Burford Governance Changes

Burford Capital (BUR) have announced a number of changes to their board to meet the concerns of investors about corporate governance at the company. It includes the CFO (wife of the CEO) moving to another role, and refreshing the board in due course.

This is what Chairman Sir Peter Middleton had to say: “Companies are owned by their shareholders, and when the shareholders speak, it is the role of boards and management to listen.  While we may take a different view on some of these points, shareholders have clearly spoken and we have listened, just as Burford has throughout its existence.  We trust that these governance enhancements operate to bolster investor confidence in Burford as it enters its next era of growth and success.”

I hope the directors of the Ventus VCTs (see previous blog post) are listening also.

Burford is also looking for a US listing (on the NYSE or Nasdaq) as investors have made it clear they do not support Burford being solely listed on AIM.

These changes will help to make the company more of a sound investment proposition but the question remains over whether their financial accounting is prudent, and has been historically accurate. Muddy Waters clearly suggested otherwise. The key question for investors is whether a new CFO will take a different approach to their accounting and decide it should be done differently.

Unfortunately the new CFO, Jim Kilman, was the former investment banker at Morgan Stanley for the company and has been acting as an advisor to the company since 2016. It hardly looks like they undertook a formal recruitment process but have just appointed someone they already know, and who knows them, to the position as a stop-gap measure. That is not the best way to reassure investors on financial prudence.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Ventus VCT AGMs – A Disappointing Result, National Grid and Sports Direct

I have mentioned previously the attempt by a shareholder in the Ventus VCTs (VEN and VEN2) to start a revolution, i.e. replace all the directors and appoint new ones. See https://tinyurl.com/y6e5fafo . Nick Curtis was the leader of the revolt but at the AGMs on the 8th August the required resolutions were narrowly defeated with one exception. This was after the boards of these companies paid a proxy advisory service £38,000 to canvas shareholders, which of course shareholders will be paying for as it is a charge on the companies.

There is a report on the meetings by Tim Grattan in the ShareSoc Member’s Area which gives more details. One surprising bit of information that came out was that the performance incentive fee payable to the manager would be paid in perpetuity even if the management agreement is terminated. This is an outrageous arrangement as it would effectively frustrate any change of manager, i.e. it’s a “poison pill” that protects the status quo.

In addition the performance fee calculation is exceedingly complex, and allegedly double counts the dividends because it is based on the sum of total return and dividends. It seems to be yet another incomprehensible performance fee arrangement which I have often see in VCTs.

Comment: I think the existing directors deserve to be removed solely for agreeing to such arrangements. I have repeatedly advocated that performance fees in investment trusts (including Venture Capital Trusts) are of no benefit to shareholders and typically just result in excessive fees being paid to fund managers. There is no justification for them. Fund managers say that they are essential to retain and motivate staff, but I do not know of any VCT where the fund manager has voluntarily given up the role because of inadequate fees being paid even though some of them have had quite dire performance.

The boards of these VCTs are reflecting on the outcome. Let us hope that they decide it is time to step down and appoint some new directors who need to be truly independent of the manager. The candidates for the board put forward by Nick Curtis are a good starting point.

If the board does not respond appropriately, then I think shareholders should pursue the matter further with another requisition for an EGM to change the directors. It can take time to educate all the shareholders in such circumstances so perseverance is essential in such campaigns.

The Financial Times had more lengthy coverage on National Grid (NG.) and its power outage last week, which I covered in a previous blog post. It seems the company is blaming the power failures on the regional distribution operators for cutting the power to the wrong people, e.g. train line operators rather than households. But they suggest otherwise. Meanwhile an article on This is Money suggests that the increased sales of electric vehicles will cause the grid to be overloaded by 2040, even though sales of such vehicles are well behind those in some other countries. They were only 2.5% of sales in the UK in 2018, versus 49% in Norway. Surely what the UK needs is more back-up capacity based on batteries, gas turbines or like the Dinorwig pumped storage power station in North Wales. That can bring large amounts of capacity on-line in seconds and is well worth a visit if you are on holiday in the area.

Other interesting news is the recent events at Sports Direct (SPD). After problems with the last audit and getting the results out, Grant Thornton have announced that they do not wish to continue as auditors. All of the big four audit firms have refused to tender for the audit and other small firms have also declined it seems. Corporate governance concerns at the company seem to be one issue.

A UK listed company does require an audit so what does the company do if there are no volunteers for the role? The FRC is being consulted apparently on how to resolve this problem. Needless to say, these issues are having a negative effect on the company’s share price.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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National Grid Power Cuts

Last Friday the electricity network suffered a number of major failures with power cuts closing Kings Cross station and associated lines, traffic lights in South-East London being cut and other areas of the country affected. This caused me to consider whether National Grid (NG.) has been running too close to the wind in terms of capacity to cope with exceptional events.

I have not held shares in the company since late 2017/early 2018 but I do recall attending one of their AGMs when a shareholder questioned whether the country and the company had enough spare electricity capacity (National Grid has a monopoly on electricity distribution in the UK and also acts as a “system operator”). The shareholder concerned was reassured by the directors so far as I recall.

Keeping the power on is quite essential in the modern world. Heating appliances rely on it to operate, phone networks fail if the electricity supply is down (unlike some years ago when landlines operated on batteries), hospitals and other essential services rely on electricity being available and even cars will soon be reliant on the electricity supply. But it seems that the grid suffered three “near-misses” in the months before Friday’s disruption. On Friday the problem appears to have been caused by the failure of a gas power plant in Bedfordshire and a North Sea wind farm at the same time. This combination caused automatic systems to be triggered that cut supplies to certain parts of the country to avoid a wider shutdown. Note that this is nothing to do with reliance on unreliable supply sources such as wind power generation. It’s about network management, being able to get alternative supplies into action quickly and having spare capacity.

Has the company been under investing in capacity and system resilience while paying out enormous sums in dividends to investors, as some people allege?

It’s worth reading the company’s last Annual Report where the risks the company faces are covered in some depth. They have added “two new principal risks” one of which is given as “failure to predict and respond to significant disruption of energy that adversely impacts our customers and/or the public”, so it seems they were already aware of this issue.

They also cover the risk of state ownership if the Labour Party gained power and they say “The Government would have to pay fair compensation for the Company’s property….”. That is simply untrue. It would only have to pay what Members of Parliament considered fair which may be very different to a truly independent valuation or what the company’s shareholders might consider reasonable.

It would appear to me that the company has been excessively optimistic over its ability to maintain the supply network when an unusual combination of events arises, and has been discounting other major risks to shareholders.

It is surely time for the Government and National Grid’s regulator (OFGEM) to take a close look at the company.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Burford – Illegal Market Manipulation?

Burford Capital (BUR) have issued an announcement that makes a number of allegations about the events surrounding the recent shorting attack involving Muddy Waters. It includes:

  • Spoofing and layering to move the share price, e.g. putting in numerous share sales on the order book and cancelling them before they can be filled.
  • That includes numerous such transactions just before Muddy Waters issued a tweet giving Burford as the target, and as that tweet was delayed only Muddy Waters or its associates could have known of the timing.
  • Exiting their short position by buying Burford shares at the same time as continuing on the same day to make their allegations.
  • Falsely alleging the company was “insolvent” which would have been picked up by algorithmic traders.

They allege these activities are simply illegal and have informed the regulatory authorities on the matter, plus hired three large law firms (Quinn Emanuel Urquhart & Sullivan LLP, Freshfields Bruckhaus Deringer LLP and Morrison & Foerster LLP) plus a Professor at New York’s Columbia University who is an expert to look into the trading activity.

For those not familiar with market manipulation techniques, just read the Burford announcement for a good explanation: https://tinyurl.com/y6xrs38h.

Let us hope that the UK’s Financial Conduct Authority (FCA) promptly looks into these complaints, and that the Financial Report Council (FRC) also investigates the accounts and past audits of the firm. Despite Burford being a very large company, it is listed on AIM so the AIM regulators (i.e. the LSE) and its NOMAD should also be looking into the matter surely?

As I said in a previous blog post here: https://tinyurl.com/yy9pamh5, one of the problems in most shorting attacks is the mixture of possibly true and false allegations, which the shorter has not even checked with the target company, along with unverifiable claims and innuendo. The shorter can make a lot of money by such tactics while it can take months for the truth or otherwise of the allegations to be researched and revealed. By which time the shorter has long moved on to other targets.

Shorting is not wrong in essence, but combining it with questionable public announcements is surely market manipulation which is covered by the law on market abuse.

To remind you, I have never held any position in Burford Capital, short or long, and there are good reasons why not which I give below. But I have held shares in other companies which have been the victim of shorting attacks – in one case justifiable in another not, so I would like to see some reform of this area of the market.

As regards Burford, just reviewing this company against the check lists given in my new book, it would have failed as an investment proposition on several counts. These are:

  • Smaller transactions (Chapter 2). Burford’s profits are very dependent on a few large legal cases. Any problems in such cases could wipe out the profits whereas companies who have many smaller contracts rather than a few large ones are less vulnerable to surprises.
  • Repeat business (Chapter 2). Every legal case they pursue is a “one-off” transaction which means there is no certainty of future such business.
  • Short term contacts (Chapter 2). The legal case the company pursues can take years to finally resolve, i.e. they are long-term contracts rather than short-term ones. This means they are complex in accounting terms and risky.
  • No risk of Government regulation (Chapter 4). This area of legal practice is very much subject to Government regulation and has significantly changed in recent years.
  • Applicable listing rules (Chapter 7). The company is listed on AIM which is a much lighter touch regulatory regime than that for fully listed companies despite the fact that it is a very large business (market cap still £1.8 billion even after recent share price falls).
  • Adhere to corporate governance code (Chapter 7). Corporate governance at this company is odd to say the least with directors serving for more than ten years and no executive management on the board. In addition the CFO is married to the CEO.
  • AGMs at convenient time and place (Chapter 7). The company holds its AGMs in Guernsey where it is registered.
  • Accounts easy to understand and accounts prudent and consistent (Chapter 8). I would certainly question whether both the recognition of the value of on-going legal claims in the accounts is prudent. It is also very difficult for any outsider to judge the merits of the claims.
  • Do profits turn into cash (Chapter 10). From the 2018 accounts: Pre-tax profit was £307 million while Cash Outflow from Operating Activities was £233 million. Enough said.

The above are just a few easy points to pick out, but I could go on at some length on why I would not have invested in Burford and did not despite it being regularly tipped in the financial press.

See here for the book details that includes the checklists used in the above analysis: https://www.roliscon.com/business-perspective-investing.html

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Burford Response and Shorting Regulation

Burford Capital (BUR) have issued a response to the allegations of false accounting from Muddy Waters. It goes into some detail and appears to at least contradict some of the allegations, if not all. It could take some weeks to analyse and verify who is correct but it leaves outstanding the basic issue of whether the accounting treatment of on-going law suits is prudent. My view is not simply because the outcome of any law suit is basically uncertain. Even if the case is won, there is no certainty that the litigants will get paid.

But there is one law suit that looks fairly certain to proceed. US lawyers Rosen Law Firm are already lining up folks to join a class action over the matter against Burford Capital Ltd. See https://www.rosenlegal.com/cases-register-1647.html . More background information is available here: https://tinyurl.com/yxvnc3yj .

Burford are also threatening legal action against Muddy Waters. So it looks like another lawyers’ beanfeast.

As one commentator said, those aiming to profit from shorting a stock tend to throw all kinds of mud at their target in the hope that some of it sticks. The target company is often unable to respond quickly and the issues are often so complex (as in the Burford case), that investors don’t know who to believe. So the damage is done, the share price collapses and the shorter makes an immediate handsome profit. Is this morally sound? I think not.

As I said in a previous blog post, “it is surely wrong for anyone to make such allegations and publicize them with the objective of making money from shorting the stock without first asking the company concerned to verify that what they are alleging is true – at least as far as the facts they report are concerned rather than just their opinions”. Muddy Waters did not apparently do that in this case and most shorters do not.

As someone who writes frequently on companies, it is good journalistic practice to verify with the company what you are about to publish. It is so easy to make simple factual errors or misinterpret the facts. There is nothing wrong per se in shorting as it can help to ensure that stock valuations are fair and reasonable and maintain liquidity. Most shorters do not publicise what they are doing.

Paul Scott of Stockopedia did a good analysis of the allegations and counter allegations at Burford. This is what he also said: “My feeling is that short sellers should be required to submit such a dossier to the target company, and give them say 7-days to respond privately. This would allow companies to point out the mistakes in the draft report. It does appear that the MW report might have misinterpreted some of the cases it comments on. Or at least, Burford seems to have provided reasonable explanations in most cases”. But Paul was also critical of their accounting policies and reliance on a few big cases.

I agree with him that such a regulation would be a good idea. It would stop a lot of wild and inaccurate allegations being published and at least give the target company the opportunity to issue a quick rebuttal if the allegations were still published.

The difficulty might be in framing such a regulation to cover those publishing a critique on a company at the same time as shorting the stock while excluding general market commentary and company analysis. But it would not seem impossible to do so.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Burford Capital, Goals Soccer Centres, Carillion, and Why Numbers Are Not Important

To follow on from my previous comments this morning on Burford Capital (BUR), this is a typical “shorting” attack where the shorter (Muddy Waters) and their supporters make a lot of allegations which investors are unable to verify in any useful time frame. I certainly questioned the accounting approach used by Burford and other litigation finance firms as I commented on it back in June, but disentangling the factual accusations in the Muddy Waters dossier from innuendo and comment is not easy.

It is surely wrong for anyone to make such allegations and publicize them with the objective of making money from shorting the stock without first asking the company concerned to verify that what they are alleging is true – at least as far as the facts they report are concerned rather than just their opinions.

The company may threaten legal action for libel where misleading or inaccurate information is published but in practice such law suits take so long to conclude, with major practical problems of pursuing those who are resident overseas while actually worsening the reputational damage rather than improve it that few companies take that route.

This is an area of financial regulation that does need reform. In the meantime the damage to Burford is probably likely to persist for many months if it ever recovers.

What is the real moral of this story so far as investors are concerned? Simply that trusting the financial accounts of companies when picking investments is a very poor approach. This was reinforced by more news about the accounting problems at Goals Soccer Centres (GOAL) which I also commented on previously. Apparently a report to the board by forensic accountants suggests that the former CEO corroborated with the former CFO to create fictitious documents including invoices (see FT report on 3/8/2019). Clearly the audits over some years failed to pick up the problems. In addition it looks like the demise of Carillion is going to be the subject of a legal action against their former auditors (KPMG) by the official receivers. Financial accounts, even of large companies such as Carillion, simply cannot be trusted it seems.

This is not just about poor audits though. The flexibility in IFRS as regards recognition of future revenues is one of the major issues that is the cause of concerns about the accounts of Burford, as it was with Quindell – another case where some investors lost a lot of money because they believed the profit statements.

This seems an opportune moment to mention a new book which is in the process of being published. It’s called “Business Perspective Investing” with a subtitle of “Why Financial Numbers Are Not Important When Picking Shares”. It’s written by me and it argues that financial ratios are not the most important aspects to look at when selecting shares for investment. Heresy you may say, but I hope to convince you otherwise. More information on the book is available here: https://www.roliscon.com/business-perspective-investing.html

There are some principles explained in that book that helped me to avoid investing in Burford, in Quindell, in Carillion, in Silverdell and many of the other businesses with dubious accounts or ones that were simple frauds. These are often companies that appear to be very profitable and hence generate high investor enthusiasm among the inexperienced or gullible. It may not be a totally foolproof system but it does mean you can avoid most of the dogs.

With so many public companies available for investment why take risks where the accounts may be suspect or the management untrustworthy? One criticism of Neil Woodford is that his second biggest investment in his Equity Income Fund was in Burford. If you look at his other investments in that and his Patient Capital Trust fund they look to be big bets on risky propositions. He might argue that investment returns are gained by taking on risk which is the conventional mantra of investment professionals. But that is way too simplistic. Risks of some kinds such as dubious accounts are to be avoided. It’s the management of risk that is important and size positioning. The news on Burford is going to make it very difficult for Woodford’s reputation as a fund manager to survive this latest news.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Market Crashes and Burford Capital

Investors might have been panicked by the recent market falls driven by the US/China trade wars, Brexit and gloomy economic forecasts. As usual, the UK market is led by the US markets. The S&P 500 is down 5% since the 26th July even though there was a slight bounce upwards yesterday. There can be few readers portfolios which have not suffered some impact because there were few stocks that did not fall.

Now I am an inveterate trend follower so how did I react to the falls? I did nothing because a few days is too short a period to determine whether it is a short-term panic or a real change in the trend. I am not convinced that we have moved from optimism about shares, to a real bear market. I’ll wait and see whether a trend develops because responding to short term share price fluctuations can be an expensive mistake.

One big faller this morning was Burford Capital (BUR) – down 60% at the time of writing. This is a litigation funding business that has come under attack for alleged dubious accounting by Muddy Waters in a report published this morning. I do not hold the stock and made some somewhat negative comments on their revenue recognition on June 12th – see https://tinyurl.com/y3ljqqvr . You can see Carson Block of Muddy Waters describing some of the issues in a video here: https://tinyurl.com/yxcq24ol or you can read the full report here: https://tinyurl.com/y6arozr9 .

I have read the report and I think it makes some valid points. The company issued a statement this morning calling it a “shorting attack” which it undoubtedly is, i.e. Muddy Waters have taken a position that might motivate them to exaggerate as shorters invariably do. For example they say Burford is a fund that “invests in an illiquid and esoteric asset class” and suggests they are using a “mark to market” accounting model of “Enron fame”. But they highlight the fact that the CFO is the wife of the founder/CEO which I find somewhat surprising, and the long service of all the directors which is not good corporate governance.

I remain skeptical of the accounting treatment of litigation funding by this company and others. Burford is of course one of the big investments made by Neil Woodford which will not enhance his reputation for prudence.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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