Category: Accounting

Yet Another Major Accounting Error – WH Smith

This week WH Smith (SMWH) was yet another major public company who had to announce that it could not publish accurate accounts. To quote from their announcement on Thursday: “a current financial review has identified an overstatement of around £30m of expected Headline trading profit in North America. This overstatement is largely due to the accelerated recognition of supplier income in the North America division. WHSmith now expects Headline trading profit from the North America division for the financial year ending 31 August 2025 to be approximately £25m, down from previous market expectations of approximately £55m”.

The share price promptly collapsed by over 35%.

I am not a holder of the shares but those who do are probably feeling angry. Broker Peel Hunt cut their rating on the shares to “hold” but why would anyone want to hold shares in a company where you cannot trust the accounts, or trust the management who cannot publish accurate accounts? Certainly not me.

As I said in my book “Business Perspective Investing”, financial numbers are not important when picking shares for investment because all public company accounts cannot be trusted. But trust in the competence of management is certainly one aspect to consider when buying shares.

It will no doubt take a long time to rebuild confidence in WH Smith.

P.S. The most amusing thing about this event was that Investors Chronicle published a very positive article on the company in their 22-28 August edition headlined “This streamlined retailer is going global”. Presumably they went to press just before the bad news broke.

How does one protect against such events? Don’t plunge into buying a new holding all in one go. Stagger your investment until you have established confidence in the company and its management.

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

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Mike Lynch Acquitted

Dr Mike Lynch has been acquitted of fraud in a California Court over the alleged misleading accounts of Autonomy. This has been a long running legal case after the acquisition of Autonomy by HP who alleged Mr Lynch and his co-defendants illegally inflating revenues by backdating some of Autonomy’s contracts, using “round trip” deals to compensate customers for making purchases, and hiding the fact that some of its high-margin software revenue was really coming from unprofitable hardware sales (software revenue is typically valued higher than hardware revenue).

I have made negative comments on Autonomy’s accounts in the past but it would not be appropriate to discuss why the jury reached the latest verdict. Without studying all the evidence presented in court it is very easy to jump to the wrong conclusions based on media reports.

But after 13 years that this saga has been running, it will certainly be the case that directors of software companies operating in the USA will be a lot more careful about their revenue recognition practices which is surely a good thing.

For more information on the background to this legal case see:  https://www.ft.com/content/62b6af38-ff48-43a9-9403-2a18a1ddca3d?

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

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Beware of Greeks Bearing Gifts

“Beware of Greeks bearing gifts” is a saying from Virgil’s Aeneid based on the story of the ruse used by the Athenians to gain access to Troy. It is a saying used ever since to beware of the sharp practices of Greeks or anyone appearing to offer something that is too good to be true. Globo was a company registered in the UK but with Greek management (both the CEO and CFO were Greek nationals). It was listed on AIM in the UK. Globo looked highly profitable but collapsed in 2015 as the cash on the alleged balance sheet was simply not there and revenue was clearly imaginary.

In my last blog post on the subject of Globo (see https://roliscon.blog/2024/02/17/globo-a-final-report/ ) I said “Do not trust the accounts of companies particularly those with Greek associations”. This comment has been attacked by a certain person, who shall remain nameless as I do not wish to promote his intemperate views. He has said “should we tar all Greeks with the same brush?” Despite the fact that he points out other Greek company frauds (InternetQ/Akazoo and Foli Follie) he thinks I have made a slur on an entire nation. But he admits to being a Hellenophile and having a house in Greece.

Let me be more specific as to why you should avoid Greek companies and their management.

Globo and its management should clearly have been pursued by legal criminal actions for fraud in the UK targeting the CEO and CFO but that was impractical because in extradition proceedings, in general Greece does not extradite a person who was a Greek citizen when the offence was committed or is a Greek citizen when the request is made. Neither does Greece accept enforcement of a European Arrest Warrant with some exceptions. See  https://globalinvestigationsreview.com/insight/know-how/extradition/report/greece#:~:text=In%20extradition%20proceedings%2C%20in%20general,when%20the%20request%20is%20made  

So in summary there was little deterrent to stop a Greek national from defrauding investors so long as they stayed in Greece and that is what happened.

In addition Greece is well known to be a country where accounting practices are dubious. To quote: “Creative accounting and profit management practices are well documented in the bibliography (Spathis, 2002; Spathis et al., 2002; Leuz et al., 2003; Baralexis, 2004; Caramanis and Spathis, 2006; Burgstahler et al., 2006). In fact, Leuz et al. (2003) rank Greece (along with Austria), as the country (out of a total of 31) with the highest rank in profit management” – see https://thescipub.com/pdf/ajassp.2019.327.335.pdf

I am sure most investors in the shares of Globo were not aware of these facts and the same problem applies to other Greek companies who might list in the UK. So I think my previous comments were very justified.

But the person who criticised them has been making snide comments about my views on Globo ever since he had to withdraw many of his allegations against me after I pursued a legal claim for libel against him some years ago. This was eventually settled by agreement of both parties but like any bad loser he keeps on raising the subject again and again.

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

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Patisserie Valerie and Shell Legal Cases

Shareholders in café company Patisserie Valerie were wiped out in 2018 after the accounts were shown to be fictitious and the company collapsed. It has now been announced that a trial date of four people alleged to be involved in the fraud has been set for March 2026. See https://www.lawgazette.co.uk/news/2026-trial-date-for-patisserie-valerie-criminal-case/5117808.article

Is it not astonishing that it has taken so long to bring the case to court? Compare that with the recent case of FTX/Alameda Research in the USA where Sam Bankman-Fried was prosecuted and found guilty in just a few months. This demonstrates what is wrong with the English legal system for dealing with fraud cases. Justice delayed for years is no justice and is no deterrent to criminal action.  

Another recently reported legal case is that oil company Shell is suing Greenpeace for £1.7 million after “activists” boarded an oil platform that was in transit off the Canary Islands. Shell incurred substantial costs as a result.

Comment: as a Shell shareholder I fully support the company actions. I think more such lawsuits should be pursued against organisations such as Greenpeace and Just Stop Oil who clearly have substantial resources which are financed by the ill-informed and take part in criminal activities in pursuit of their goals.

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

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Four Charged with Fraud over Patisserie Valerie Case

Four people have been charged over the fraud at café company Patisserie Valerie. Ordinary shareholders in the company were wiped out in 2018 after the accounts were shown to be fictitious.

More details here:  https://www.sfo.gov.uk/2023/09/13/sfo-charges-four-individuals-behind-patisserie-valerie-collapse/

A shame it has taken so long to actually bring charges which is not unusual in fraud cases.

Auditors Grant Thornton were also fined over their involvement in the case. Grant Thornton was fined £2.3m because it had “missed red flags” and failed to question information provided by management. A trivial fine in relation to the losses suffered by investors.

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

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Dividend Exasperation

Since share registrars have been discouraging dividend payments via cheques, and some companies have insisted on bank transfer payments, it has become increasing difficult to keep track of dividends.

In the good old days you knew the dividend had been paid and who it was from when a cheque in the company’s name was received. Now some payments arrive into our joint bank account and some arrive via cheque still. Some also go into our accounts with ISA and SIPP providers where the shares are held in nominee accounts.

The direct bank payments do not indicate whether they are for me or my wife so I have to figure it out from my Sharescope system and the worst culprit is City Partnership who send dividend payments for some VCT holdings without referencing the company name in the bank transfer.

Other companies send dividend cheques where the company issuing the cheque is not clear.

These changes mean I have significant extra work to figure out the dividends received and to check none have gone missing. It’s becoming quite exasperating having to waste time on this. Basically the system is a mess and not fit for purpose.

Paying in cheques has also got more difficult as so many bank branches have closed. And paying in a cheque via scanning it with a mobile phone app only works for smaller amounts.  In addition, one recent such transaction for one our trust accounts was rejected for no good reason.

The assumption seems to be that recipients don’t bother to check dividend payments received (which I certainly do) and that they are always paid correctly (which is not the case).

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

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Future Disclosure Framework, Revolution Beauty Case and Performance of Slater Growth Fund

Having concluded that the existing KIDs are not fit for purpose, with which I totally agree, the FCA are consulting on the “Future Disclosure Framework” for investments, i.e. what investors should be told before they splash their money out. You might think this would be a relatively simply matter to define but it is not – or at least the FCA wishes to make it complex as usual.

You can read their consultation document which they recently published here: https://www.fca.org.uk/publication/discussion/dp22-6.pdf

I have submitted a response which you can also read here: https://www.roliscon.com/Future-Disclosure-Consultation-Response.pdf

One particular point to note is that they fall into the common trap of suggesting the riskiness of an investment can be simply measured by the volatility of the share price. This is nonsense. Warren Buffett has said that stocks are more volatile than cash or bonds, but they’re safer to own in the long run, and he is quite right. The riskiness of an investment is a function of many other factors than price volatility. Major risks are the trustworthiness of the investment manager – the case of Revolution Beauty is discussed below as an example of what investors would have liked to know before they purchased the shares.

Revolution Beauty

The shares in Revolution Beauty (REVB) were suspended in September 2022 after the auditors raised concerns. On Friday (13/1/2023) all the bad news was revealed.

One of the issues is that larger than normal sales were booked to three distributors in the last month of the financial year. Payment for these orders was delayed. Two of the distributors returned some of the stock at a later date. This is a classic example of “channel stuffing” to improve a company’s financial reports. This is a very well known method of improving a company’s financial figures and is a fraud on investors. It’s a clear example of orders being booked in the expectation that they would never be delivered but reversed out in the next financial period.

There were also personal loans from two of the directors to the distributors or their affiliates and also loans made to some of the non-exec directors and senior managers which were not disclosed to the board.

We wait to see what action is taken against the directors who orchestrated this conspiracy but I suspect it won’t be as severe as I would like to see.

Slater Growth Fund

I have been monitoring the performance reports of other investors last year to see who did worse than me. Another recent example reported is that of the Slater Growth Fund run by Mark Slater. He is usually a sound manager – performance of +23% in the last five years well ahead of the relevant index and that includes a negative 25.5% last year. Last year was definitely not a good year for “growth” funds and my portfolio was certainly focussed on growth companies at the start of 2022. Similar problems were faced by the Fundsmith Equity Fund and the CFP SDL Buffettology Fund.

But as an individual investor I could quickly exit some of my holdings when I saw the way the wind was blowing while fund managers would have had more difficulty in moving rapidly as a few large sales would have depressed the share prices of companies they were selling. The other issue is that open-ended fund managers may have to sell holdings to meet redemption requests when investors want to withdraw their money which many did as gloom spread through markets. This is why I prefer closed-end investment trusts to open-ended funds – the former managers can make their own decisions about whether it is a good time to sell or hold on.

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

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Earnings Per Share and Is It Well Defined?

Most investors rely on Earnings Per Share (EPS) as a measure of the performance of a company. In theory it’s a simple calculation based on post-tax earnings divided by the number of ordinary shares in issue as defined by the IAS 33 accounting standard (see link below).

But the number of shares can be affected by the future exercise of options, convertibles and warrants so in addition to the “basic” figure a “diluted EPS” figure is also required to be published. The EPS figure is also calculated not on the simple number at the end of a period but on the average over the time period to reflect the fact that earnings accrue over the period. This can create complications when there has been restructuring of a company involving share issuance or consolidation.

Another point to note is that only profits or losses from “continuing operations” are included in the basic EPS figure so as to reflect the fact that only those operations will be generating profits in future.

The Financial Reporting Council (FRC) has recently undertaken a thematic review of EPS to identify any possible issues in how EPS is calculated and reported – see link below.

They have identified some problems in practice and say “Certain requirements of IAS 33 appear to have been overlooked or not well understood by companies” and they are concerned that as judgements are sometimes used on share reorganisations the lack of disclosure on how EPS has been calculated is of concern.

EPS can also be used as a performance measure in bonus or LTIP calculations but it seems that sometimes EPS is calculated in a different way for that purpose. The FRC suggests any difference needs to be explained.

They also discuss the problem of “adjusted” EPS which are commonly reported. The FRC expects these to be reported in accordance with the ESMA Guidelines on Alternative Performance Measures – see link below. But what adjustments are included and how tax is taken into account can often be unclear. What is a reasonable adjustment is also often a subject of management opinion and this is surely an area where tougher standards could be introduced.

Companies where adjusted earnings are wildly different to basic figures should be viewed with suspicion in my opinion and a close examination of the adjustments is worthwhile in those cases (usually given in the Notes to the accounts).

The FRC Review is worth reading to get some understanding of the issues but a detailed study may be of more interest to accountants and auditors.

In summary, EPS can be a useful measure but it is only one measure of the performance of a company. It should not be relied on alone to judge the quality of a business and it is necessary to have some understanding of how it has been calculated.

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

IAS 33 Standard: https://www.ifrs.org/issued-standards/list-of-standards/ias-33-earnings-per-share/

FRC Thematic Review: https://www.frc.org.uk/news/september-2022/frc-publishes-review-of-earnings-per-share

ESMA Guidelines: https://www.esma.europa.eu/sites/default/files/library/2015/11/2015-esma-1057_final_report_on_guidelines_on_alternative_performance_measures.pdf

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Another Fine for Grant Thornton over Audits at Sports Direct

Back to more serious issues after my last blog post on selecting a Prime Minister. The FRC have issued penalties against Grant Thornton for their audit work at Sports Direct in 2015-16 and 2017-18. One concern was about the failure to recognise that contracts with a delivery company were probably “related party” transactions.

To quote from the FRC announcement: “The audit failings in this case were serious and relate to fundamental auditing standards. It is particularly important that auditors follow up with due rigour where they have identified potential related party transactions as a significant audit risk. Auditors must adopt a mindset of professional scepticism, and exercise good judgment based on sufficient and properly documented evidence. The package of financial and non-financial sanctions imposed by the FRC on the auditors in this case will help to drive improvements at the firm and the wider industry.”

See https://www.frc.org.uk/news/july-2022/sanctions-against-grant-thornton-uk-llp-and-philip  for more information.

This is of course not the first time Grant Thornton has been involved in defective audits – see the cases of Patisserie Valerie and Globo for example.

Grant Thornton may be more careful in future but as I keep on saying, even audited accounts cannot be trusted at present. I don’t think that will change until the penalties for failed audits are made larger and the penalties for errant directors who publish misleading accounts made a lot more severe.

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

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Restoring Trust in Audit – A Long Way to Go Yet

The Financial Reporting Council (FRC) have recently published a “Position Paper” entitled Restoring Trust in Audit and Corporate Governance. It sets out how the FRC will be supporting the Government’s reforms under the new ARGA regime.

This is not a very exciting document as it’s very short on specifics. For example under Corporate Governance and Stewardship is says “including a provision for boards to consider how audit tendering undertaken by the company takes account of the need to expand market diversity…”. What exactly does that mean?

However it does say that the Government intends to put Actuarial Regulation on a statutory footing which is long overdue and the intention is to put ARGA on a new funding basis with market participants paying a levy to meet its regulatory function costs. So perhaps auditors should read this Position Paper carefully.

The Position Paper can be obtained from here: https://www.frc.org.uk/news/july-2022/frc-sets-out-next-steps-in-transition-to-new-regul

There might have been more information provided in a webinar on the 14th August but I missed it for two reasons: 1) they sent the login information but it ended up in a spam folder on my BT server; and 2) They sent it as a Teams invite but even though I chose the web browser option it blocked me with an incomprehensible error message. Is it just me that has endless problems with Teams? I wish people would use other products such as Zoom for webinars which I never have problems with.

Incidentally the latest example of the failures of the audit profession was an announcement by the FRC of sanctions against UHY Hacker Young LLP and their audit partner in relation to Laura Ashley Holdings.

To quote: “LAH’s shares were listed on the main market of the London Stock Exchange. As at 30 June 2019, the Group had 155 UK stores, employing over 2,700 people. The Group’s revenue, operating profit, profit before tax and profit after tax consistently declined between FY2016 and FY2019, and the Group’s loss after tax increased ten-fold from £1.4m in FY2018 to £14m in FY2019. Against this backdrop, the audit reports for FY2018 and FY2019 were unmodified and noted no material uncertainty related to the use of the going concern assumption”. Laura Ashley went into administration in April 2020.

The fine imposed by the FRC was only £217,500, a trivial amount!

See https://www.frc.org.uk/news/july-2022/sanctions-against-uhy-hacker-young-llp-and-martin for details.

There is certainly a long way to go to restore trust in the audit profession after a whole series of failures in the last few years.

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

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