. While this was contrary to the Investment Strategy, the

Executive Director Corporate Services did not consider the matter to be important and

described himself as being ‘relaxed‘ about such extensions.

35 In September 2008 and in response to the worsening financial crisis, the Executive

Director Corporate Services requested an update of the counterparty list. A list was

prepared by the Principal Accountant with some minor changes to the previous

December 2007 listing but still included the Icelandic banks. The list was signed by the

Deputy Director of Finance on 1 October 2008 as conforming to the Investment

Strategy and Treasury Management Strategy. This was not correct because of the

failure to follow the advice received from the Council’s investment advisers in

February 2008 and the subsequent weekly investment monitors. Furthermore, a

significant change to the credit ratings of all the Icelandic banks had taken place on

30 September 2008 when the banks were downgraded to BBB (adequate). This was

not taken into account and this failure led the Council to deposit money with unsuitable

institutions after credit ratings had been downgraded.

36 In my view, there was a clear lack of professional care shown by the Deputy Director of

Finance. He informed me that he did not routinely request supporting information when

signing documents relating to treasury management or question his staff over the

content. In the transcript of the disciplinary investigation, the Deputy Director of

Finance said that he had ‘to sign a lot of things‘ and that there was ‘no specific

requirement for me to check [the counterparty list] had been updated‘. He also

indicated that he assumed the instructions of the Executive Director Corporate

Services had been followed because the Executive Director often spoke directly to the

Principal Accountant on investment matters. The Deputy Director of Finance has told

me he accepts my conclusion that he did not take sufficient care when signing the

counterparty list on 1 October 2008 and that he is now aware of the steps he should

have taken to protect the Council’s interests.

37 The Council made a further two investments in Icelandic banks totalling £4.5 million on

the 2 and 3 October, the final Icelandic investments made by a local authority.

Detailed report

North East Lincolnshire Council 14

Operational controls

38 Operational controls were weak with poor audit trails maintained as a consequence of

the low priority given to control. The work of Internal Audit found that most of the

operational controls over investments were not fully in place or recorded properly:

• Treasury management decisions were not properly documented in all cases, so

authorising officers would not have sufficient evidence to check a transaction was

valid.

• Processing investments and maintaining and reconciling records was often carried

out by one person and not two. I would have expected this to be carried out by two

people to reduce the risk of fraud and error and I consider this to be the normal

practice in local authorities.

• 22 per cent of funds invested had been released without the proper authorisation

or independent checking, including one ill-fated investment in the Icelandic banks.

• Controls over the CHAPS system to transfer investment cash directly into external

bank accounts were not fully effective because two officers shared passwords,

records were not fully up-to-date and no record of officers authorised as having

access to the system was maintained.

• Bank signatories included one officer no longer employed by the Council.

• There was no signed contract with the Council’s investment advisers.

39 My audit work also highlights deficiencies in the risk identification and management

assurance systems, which did not require officers to test the effectiveness of the

controls in the investment systems during a period of increasing risk in the financial

markets. The system of assurance was based upon untested assumptions about the

effectiveness of controls.

System procedures and management controls

40 The systemic failure in controls was in my view a consequence of the lack of clarity of

the structure and roles and responsibilities, along with a fundamental failure of senior

officers in understanding the purpose and importance of the control framework. It is of

serious concern to me that I have not found evidence of an effective system of

monitoring and managing operational performance of systems that involve significant

sums of public money.

Detailed report

15 North East Lincolnshire Council

Procedures and roles and responsibilities

41 Procedures and control arrangements were not properly defined or formalised and

roles and responsibilities were not clear: Key weaknesses include:

• Internal Audit reported that treasury procedures manuals were many years

out-of-date and did not reflect current practice;

• the investigation under the disciplinary procedure also found that the role of the

Executive Director Corporate Services and Principal Accountant were defined in

respect of treasury management, but not that of the Deputy Director of Finance or

Chief Accountant; and

• job descriptions were generic and out-of-date.

42 The Council’s treasury management arrangements did not include an established

framework for supervision and monitoring. The Executive Director Corporate Services

was directly involved in day-to-day management and direct supervision of the Principal

Accountant, including updating the counterparty list and attending meetings with the

Council’s investment advisers. The Deputy Director of Finance and Chief Accountant,

whilst also attending these meetings, were not always informed of communications

between the Executive Director and the Principal Accountant. Both the Chief

Accountant and Deputy Director of Finance were aware of this but did not seek to

change the arrangement, and there is little evidence of consistent, active performance

management by any officer.

43 The investigation under the disciplinary procedure found that management controls

were largely informal and ad-hoc:

• The Executive Director Corporate Services described his supervision over the

Deputy Director of Finance as periodic one-to-one discussions, the Departmental

Management Team and via email and phone. Other than setting targets, these

were not systematically recorded.

• The Deputy Director of Finance’s supervision of the Chief Accountant was regular,

but not formally structured and documented.

• The Chief Accountant indicated that he worked closely with the Principal

Accountant and discussed targets, but that the documentation was ‘not great’.

Control assurance

44 There were serious weaknesses in the Council’s overall governance arrangements.

The Executive Director Corporate Services did not provide assurance to Members,

such as the portfolio holder for finance or the Chair of the Audit Committee, because

he and the Deputy Director of Finance were not monitoring the effectiveness of the

controls or compliance with the Investment Strategy. Members did not seek assurance

and, as a consequence, the Council’s treasury management arrangements did not

receive proper oversight or scrutiny to confirm Council policies and strategies were

being followed.

Detailed report

North East Lincolnshire Council 16

45 I have seen no evidence that confirms that either the Executive Director Corporate

Services or the Deputy Director of Finance took steps to confirm that an appropriate

internal control framework was operating effectively. In particular, there was no system

in place to check compliance with the Investment Strategy through management

supervision, review or independent check. In my view these officers therefore failed to

exercise the professional care that the Council and taxpayers have a right to expect.

• The Executive Director Corporate Services told me that he would expect his

officers to inform him if there were system or control problems, and that he had no

contrary evidence and ‘no cause for concerns’ during this period. This assumption

was untested and he did not seek positive assurance that the controls were

working as intended or that officers were operating in accordance with the

Investment Strategy agreed by the Council.

• The Deputy Director of Finance told me that he had regular informal discussions

with his staff but did not ask for ‘absolute assurances‘ that controls and processes

were working.

46 These two officers did not seek to test the effectiveness of the controls during a period

of increasing risk when the Council had higher levels of cash available to invest and

the financial markets were becoming increasingly volatile. The Executive Director

Corporate Services told me he did not consider bringing Internal Audit in to look at the

arrangements as their previous audit report in January 2007 did not identify any issues

and that in his view there was a ‘strong’ team in finance.

47 The Executive Director Corporate Services also told me that concerns about systems

would be reported to Members on an ‘exception‘ basis and that Members could ‘rightly

assume [there was] nothing to tell them’ if nothing was reported to them. This

discouraged both officers and Members from actively seeking positive assurance that

proper arrangements were in place. If the Council’s control environment required

officers to positively confirm that controls were working, I believe the weaknesses

could have been identified at an earlier stage.

Understanding of controls

48 There was in my view a clear lack of understanding as to the importance of controls by

all staff operating the investment system given the systemic control failures described

above. Although aware of the failures:

• the Executive Director Corporate Services told me that in his view the controls

were ‘there‘ but were just ‘not fully‘ in place. He also told me that the only control he

was relying on to ensure arrangements were in place was the Council’s investment

advisers, even though they were not contractually obliged to check the Council’s

arrangements; and

• during the disciplinary investigation the Deputy Director of Finance described the

arrangements as ‘significantly’ compliant with the procedures but ‘not 100 per cent‘

meeting their requirements.

Detailed report

17 North East Lincolnshire Council

Internal investigation

49 In my view the disciplinary investigation either ignored or failed to recognise the far

reaching conclusions implied by its detailed findings. I reviewed both the Internal Audit

report and the investigation under the disciplinary procedure. Internal Audit considered

all relevant matters and reported their findings at the meeting of the Audit Committee in

January. The disciplinary investigation was detailed but would have benefited from the

input of a senior qualified accountant with a greater insight into the expected

arrangements for managing a finance department. As a consequence my view is that it

did not adequately consider the overall responsibility and accountability for the control

failures and focused more on the failure to take account of the information received

from the Council’s investment advisers.

50 Following the failure of the Icelandic banks the Executive Director Corporate Services

reported details to a special Council meeting on the 23 October 2008 and described

how the Council could manage the potential loss. Following Internal Audit’s report to

the Audit Committee in January 2009, the Chief Executive instigated an investigation

under the disciplinary procedure led by the Executive Director Environmental Services

and Deputy Director Human Resources. This investigation consisted of a series of

interviews with the four key finance officers and a summary report to the Chief

Executive was completed in February 2009.

51 The investigation concluded:

‘Given the findings in respect of the control environment and absence

of robust supervision/performance management arrangements there

appears to have been a systemic management failure at all levels to

manage and mitigate the risk of poor/non-compliant investments.’

52 The recommendations made to the Chief Executive were:

• an external whole service review be commissioned, considering the structure,

resource allocation and roles and responsibilities and accountabilities;

• formalised supervision be introduced within finance; and

• formal disciplinary action be considered in respect of the Principal Accountant.

53 The Chief Executive accepted the findings and recommendations of the investigation

team following discussions with the Deputy Director Human Resources but without a

detailed review of the evidence.

Detailed report

North East Lincolnshire Council 18

54 Our work confirmed the overall findings of the disciplinary investigation, which focus on

overall management failings, lack of proper supervision and the control framework.

Whilst disciplinary issues are a matter for the Council, it is not clear why the report

recommends disciplinary action should only be considered in respect of the Principal

Accountant in view of:

• the Executive Director’s overall statutory responsibility for ensuring the proper

administration of the financial affairs of the Council when they clearly were not in

place; and

• the Deputy Director of Finance’s responsibility for ensuring that the control

environments were in place and as robust as possible, when the evidence was

clear that the control and management failures were systemic.

55 The Executive Director Environmental Services led the investigation team and the

explanation he gave to me was that the Executive Director Corporate Services was

leaving the Council, having accepted a similar post at another local authority. Although

the possibility of action against the Executive Director Corporate Services was

considered by the investigation team, the benefit to the Council of pursuing disciplinary

action was not clear to the team and this was not explored in their report to the Chief

Executive.

56 The Deputy Director Human Resources told me that while the Principal Accountant

had specific responsibilities in respect of investments, this was not the case for the

Chief Accountant and Deputy Director of Finance as their roles were not clearly

defined. In my view this did not take into account the Deputy Director of Finance’s

specific responsibility for ensuring that effective control frameworks were in place to

monitor and manage operational performance. He should have ensured that his

responsibilities in respect of the Investment Strategy were defined and control

arrangements were documented and working.

57 Accountability for the control failures individually or as a whole was not considered as

part of the investigation. The focus was the counterparty list and failure to follow the

information received from the Council’s investment advisers which was the direct

responsibility of the Principal Accountant. Sufficient weighting was not given to the

overall failures to:

• make arrangements for the proper administration of the Council’s financial affairs;

• follow the investment strategy; and

• monitor compliance with the investment strategy.

Detailed report

19 North East Lincolnshire Council

Current status

58 The Council is now looking to an external professional organisation for the overall

review of financial services recommended in the disciplinary investigation report.

Surprisingly, and before the completion of this review, the Council has already reduced

the professional financial support at a senior level in the organisation. Following the

departure of the Executive Director Corporate Services, the most senior financial

officer in the Council, the Council’s former Director of Law and Democratic Services

was the successful applicant to replace him. At the meeting of the Appointments

Committee in March, Members resolved to delete the current post of Deputy Director

of Finance and to create a new post of Chief Finance Officer.

59 The Deputy Director of Finance has been promoted on an acting basis to Chief

Finance Officer. He is now responsible for carrying the overall responsibility for

Finance under section 151 of the Local Government Act 1972, as the most senior

qualified accountant in the Council. I am informed that there will now be a competitive

recruitment process before a permanent appointment is made to the new post.

Closing remarks

60 Leading Members and the Chief Executive have expressed their commitment to

address the deficiencies highlighted in this report and refer to the work already done in

response to the findings reported by Internal Audit in January. I note that structured

Member briefings have been introduced already and the Council has commissioned an

independent review of elements of the finance function. This additional capacity should

mean the Council is better placed to implement my recommendations and secure the

fundamental improvements needed.

Mark Kirkham

District Auditor

24 June 2009

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