FRC Seminars, Lookers Results, Caparo Judgement and Autonomy Case

I attended two seminars organised by ShareSoc and UKSA with the Financial Reporting Council (FRC) yesterday (24/11/2020) and the day before. The first session was about the “ARGA transformation”, i.e. the steps being taken to improve the audits of companies and the reporting of accounts following the Kingman review two years ago. ARGA stands for Audit, Reporting and Governance Authority which will be the new name for the FRC.

Before reporting on the meeting, it’s worth noting the latest example of how audits have failed to disclose substantial errors in accounts, including fraud, in the case of Lookers (LOOK). In their announcement on Tuesday they made it clear that profits had been wildly overstated for some years and the balance sheet was likewise overstated. To quote from the announcement: “A total of £25.5m of non-cash adjustments are necessary to correct misstatements in PBT over a number of years” and “Adjustments reduce  PBT by £10.9m in 2019 and £7.2m in 2018 with the balance cumulatively decreasing PBT by £7.4m in 2017 and earlier”. Auditors Deloitte have resigned.

It is a regular occurrence that the published accounts of public companies are subsequently shown to be wrong and that fraud goes undetected. The audit process which investors rely on to enable them to have confidence in the accounts on which they are basing investment decisions is clearly regularly failing.

The FRC seminar was presented by Sir Jon Thompson, their new CEO following a wholesale shake-up of management, and Miranda Craig, Director of Strategy and Change. They reported on the progress to implement the required changes, many of which require changes to legislation. They hope to get those implemented in the second half of 2021 with ARGA becoming live in 2022. But none of this is certain as it depends on Government co-operation and priorities. There will also need to be another consultation round on the details of the proposals.

The Kingman review proposed joint audits be introduced but the Government has decided against that but managed shared audits are being considered so as to give smaller audit firms some involvement in bigger audits.

ShareSoc Director Cliff Weight asked a question about the Caparo legal judgement and the problem of people holding shares in nominee accounts not being “members” of a company.  I followed up with some points on Caparo, which Sir John Thompson did not appear to know much about and assigned a response to someone else.

Let me explain why this issue is so important and how the Caparo legal judgement undermined the duties of auditors.

Investors in the stock market purchase shares on the basis of the published accounts of companies being a fair view of their financial position. Before the Caparo legal judgement in 1990 it was widely assumed that auditors had a duty of care to shareholders – after all what was the purpose of the audit other than to provide reassurance to shareholders? Historically that was why audits were introduced. See this ShareSoc blog for more information https://www.sharesoc.org/blog/regulations-and-law/audit-quality-caparo-judgement and there are more details of the legal case on Wikipedia.

This judgement effectively meant that no shareholder in a company could sue the auditors for incompetence or breach of duty, only the company could. But that rarely happens, when it is the shareholders that have typically lost money as a result. In fact some auditors have claimed that even the company does not have a claim if the reported accounts were false because it might not necessarily have affected what actions the company took. Sometimes when a company goes into administration the liquidators might sue, as in the recent example of Patisserie (CAKE) but there is no certainty of success or any pay-out to shareholders.

The failure to make auditors responsible financially to investors relieves them of a big financial incentive to do their work properly and to identify false or fraudulent accounts.

I put it to Miranda Craig that all that was required to fix this problem was a simple Act of Parliament to overturn the Caparo judgement. She suggested they did not have the powers to implement this but that is a weak excuse.  They could surely suggest to the Government that such an Act be introduced as it’s perfectly practical. It just needs to reinstate the duty of auditors to shareholders and overturn the somewhat perverse decision in the Caparo judgement.

Another attendee at the seminar raised the issue of the auditors being able to limit liability to the company by contractual means which is another issue that needs tackling.

The second seminar was about “Enforcement”, presented by Claudia Mortimore and Jamie Symington. There has been growth in the enforcement team – from 9 staff in 2012 to 54 now. Certainly enforcement has been more active but they are still hampered in some cases by limitations on their powers – for example they only have powers over members of regulatory bodies whereas many company directors are not such members (even finance directors or chairs of audit committees). There are plans to change this.

They have identified two main issues from past audits: 1) A failure to plan and perform audits with professional scepticism; and 2) Failure to obtain sufficient audit evidence.

Enforcement does seem to be improving, but there are still some issues as Robin Goodfellow pointed out (a failure to communicate with complainants over FRC findings or during investigations).

There is also an issue that fines on audit firms or partners are still not enough to discourage poor behaviour or match the losses incurred by shareholders due to incompetence or inadequacy. For example, one of the cases mentioned in the seminar was that of Autonomy. Deloitte was fined £15 million in September over their audit work for the company. But Hewlett-Packard (now HPE) claimed for £3.8 billion over their losses resulting from the acquisition of Autonomy, i.e. 250 times what Deloitte were fined!

Altogether these were somewhat disappointing seminars for those of us looking for vigorous action and speedy revolutions in the FRC. I am not convinced the culture of the FRC has yet changed, with progress being slow and decisive actions to improve audit standards not being implemented, although others do think there is progress being made. Improvements are being implemented but not nearly as quickly as I would like and auditors are still being protected from the worst impacts of incompetent audits. The fines that are issued are still too low – for example Deloitte registered a profit of £518m for the year ended May 2020 so they probably won’t worry too much about a £15 million fine.

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

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Law Suit Launched Against Grant Thornton over Patisserie Valerie Audits

The Daily Telegraph and some other sources have reported that the liquidators of Patisserie Valerie (CAKE) have filed a claim in the High Court against Grant Thornton over the audits of Patisserie Valerie in the years before it went into administration.

I reported previously that the accounts of Patisserie were a complete fiction see Reference 1 below – with the assets of the firm overstated by more than £90 million.

The liquidators are FRP Advisory and they have appointed lawyers Mischon de Reya to pursue the case. Will this mean that if the action is successful that ordinary shareholders will see any return? Highly unlikely I would guess as secured creditors will take priority, and those include the former Executive Chairman of the company, Luke Johnson, who lent the company many millions in an attempt to keep if afloat before it failed. In addition there will be very substantial legal costs which cannot always be recovered in full even if the action is won. In addition, administrations and liquidations always consume a very large amount of cash.

Grant Thornton only recently lost another legal action over their audit work at AssetCo where they not only blamed everyone else for the defective accounts but actually claimed that AssetCo was better off not knowing the truth of its own financial position! See Reference 2 below.

The Financial Reporting Council (FRC) have proposed to tighten up the responsibility of auditors to identify fraud (see Reference 4) which has been far too lax in the past. But the Patisserie action will depend on the historic rules. However the Courts have clearly made it plain that irresponsible audits will not be totally excused. Without wishing to prejudge the case, Grant Thornton looks like they will have a lot of explaining to do because the fraud looks a simple case of assets such as cash being grossly overstated. Grant Thornton have however said they will “rigourously defend the claim”.

Reference 1: Patisserie Administration: https://roliscon.blog/2019/03/16/patisserie-and-interserve-administrations-plus-brexit-latest/

Reference 2: AssetCo case: https://roliscon.blog/2019/02/06/assetco-case-and-grant-thornton-defense/

Reference 3: Daily Telegraph article: https://www.telegraph.co.uk/business/2020/11/20/grant-thornton-hit-legal-challenge-collapse-patisserie-valerie/

Reference 4: FRC Tightens Audit Rules: https://roliscon.blog/2020/10/29/preventing-fraud-in-accounts-fca-tightens-audit-rules/

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

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Petrol and Diesel Cars Face Extinction

After being preceded by numerous leaks, the Government has finally announced that it is bringing forward the date when sales of new petrol and diesel powered cars are banned to 2030 (see Reference 1 for details). The only exception is that sales of hybrid vehicles will be permitted until 2035. In practice such vehicles will go the same way as the dinosaurs, facing extinction in a few years’ time.

That will not stop such vehicles already purchased from being used after those dates but they may be discouraged in other ways of course (such as by the ULEZ in London).

This is what Allistair Heath (who described himself as “a convert” to electric cars) said in the Daily Telegraph: “The green agenda has triumphed, in the sense that cultural, political, educational and corporate elites, in the US, UK and every European country, are all in favour of decarbonisation. Opponents have been routed, with almost no chance of a way back”. He’s definitely right in that regard. There has been no cost/benefit analysis of these proposals or rational justification given. It’s all about cutting air pollution and saving the planet regardless of the negative consequences of these moves.

To start with the Government is spending £1.8 billion to support the charging infrastructure and other measures required by electrification of all vehicles. That will come out of your taxes. This is far from a trivial matter. In London and other major UK cities one big problem is that many households do not have off-street parking so there will need to be kerbside charging points installed in many streets.

The car industry, one of the major UK exporters, will have to adapt to only producing electric vehicles and much faster than they expected. They may be able to cope with that but will it damage their export capability? Nobody seems to have looked at that issue. The Government says it will create 40,000 extra jobs by 2030, particularly in our manufacturing heartlands of the North East and across the Midlands, but that seems to be very unlikely to be the case. These will not be new jobs surely, just replacing existing ones.

This is what Lord Lawson, former Chancellor of the Exchequer, had to say about the new “Green revolution”: “If the Government were trying to damage the economy, they couldn’t be doing it better. Moreover, the job creation mantra is economically illiterate. A programme to erect statues of Boris in every town and village in the land would also ‘create jobs’ but that doesn’t make it a sensible thing to do.”

Does the public demand cuts in air pollution? It was interesting to read some of the response to a recent survey of Lewisham residents where 13% said they suffered from medical conditions as a result of air pollution in their local street. Some of them might be suffering from more pollution because of the closed roads in Lewisham though where a Low Traffic Neighbourhood has been installed and it’s worth pointing out that the majority of air pollution in the borough comes from other sources than transport. In reality diesel and petrol cars contribute only 12% and 6% respectively of all emissions in London and they are falling rapidly.

But a survey by London Councils reported that “The vast majority of Londoners (82%) are concerned about climate change with half of concerned respondents going further saying they are very concerned (40%). Over half of respondents (52%) feel their day-to-day life in London had been impacted by climate change”. Many years of scaremongering over climate change has clearly brainwashed the general public into believing it’s a major threat to their life. The metropolitan elites who can afford to buy electric vehicles (which currently cost a lot more than diesel/petrol ones) can salve their consciences by buying electric vehicles despite the fact that they will have minimal impact on overall levels of air pollution while UK emissions from all sources contribute only 1% to global CO2 emissions and hence cannot have any significant impact.

Will the public accept the ban on the sale of new diesel/electric vehicles and cope with it? Based on public opinion, they are likely to accept it and in reality, with a few exceptions they should be able to cope.

By 2035, electric vehicles are likely to be cheaper and also have longer range, and older vehicles will still be able to be used. If charging points are much more common as they should be in a few years, that will lessen the problems. But there are two problem areas:

Those vehicle owners with no off-street parking might find charging their vehicles problematic. And those who wish to own motorhomes or tow caravans will find electric vehicles have very short ranges.

In summary, the Government’s announcement will impose major costs on people, and on the economy while having little real impact in reality on air pollution or global warming. However, the encouragement of electric vehicles does make sense in some ways but that is already being done by taxation, by subsidies and by measures such as zero emission streets in problem areas in London.

Putting a sharp deadline on sales of some vehicles, particularly hybrid ones in 2035, just seems somewhat irrational when the dangers of air pollution have been grossly exaggerated and there will be significant problems in making the change for some people. More attention needs to be paid to other sources of air pollution and one of the major factors that has caused increases in that is the growth of the population, an issue few politicians seem to want to tackle. Air pollution directly relates to population numbers and density and London is a good example of the negative consequences of allowing unlimited population growth.

Reference 1: DfT Announcement: https://tinyurl.com/y2l4xhcw

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

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Law Commission Review of Intermediated Securities

The Law Commission has published a “scoping paper” on Intermediated Securities (See Reference 1 below). This might sound a pretty dry technical subject but the subtitle of the report asks the important question – it covers “Who Owns Your Shares?”

I have written about the problem of the growth in the use of nominee accounts as on-line platforms have replaced share certificates many times in the past. ShareSoc has a web page with voluminous information on this subject including reports written by me (see Reference 2). It is certainly an area well overdue for reform.

I also submitted a personal response on the subject to the Law Commission (See Reference 3) – the Commission did quote from it in their report, but they did not get that many submissions from investors.

The Law Commission has actually done a good job of explaining most of the problems inherent in the current system of “intermediated securities”, otherwise known as the use of “nominee accounts”. I can do no better than to repeat their summary of the issues: “The system of holding investments through a chain of financial institutions (“intermediated securities”) stops investors being able to exercise shareholder rights and can lead to legal uncertainty”.

The Commission identifies these advantages and disadvantages of the current use of intermediated securities:

Advantages

The Commission found a number of strengths of the intermediated securities system, including increased efficiency and economies of scale, and convenience for ultimate investors, who may hold a diverse, cross-border portfolio of investments through a single intermediary.

 Disadvantages

On the other hand, there are well-founded concerns relating to corporate governance and transparency, and uncertainty as to the legal rights and remedies available to an ultimate investor. An ultimate investor is not a “member” or shareholder of the company under the Companies Act 2006, and it is therefore unlikely that they will receive information from companies, have voting rights (for example at AGMs) or be able to attend meetings. Even where an ultimate investor is able to vote, they may find it difficult to confirm that their vote was received and counted by the company.

There is also legal uncertainty around a number of scenarios that could play out, including what happens when an intermediary in the chain becomes insolvent, and the legal position when intermediated securities are wrongly sold.

The fact that most retail investors do not own the shares they think they do is spelled out in this paragraph in the report summary: “As an ultimate investor, your name will not appear on the register of members and you are not a member of the company. You will not automatically have a direct relationship with the company. Instead, the financial institution (the “CREST member”) at the top of the intermediated securities chain will be the legal owner of the investments and the legal shareholder or member of the company. They will receive information and correspondence from the company, be able to attend company meetings and vote in relation to the shares”.

This is a good quotation from the full report: “When people have money saved, they may wish to invest it. But not all investments are straightforward to own. If you buy a gold bar, you own the gold bar. If you buy a piece of art, you own the painting or sculpture. If you decide to buy securities, such as shares or bonds issued by a company, the position is more complicated”. In essence, way too complicated!

The Scoping Paper explains all the above in a lot of detail, and they conclude by suggesting how the system could be improved, with a number of options covered.

They point out that the prospect of “dematerialisation” gives the opportunity to either remove intermediation altogether or introduce a genuine alternative for investors so that they could hold their shares directly if they wished. They favour the latter because they consider it more “proportionate”. But also suggest the Government should consider the long-term systemic advantages of removing intermediation altogether by the use of a “name on register” system.

The Law Commission’s report is very comprehensive (at 200 pages) and well covers the legal complexities. It also provides some useful information on the way shares are held and voting turn-outs.

One area which they do not cover well is the issue of the engagement with investors by companies and by other shareholders. Companies cannot communicate with their ultimate investors if they hold their shares in intermediated form. This can be very important when takeover bids arise or there are corporate governance issues (see pages 40-41 of the report). This is also very important when shareholders wish to communicate with other “members” (i.e. shareholders) which they have rights to do under the Companies Act. But this is thwarted when most shareholders are in nominee accounts (theoretically they can but practically it is almost impossible to do so in most cases – see pages 63 to 66 of the report where some solutions are suggested). But the Commission does not go into these issues because apparently this policy issue was not included in their terms of reference from BEIS. That is most unfortunate.

The failure to have all shareholders on the share register fatally undermines shareholder democracy. But even if the use of intermediaries was retained it is still possible to have all shareholders (including beneficial owners) on the share register. Technically that is not difficult to achieve (I speak as an former IT system designer). That would solve many of the problems associated with voting and shareholder democracy.

Chapter 3 of the Report on “Voting” gives you a good picture, if not understanding as it is horribly complex, of how shareholders can vote at General Meetings. This is normally possible, if your broker (nominee operator) agrees but perhaps at some cost. But it typically does not allow someone in a nominee account to appoint someone else as a proxy – you can only appoint your nominee operator. This is a big defect as it makes it difficult for any person or organisation to collect proxy votes.

Unfortunately the Commission only proposes minor improvements in the voting system, not a wholesale reform. But they do discuss extending the Shareholder Rights Directive to cover beneficial (ultimate) owners which it certainly should have done anyway, but did not as implemented in the UK.

Chapter 4 of the Commission’s report covers the problems related to Schemes of Arrangement. The “headcount” test can result in bizarre consequences when such schemes are voted upon as only Members are counted, not beneficial owners. Or it can result in exploitation of the anomalies by clever persons. The Commission recommends the headcount test be removed which I consider makes sense but other provisions to protect small minority investors should preferably be added (relying on a court’s discretion to protect minorities does not in my experience work).

The Commission’s discussion of the “No Look Through” Principle in Chapter 5 makes for interesting reading. This principle in contract and trust law prevents any beneficial owner in a nominee account from pursuing the share issuer (company) in law as they only have a contract with their nominee operator. The Commission suggests some improvements that might assist in this area and which appear to be sensible.

In Chapter 6 the insolvency of an intermediary is discussed, i.e. what happens if your stockbroker or platform operator goes bust. This is big concern for investors as the use of intermediaries undermines your legal rights of ownership to shares, and there have been a number of examples of where ultimate owners were prejudiced, or lost money, as a result. The use of “omnibus” or “pooled” nominee accounts is particularly dangerous.

The position of investors was improved when the Special Administration Regime was introduced but it has not resolved all the problems. The Commission proposes some improvements that might help but also suggests more research and consideration is required in this area. This area could justify a 200-page report alone and the solutions are not at all obvious.

Chapter 7 of the report covers the legal problems associated with the sale and purchase of intermediated securities. It may be of more interest to lawyers than casual readers.

Chapter 8 covers dematerialisation (scrapping paper share certificates) and the opportunities for reform it creates. It covers the proposals developed by the Demateralisation Working Group and Registrars Group to create a replacement electronic system. That would support a “name on register” system and hence preserve voting and information rights to certificated shareholders. But extending such a system to cover intermediated securities might be a very big and costly task it is suggested. It would also create some legal issues apparently.

The Commission recommends, in Chapter 9, that a new set of best practice principles be developed in regard to intermediated securities. The report explains how that might assist. The discussion makes it clear that a lot more work would be required in this area to develop a code of practice that was both clear and understandable by retail investors.

The report concludes by covering the areas where further work is required, which is clearly very extensive. It is does however provide a very comprehensive review of the legal and technical aspects of this subject and I could not find any inaccuracies therein.

It is good that they have clearly read, reported and understood the submissions not only by several individual investors like me, but also of ShareSoc and UKSA. I am hopeful the report will lead to some improvements in due course, but regrettably the pace of change is low.

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

Reference 1: Law Commission – Intermediated Securities Scoping Paper: https://www.lawcom.gov.uk/project/intermediated-securities/

Reference 2: ShareSoc Shareholder Rights Campaign: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Reference 3: Roliscon Submission to Law Commission: https://www.roliscon.com/Intermediated-Securities-Consultation.pdf

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More on the Capital Gains Tax Review

I commented briefly yesterday on the Review of Capital Gains Tax by the Office of Tax Simplification (OTS)  – see https://roliscon.blog/2020/11/12/capital-gains-tax-review-a-missed-opportunity/ where I called it a “missed opportunity” to substantially reform the tax.

The more one looks at their proposals the more some of them appear to become absolutely bizarre. For example I mentioned the proposal that the rebasing of an asset to the current value when it is inherited should be removed – in effect the new owner would have the original cost retained.

This has two implications. Firstly it means that the full value of the same asset is taxed twice – once in IHT when it is inherited, and again when the inheritor subsequently disposes of it in capital gains tax. At least at present, the inheritor only pays tax on the growth in value during their ownership. But if the latter tax is based on the original value rather than the last inheritance, it could go back very many years in time. This is what Tim Stovold of Moore Kingston Smith said in the FT on this issue: “If this change should become law, capital gains could accrue across multiple generations making assets unsaleable due to the astronomical tax liability — a liability that could come home to roost if they were ever sold”.

The second issue with this is that in practical terms it means that an inheritor would need to know not just the value of the asset as fixed by probate, but the value when originally acquired by the deceased. This could be an impossible task because past records are rarely kept with such accuracy and longevity.

The FT published a good article under the headline “What does CGT review mean for investors” where it pointed out other problems with the review’s proposals and quoted a number of people giving negative comments.

One can only conclude that if the Government pushes ahead with these proposals, that one should rearrange one’s financial affairs to hide as much as possible in ISAs and SIPPs, or buy big houses to live in (not subject to CGT) and not invest in company shares or your own businesses. Or alternatively avoid accumulating assets and spend the cash before you die. This surely makes no sense in policy terms!

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

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Wey Education and Silence Therapeutics Webinars

I attended a couple of webinars yesterday – one for a company I already hold shares in (Wey Education) and one I do not (Silence Therapeutics). Both good examples of the genre.

Wey Education (WEY) published some preliminary results for the year on Tuesday. Revenue was up 38% and adjusted profits more than doubled. These figures and what the company said in the announcement impressed me, but the share price dropped almost 20% on the day. Perhaps investors expected more because as a provider of “on-line education” they surely should have benefited from the epidemic, or perhaps the prospect of a good vaccine made them appear less attractive. But with people more used than ever to doing things on-line, this has surely accelerated the demand for on-line education.

Regardless it was a good presentation from CEO Jacque Daniell and Chairman Barrie Whipp. They explained what the company does well and what their USP is. They had an ambition to become the largest UK secondary school and they ticked that box in the first half. They are also developing internationally as they see that as the market opportunity, and have appointed a new Director of Education, a Director of Marketing and a CTO. They are aiming for a world class user experience and are now geared for expansion. They have achieved a CAGR in revenue of 41% since 2016. Comment: they just need to keep that up! 

The concluding outlook statement in the announcement said this: “Wey is going forward into the 2020/21 academic year with mastery, autonomy and a great sense of purpose”. They have an interest in AI and that sounds like a statement written by a robot.

The second company was Silence Therapeutics (SLN). I missed both the start and end of this webinar so this is only a brief report. This company, as its name suggests, is focusing on silencing defective genes. To put it more fully, I quote from their web site: “Silence Therapeutics is developing a new generation of medicines by harnessing the body’s natural mechanism of RNA interference, or RNAi, to inhibit the expression of specific target genes thought to play a role in the pathology of diseases with significant unmet medical need”.

But it’s still an early stage business with minimal revenue but a large market cap (about £370 million). Clearly it’s a typical biotech stock where a lot of the share price depends on hopes for the future.

This is a sector in which many companies are active including some big players who are making profits, with lots of minnows showing losses. Whether this company will be successful in achieving its objectives and developing products that can be practically used and profitable remains to be seen. But the management certainly made a good impression, as they often do in such businesses (they need to be good at doing that to raise the funds they need).

One to wait and see I suggest, as my past forays into this market segment have not been a great success.

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

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Capital Gains Tax Review – A Missed Opportunity

The Government Office of Tax Simplification (OTS) has published a first report on its review of Capital Gains Tax. I did actually submit a personal response to their consultation on this subject back in August – see https://www.roliscon.com/Capital-Gains-Tax-Review.pdf. This is one thing I said in that: “It is of course a horribly complex tax with several different rates and numerous exemptions”.

The OTS suggests that Capital Gains Tax rates be more closely aligned with Income Tax rates but it also suggests that if that is done a form of relief for inflationary gains be done. I tend to agree with that proposal as it is certainly an anomaly that income is taxed differently to capital gains (it’s easy to change income into capital gains or vice versa). The lack of indexation relief is also a sore point to anyone who holds shares for long time periods.

There is apparently a particular concern about the owners of small businesses retaining cash in their companies rather than paying it out in taxable dividends. They can then realise it as a capital gain later at a lower rate of tax.

They also recommend reducing the annual exempt amount (currently £12,300) to between £2,000 to £4,000. There is clearly a lot of “tax management” taking place at present where people use up the allowance by deferring or bringing forward disposals. Reducing the allowance to a level where it just reduces some administrative effort (excluding those taxpayers with minimal liabilities) makes sense.

The OTS is also suggesting that the rebasing of an asset to the current value when it is inherited should be removed – in effect the new owner would have the original cost retained.

They also propose changes to Business Asset Disposal Relief and Investors’ Relief including scrapping the latter as it seems to be little used.

All of the above changes would generate very substantial additional revenue for the Government, but only if people did not change their behaviour as they always do of course in response to any demand for more tax. Harmonisation of tax rates makes sense but only if the overall tax taken is unchanged.

It is also unfortunate that the OTS review has ignored suggestions for more substantial changes such as permitting gains to be “rolled-over” as I suggested or the proposals submitted by ShareSoc. They just seem to be tinkering with the details rather than making proposals for substantial reforms to simplify the tax.

But it’s worth pointing out that the Government might ignore their recommendations as tax rates and tax structures are political decisions in essence.

The full OTS report is present here: https://www.gov.uk/government/publications/ots-capital-gains-tax-review-simplifying-by-design

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

Epidemic Over? Unable to Trade and Chrysalis VCT Wind-Up

The news that the Pfizer vaccine for Covid-19 appears to work (at least 90% of the time) and has no negative side effects gave stock markets a good dose of euphoria yesterday. It suggests that we might be able to return to a normal life in future, but exactly when is far from clear. Actually producing and distributing the vaccine is going to be a mammoth task and it is very clear that it will only be given to certain people in the short term – the elderly and medically vulnerable. Some people might not accept the vaccine and transmission of the virus may still take place. It is clearly going to be many months before we can cease social distancing and wearing face masks – at least that is the situation if people follow sensible guidance which they may not. Some countries may not be able to afford to immunize everybody so how this good news translates into reality is not clear. In summary, the epidemic is not over.

But the good news did propel big changes in some stocks such as airlines, aerospace industry companies and the hospitality sector which have been severely damaged by the epidemic. Rolls-Royce (RR.) share price was up 44% yesterday for example, although I wouldn’t be buying it until it can show it can make a profit which it has not done for years. In the opposite direction went all the highly rated Covid-19 diagnostic stocks such as Novacyt (NCYT) which I hold. There have probably been way too extreme movements both up and down in the affected stocks as sentiment was only one way.

The big problem faced by many investors though was that platforms such as Hargreaves Lansdown and AJ Bell Youinvest actually ceased to function. It is reported that their customers were unable to log in and trade. But this is not a new problem. See this report in December 2019 when there was a previous bout of euphoria that affected the same two brokers: https://roliscon.blog/2019/12/16/euphoria-all-around-but-platforms-not-keeping-up/ .

They clearly did not learn their lesson and should have done better “load testing”. Perhaps the moral is don’t put all your eggs in one basket by relying on one broker (I use 5 different ones and spread my holdings over them).

For those with an interest in Venture Capital Trusts (VCTs) it has been pointed out to me that Chrysalis VCT (CYS) is putting proposals to wind up the company to its shareholders. I used to hold the company, but sold out in 2018 at prices ranging from 62p to 66p – the current share price is 35p. I had big concerns then about the shrinking size of the company (NAV now only £14.9 million) as cash was returned to investors. The other major concern was the holdings in the company, particularly that in media company Coolabi and the valuation thereof (last filed accounts were to March 2019 and showed a loss of over £7 million).

VCTs that shrink too much, even if they are good at returning cash to shareholders, can get themselves into an unviable position as costs of running the VCTs sooner or later get out of proportion. As the announcement by the company makes clear, in such a situation a VCT has the following options: a) merge with another VCT; b) change the manager and raise new funds; c) sell the company or its portfolio; or d) wind it up.

But raising new funds under the tougher VCT rules that now apply might not be easy, while mergers with another company might be difficult. Who would want to acquire a portfolio where 29% of the current valuation is that of Coolabi – even if you believe that valuation!

The directors give numerous reasons why a wind-up is the best option after they got themselves into this difficult situation. They correctly point out that some investors will be prejudiced by this move as some original investors will have claimed capital gains roll-over relief. They will get their tax liability rolled back in after the wind-up and the ultimate cash cost might be more than what they obtain from the wind-up. Ouch is the word for that. But the directors are going to ignore those investors on the basis that a wind-up “best serves shareholders as a whole”.

The other problem is that a wind-up of a company with holdings of private equity stakes takes a long time and there is no certainty that the value they are held at in the accounts can actually be obtained. Investors in Woodford funds will have become well aware of that issue! Who would actually want to buy Coolabi for example, or some of the other holdings?

Another VCT I held in the past that got into the situation of returning cash to shareholders while finding no good new investments and not raising funds was Rensburg AIM VCT. They managed to escape from it after a lot of pushing from me by merging with Unicorn AIM VCT. But I fear Chrysalis VCT have left it too late and hence the choice of the worst option.

But if I still held the shares, I might vote against the wind-up and encourage the directors to take another path. It is possible to run VCTs on a shoestring if a big focus on costs in taken. In addition, the directors say that they did have some discussions about fund raising, possible mergers or the acquisition of the company but have rejected those for various reasons. But I think they need to look again, after a more realistic view of the values of the existing portfolio holdings has been obtained.

One change that should certainly be made if the company chooses not to wind-up is a change in the directors and fund managers who allowed the company to get itself into this unenviable situation. Regrettably there often appears to be a tendency for directors and fund managers to want to keep their jobs and their salaries long past when tough decisions should have been made.

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

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Portfolios for Ageing Brains and Value Hell

There were a couple of good articles in last week’s Investors Chronicle – one of which I totally agreed with and one which I did not.

The first was by Chris Dillow who reported on academic studies of aged Americans. It was suggested that investment skill declines with age and those who were unaware of their cognitive decline were substantially poorer than others who were aware of it who hadn’t suffered such a decline. Now as someone who is about to reach the age of 75, this is not solely an academic issue.

The article suggested that older people might have acquired some wisdom over the years, and tend to acquire better rules of thumb, but their stock picking ability does decline. Mr Dillow suggests that one answer to this problem is to delegate our wealth management to others. But he does point out that this leaves you still with the problem of picking a good fund manager when your ability to do that might also decline. His other solution is to simplify your portfolio so you just hold equity and bond trackers plus cash.

I am not convinced by this at all. Clearly some people suffer sharp mental degradation with age and should delegate portfolio management to others, or buy managed funds of various kinds. But others do not.

Has the performance of Warren Buffett (Aged 90), or his partner Charlie Munger (Aged 96) or George Soros (Aged 90) declined in recent years? It’s not obvious at all.  My own portfolio performance last calendar year was double that of the FTSE All-Share and almost double that of the MSCI WMA Balanced Private Investor Index. So I don’t think I’ll give up managing my own portfolio just yet.

The other interesting IC article was entitled “Welcome to Value Hell” by Algy Hall. It reported on the performance of a “Value” based screen over the last year and said “the performance over the last 12 months has been extraordinarily bad”. The top 50 picks did worse than the FTSE All-share and the top 5 were a disastrous -69%. Even over the last three years, it returned minus 19.3% total return compared with plus 10.7% from the FTSE.

Looking down the list of shares recommended last year, they are a very mixed bunch but gaming companies did well (Plus500, Flutter, William Hill, IG Group and GVC). The “Zeus” screen used is based on how much the earnings have diverged from historic means, i.e. it is based on the principle that they might “bounce back”.

I think the lesson is that looking at past profits tells you little about the future and that stocks that look cheap at a glance are to be avoided. They often need a re-rating which can be crystalised by specific events. But in the depression of a pandemic, that is unlikely to occur and even in the good times other companies will do better.

One can only conclude that these “cheap” stocks needed to be even cheaper than they were to make reasonable investments. In effect the market was not reflecting the bad news about the stocks and investors were holding them longer than they should in the hope of recovery.

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

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Revenue Recognition in Minds + Machines

Yesterday I talked about preventing fraud in accounts and the revised standard set by the FRC for the auditing of accounts. The standard actually highlights a common problem area in company accounts. Namely the question of revenue recognition. It can be easy to fabricate revenue even if somewhat more difficult to create the cash that normally flows from revenue.

But not always as one can see in the announcement today from Minds + Machines Group (MXX). It says that the board has concluded that cash of £1.125 million that was received in connection with a specific contract and £938,000 of revenue in FY 2019 was incorrectly recognised in the accounts. In reality the cash received was an advance from the customer against future end-user sales and should have been treated as a deposit.

There were also two other contracts where receipts were incorrectly categorised as revenue. Both the CEO and CFO have resigned with immediate effect.

Comment: these are of course pretty basic accounting errors which any director of a public company should be aware of. In addition the auditors (Mazars) failed to pick up the issue. These were substantial contracts in relation to the overall revenue of the company so surely should have been reviewed in detail?

These failings may not have been deliberate fraud but they just demonstrate how it’s so easy for investors to be misled by false accounting. Not a company I have ever held fortunately.

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

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