AssetCo, Patisserie, Stockpiling, Warehouses, Sheds, Brexit and Venezuala

A week ago, an award of damages of £21 million plus interest and costs was made against Grant Thornton for their breach of duty when acting as auditors of AssetCo Plc (ASTO) in 2009/10. See https://www.bailii.org/ew/cases/EWHC/Comm/2019/150.html for the full judgement. I understand Grant Thornton may appeal. These are the key sentences in the judgement: “It is common ground that in those years the senior management team at AssetCo behaved in a way that was fundamentally dishonest. During the audit process management made dishonest statements to GT, provided GT with fabricated and massaged evidence and dishonestly misstated reported profits, and provided GT with flawed and dishonest forecasts and cash flow projections. Outside of the audit process, management were engaged in dishonestly ‘overfunding’ assets (i.e. misleading banks as to the costs of new purchases etc so as to borrow more than was permitted), misappropriating monies, dishonestly under-reporting tax liabilities to HMRC, concluding fraudulent related party transactions and forging and backdating documents. GT accepts that it was negligent in a number of respects as the company’s auditor in failing to detect these matters…”

In 2012, AssetCo (ASTO) was forced to make prior period adjustments for 2010 that wiped more than £235m off its balance sheet. AssetCo was, and still is, an AIM listed company now operating in the fire and emergency services sector.

This is undoubtedly a similar case to Patisserie (CAKE). According to a report by Investors Champion, former Chairman Luke Johnson suggests it “has possible relevance for a claim against Grant Thornton” and he will be pushing the administrators to instigate similar action. Let us hope it does not take as long at ten years and millions of pounds in legal costs which administrators may be reluctant to stand.

According to a report in the FT, manufacturers are stockpiling goods at a record rate in anticipation of supply chain disruption from Brexit. Importers are also stockpiling goods – for example Unilever is storing ice-creams and deodorant such as its Magnum ice-cream bars which are made in Germany and Italy. There is also the increasing demand for warehousing by internet retailers, even for smaller “sheds” to enable them to provide next day or even same day delivery.

Big warehouses are one of the few commercial property sectors that has shown a good return of late and I am already stacked up with two of the leaders in that sector – Segro (SCRO) and Tritax Big Box (BBOX). On the 31st January the Daily Telegraph tipped smaller company Urban Logistics REIT (SHED) for similar reasons and the share price promptly jumped by 7% the next day wiping out the discount to NAV.

There has been much misinformation spread about Nissan’s decision to cancel manufacture of a new car model in the UK. They denied it was anything to do with Brexit. This was to be a diesel-powered model and as they pointed out, sales of diesel vehicles are rapidly declining in the UK. The same problem has also hit JLR (Jaguar-LandRover). One aspect not taken into account in many media stories was that Japan has just concluded a free trade deal with the EU. Japanese car manufacturers no long need to build cars in Europe to avoid punitive tariffs. Where will the new vehicle now be made? Japan of course!

There has been lots of media coverage of the politics of Venezuela and its rampant inflation. A good example of how damaging extreme socialism can be to an economy. Over twenty-five years ago it had a sound economy and I had a business trip scheduled to visit our local distributor there. But at the last minute the trip was cancelled after a number of people were killed in riots over bus fares. I never did make it and I doubt I will ever get there now.

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

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Staffline Issues, Audit Purpose and News on Patisserie

Yesterday Staffline Group (STAF) issued a statement first thing in the morning saying that the publication of results scheduled for that day would be delayed. The shares promptly dropped by about a third. Later in the day it stated that “the company can confirm that this morning concerns were brought to the attention of the board relating to invoicing and payroll practices within the Recruitment Division”. A full investigation was promised and the shares were then suspended. Is this yet another accounting scandal in an AIM company one wonders? Generally after such announcements, only bad news comes out.

Staffline is a recruitment/staffing and training business. It’s one of the largest AIM companies with revenue of nearly a billion pounds and reported profits of £71 million last year. It has been growing rapidly in recent years.

I have never held the stock although I did see a presentation by the company a couple of years ago. In general I don’t like employment businesses as they tend to follow economic cycles and the sector has few barriers to entry. I also considered the company to be at risk from regulatory and tax problems. The company also has considerable debt which is odd for this kind of business which generally have a “capital light” structure. Investors might have been concerned by the announcement on the 8th January that net debt had risen to £63 million at the 2018 year-end.

Investors will have to keep their fingers crossed for further news.

I covered in some previous blog posts the issue that audit quality is generally poor and that false accounts and outright fraud are regularly missed by audits – and it’s not just one or two firms – the whole audit industry seems to be incompetent in that regard. The Commons BEIS Committee held a meeting yesterday and one of the witnesses was David Dunckley, head of Grant Thornton, who audited the accounts of Patisserie (CAKE). He admitted that auditors did not look for fraud when auditing accounts and that there was an “expectation gap”. Committee members were not impressed.

Meanwhile Investor’s Champion revealed that Luke Johnson and Paul May, directors of Patisserie, owned a property that was leased back to a subsidiary of the company. As a related party transaction this should have been disclosed in the Patisserie accounts but was not.

The FT also disclosed that at least 30 shareholders had signed up to support a legal case with law firm Teacher Stern. But other investors are talking to other solicitors. In such cases it can be many months before the basis of a claim is clear and solicitors tend to jostle for the business of pursuing a claim in the meantime – one might call some of them “ambulance chasers”. Investors are advised not to spend money on such actions until the basis of a claim, and the ability to both finance an action and identify asset rich defendants is clear.

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

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FRC Review of Auditing Standards – They’re Looking At The Wrong Things

The Financial Report Council (FRC) have recently published a “Post Implementation Review: 2016 Ethical and Auditing Standards”. It concentrates on the changes made in 2016 to improve the independence of auditors but will that solve the lack of trust in financial accounts and audits thereof? I doubt it.

This is what I said in response to some of their questions (answers in red):

  1. Do the current ethical and auditing standards drive the auditor to deliver work that meets the expectations of users within the current scope of an audit? If there are expectations that are not being addressed, please state those along with your proposals as to how they can be addressed. The expectations of users are still not being met because simply introducing ethical rules to be followed by auditors does not tackle the basic problem that many audits do not identify false or misleading financial accounts.
  2. Are there further steps that the FRC should consider as part of this review to ensure the delivery of high-quality audit? If so, please state what they are and why. The FRC needs to spend effort to identify why fraudulent accounts can still be produced by companies and not be identified as such by auditors. In other words, they need to look at what rules or procedures could be put in place to identify such failings as false balance sheets (e.g. reported cash not being available or undisclosed overdrafts as in Globo and Patisserie), incorrect revenue recognition (Quindell et al), excessive risks being taken and poor internal controls (Conviviality, banks in 2008, etc), and other aspects of companies that cause them to fail.
  3. Do you believe the current restrictions on non-audit services are sufficient to address threats to independence, objectivity, integrity and audit quality, and address stakeholder expectations? If not, please explain why, by providing examples where audit quality has been compromised as a result of non-audit services being provided by the auditor. They do very little to affect the objectivity, integrity and audit quality or to address stakeholder expectations.
  4. Is the work required of an auditor on an entity’s compliance with laws and regulations, and those procedures to identify irregularity, including fraud, sufficient to meet the needs and legitimate expectations of users? If not, what additional work would you require and why? A lot more work would be required to identify fraud and meet the expectations of users of financial statements. What that work might be can only come out of an examination of past audit failings.
  5. Should the FRC take further steps to increase the value of extended auditor reporting to users of financial statements? If you agree, what material would you like to see included in auditor’s reports? It’s not a case of more extended auditor reporting being required – more information will just cloud the picture. We just need to have more confidence in the accounts as reported.
  6. to assess whether management’s use of the going concern basis of accounting as required by IFRS or UK GAAP is appropriate. How could auditors make their assessment of greater value to users of financial statements? Please set out what steps you believe should be required to better underpin confidence in audit and audited financial statements. The “going concern” requirement is clearly inadequate as so many companies pass the current standard and yet go into administration or have to be bailed out before the next year end. There should not be a single “black/white” comment on the financial health of a company, but a range of reported measures. One problem at present is that both auditors and companies are desperate to avoid “qualified” accounts with the undesirable consequence that minor issues (which might point to major problems) are not reported.

There was a very interesting letter in today’s Financial Times on this subject. It was from Rodger Hughes of The Family Building Society. He said that the key driver of audit quality is the ability and attitude of audit partners and managers, but he suggested that increased compliance regulations and more auditor insecurity might have made matters worse. He concludes by saying “What is lacking and urgently needed is an authoritative study of audit failures and the underlying causes”. I wholeheartedly agree with that comment as it seems the FRC has been focussed on other than the key issues.

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

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Patisserie – and How to Avoid Disasters

The events at Patisserie (CAKE) have been well covered in both the national media and financial press so I won’t repeat them here. This article will therefore concentrate on how to avoid such companies in the future. The case of Patisserie is very similar to those of Globo in 2015 and Torex Retail in 2007. All three were large AIM companies that went into administration after fraud was discovered. These were not just cases of over-optimistic or misleading financial accounts, but deliberate false accounting. Executives of Torex Retail received jail terms and Globo is still being investigated. Note that such criminal cases take years to come to a conclusion. Both Globo and Patisserie were audited by the same firm (Grant Thornton). Such cases can happen not just in relatively small AIM companies, but also large ones – for example Polly Peck.

Ordinary shareholders received zero from the administration of Torex Retail and Globo and it is very likely it will be the same from Patisserie. The only glimmer of light is that it does look as though a normal sale process is being followed by the administrators and there is at least one enthusiastic bidder for the remaining stores. There is also the prospect of a tax refund from HMRC because it is clear the fraud has been running for some years so Patisserie has been paying tax on imaginary profits. But the bank overdrafts/loans need paying, loans from Luke Johnson need repaying (which incredibly seem to rank ahead of the banks), trade creditors need paying, staff need paying, HMRC needs paying and the administrators will run up the usual enormous bills no doubt so I doubt there will be much, if anything, left after those distributions. There usually is not.

Legal action against the former directors who were culpable in these events by regulatory authorities is highly likely. For example, it is a crime (market abuse) to publish false accounts under the Financial Services and Markets Act so that would be one basis. Investors who invested in the company on the basis of those false accounts should submit a complaint to the Financial Conduct Authority (FCA) and encourage them to take such action.

Are there possible legal actions by investors to recover their losses? Perhaps and I know at least two people who are talking to solicitors about that. But such legal actions are very expensive and depend on a) Identifying defendants with sufficient assets to meet both the claim and legal costs; b) Having sufficient standing to do so. Unfortunately shareholders would probably have to do it via a “derivative action” which means applying to the court to force the administrator to pursue such a claim. Bearing in mind administrations are often relatively short term, and it will take years to conclude regulatory investigations and actions, there might be a problem there.

Who could be targeted? The auditors possibly although they will probably say they were misled by the company directors (bank accounts not disclosed, etc). Luke Johnson perhaps although he clearly denies previous knowledge of the fraud and pursuing him for breach of his responsibilities as a director might be difficult – however he does have the assets having taken well over £20 million out of the company in share sales over the years. Former finance director Chris Marsh sold shares worth £8.42 million in 2018 while former CEO Paul May sold shares worth £14.34 million in that year it is worth noting. They both appear to have been near the centre of the fraud but culpability clearly will need to be proved. They have yet to comment in public on the matter.

Were the share sales by those two executive directors a sign that all was not well at the company? Perhaps but Luke Johnson was not selling in 2018 and these sales were the result of share option exercises from LTIPs which executives often sell, partly to meet tax demands.

So how to avoid such fraudulent companies from damaging your wealth in future? From experience I can offer the following advice, and you will see why Patisserie side-stepped all the warning signs:

  1. Try to invest in directors who you feel you can trust. Luke Johnson had a very public reputation in the investment world which he was no doubt keen to protect. Indeed his actions to try and bail-out the business when the fraud was discovered shows exactly that, although institutional investors who took up the rescue rights issue will be none too happy. His fellow executive directors were a long-established team and hence should have been trustworthy. Make sure you take opportunities to meet the management.
  2. Do the financial analysis. Read the book “The Signs Were There” which I have covered in a previous article – it tells you where to look. For example, do the profits turn into cash? But if the cash on the balance sheet is a lie, as at both Patisserie and Globo, it does not help. Does the company not pay dividends when it could, or make decisions to raise more debt when it does not apparently need it or provide good justification? That was the what crystalised my views on Globo.
  3. Look at who else is investing or commenting on the company, e.g. Chris Boxall of Fundamental Asset Management, a very experienced small cap investor, or Paul Scott of Stockopedia who recently said “Quindell, Globo and Carillion were easy to spot a mile off – indeed we warned investors of all 3 long before they blew up. Patisserie Valerie however, appeared to be a wonderful, cash generative business”. Because I follow what others are saying and pay attention, I never invested in Torex Retail and I did not lose money on Globo despite holding some shares until the end. But Patisserie fooled pretty well everyone.
  4. Research the product or service offering. Some people say they were wary because when they visited the shops, they were not busy and did not like the cakes. That was not my experience after a number of visits to different locations.
  5. Read the IPO prospectus for AIM companies. It tells you a lot more than you can read in the Annual Reports and is legally required under AIM rules to be available on their web site.
  6. Invest in steps and not at the IPO so you can build confidence in the company. Private investors have the advantage of being able to do that. After all it’s unusual for frauds to run for years without being discovered by someone – rarely by auditors though. I first invested in Patisserie in 2017 and built up a small holding in stages following the share price momentum. But this was only limited protection and it appears the fraud had been going on for many years at Patisserie.
  7. Have a diversified portfolio so one company can go bust and it does not undermine your overall returns. If you invest in large cap companies which may be less risky, perhaps 10 to 20 shares are sufficient diversification. Throwing in a few investment trusts or other funds will help as they are intrinsically diversified. But if you are investing in AIM shares you need a lot more. By having a large portfolio of shares in terms of numbers of holdings the damage to my portfolio from the administration has been a loss of 0.9% of my portfolio value. That’s less than the portfolio varies from day to day on some days. I have spoken to a number of investors who bet their houses or life savings on one share, e.g. Northern Rock or the Royal Bank of Scotland rights issue. One at least went bankrupt. Don’t be so daft.
  8. Monitor news flow on a company and unusual share price movements. But at Patisserie there was really nothing unusual until the date the shares were suspended.

I hope the above comments help investors to avoid the dogs and complete frauds of the investment world. Some of these avoidance techniques help you to avoid not just outright frauds but general financial mismanagement by company directors.

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

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Improving Auditing – It’s Certainly Time

Readers don’t need to be reminded that many of the most damaging events for investors in public companies in recent years have arisen because of the failures of auditors to identify misleading accounts, if not downright fraud in some cases. The Kingman review of the FRC and the views of the Competition and Markets Authority (CMA) suggest that there is a widely recognised problem in the quality of work done by auditors and the regulation of the profession.

I have mentioned previously a report entitled “Reforming the Audit Industry” commissioned by the Labour Party which has advocated the break-up of the big four audit firms that dominate the audits of FTSE-350 firms. The report, co-authored by Prof. Prem Sikka et al (see https://tinyurl.com/yb68pfr5 ) is particularly good on the subject of how auditors have ducked any liability for their failings over the last 50 years – see Chapter 10.

If we want auditors to do a good job, then they need to be made accountable to both the companies who commission them and to investors who rely on the accounts that are published. That includes both audit firms and individual audit partners and managers. But we now have a situation where auditors have ducked both obligations by forming into Limited Liability Partnerships (LLPs), by writing contracts with their clients that exclude liability and by legal judgements such as that in the Caparo case. The aforementioned document spells out how this came about and is well worth reading. It shows how the FCA, FRC, and the Government have avoided their responsibility for ensuring that auditors are properly accountable with the result that one might expect – in essence shoddy work by auditors. One can only conclude that audit firms and accountants have had too much influence over the regulation of the audit profession. Or as the report puts it “the accounting cartel sets the rules”.

As the report says, “current liability laws do not exert sufficient pressure on auditors to be diligent or even exercise reasonable care and skill. In this environment, some audit partners cannot even be bothered to spend enough time on the job, or supervise audit staff”. It mentions that the PwC audit partner spent just two hours on the final audit of BHS and its parent company; while the Audit Senior Manager recorded only seven hours and was not involved in the final stages of the BHS audit. And at Quindell, auditors KPMG failed to obtain reasonable assurance that the financial statements as a whole were free from material misstatement, failed to obtain sufficient appropriate audit evidence and failed to exercise sufficient professional scepticism.

The reforms recommended in the report are:

  • Auditors must owe a ‘duty of care’ to individual stakeholders who have a reasonable justification for placing reliance upon auditors.
  • The incidence of liability must act as a pressure point for improvement of audit quality. Individuals and society must be empowered to seek redress from negligent auditors
  • There must be personal liability for audit failures upon partners responsible for audits.
  • Where a partner of the audit firm acts negligently, fraudulently or has colluded in the perpetration of fraud and material irregularities, civil and criminal liability must fall upon the partner of partners concerned and upon the firm jointly and severally.
  • Class lawsuits must be permitted to empower stakeholders as many stakeholders are not always in a position to seek redress from negligent auditors.
  • In the event of negligent and fraudulent practices, audit fees for the relevant years shall be returned to the audited entity.

These appear to be eminently sensible proposals to this writer.

The report covers the issue of lack of competition in the audit market as was covered by the CMA and their proposals are similar. Also covered are the failings of the FRC – lack of urgency, investigations abandoned and puny sanctions after audit failures. An example of the latter is that the fines imposed as a proportion of a firm’s global audit fees after major failings is a miniscule 0.016% on average. In other words, audit firms have no great incentive to avoid mistakes.

The concluding paragraph in the report says this: “History shows that much of the change in the world of accounting and auditing has been introduced in the teeth-of-opposition from accountancy trade associations and accounting firms. The same approach must be taken in order to make audit work for, and be accountable to, the many, and not the privileged few. Otherwise, there will be more avoidable scandals resulting in loss of pension rights, jobs, businesses, savings, investments and tax revenues, social instability and ultimately loss of faith in the ability of institutions of democracy to connect with the plight of the innocent bystanders”.

I hope everyone in the Government who has responsibility for company regulation reads this report. It is certainly time to make major changes in the audit profession.

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

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IC Share Tips, National Grid, Brexit and the Audit Market

This week’s Investors Chronicle edition (dated 28/12/2018) provides lots of food for thought. One of the most educational is their review of the share tips they published as “tips of the week” in 2018. Unlike some investment publications, who simply forget about their past tips that go nowhere, while lauding their hits, the IC is open about their performance.

They issued 173 “BUY” tips and 24 “SELL” tips in the year. That is quite some achievement by itself as I rarely have more than a very few good new investment ideas in any one year and tend to hold most of my investments from year to year.

How did their tips perform? Overall the “BUYs” returned minus 11.5% which they calculate as being 0.9% better on average than the relevant index. Hardly worth the trouble of investing in them bearing in mind the need to monitor such individual share investments and the transaction costs. The “SELLs” did better at -18.0% versus an index return of -8.8%.

The BUYs were depressed by some real howlers. Such as tipping Conviviality shortly before it went into administration, although they did reverse that tip to a “SELL” before it did so. The result was only a reported 12% loss. As a consequence they are making some “fundamental changes to the way we recommend shares”.

But with so many share tips, the overall performance was not impacted by one or two failures and tended to approximate to the overall market performance. Which tells us that you cannot achieve significant over or under performance in a portfolio by holding hundreds of shares.

I don’t work out my overall portfolio performance for the year until after it ends on the 31st December so I may report on it thereafter. That’s if it’s not too embarrassing. With many small cap technology stocks in my portfolio, I suspect it won’t be good. I always look at my individual gains and losses on shares at the year end, as an educational process. As Chris Dillow said in the IC, “Investing like all our dealings with the real world, should be a learning experience: we must ask what we got wrong, what we got right, and what we can learn. The end of the year is as good a time as any for a round up…”.

One BUY tip they made was National Grid (NG.) in May 2018 on which they lost 11.8%. There is a separate article in this week’s IC edition on that company which makes for interesting reading as a former holder of the stock. I sold most of my holding in 2017 and the remainder in early 2018 – that was probably wise as you can see from the chart below (courtesy of Stockopedia).

National Grid Share Price Chart

National Grid has a partial monopoly on energy distribution and always seemed to be a well-managed business. Many investors purchase the shares for the dividend yield which is currently about 6%. But the IC article pointed out that proposals from OFGEM (their regulator) might limit allowed return on equity to 3%, which surely threatens the dividend in the long term. The share price fell 7% on the day that OFGEM announced their proposals. Bearing in mind the risks of running an electricity network, and the general business risks they face, that proposed return on equity seems to be completely inadequate to me. That’s even if one ignores the threat of nationalisation under a possible Labour Government.

Another IC article in the same edition was entitled “Brexit and the UK Economy”. That was an interesting analysis of the UK economy using various charts and tables. One particularly table worth studying was the balance of trade between the UK and our main trading partners. We have a big negative balance (i.e. import more than we export) to Germany, Spain, Belgium, Holland and Italy but positive balances with Ireland and the Rest of the World – particularly the USA. The article makes clear that our trade with EU countries has been declining – exports down from 55% in 1999 to 44% of all exports. But imports have not fallen as much so the trade gap has been widening. Meanwhile our exports to Latin America and China, which have been good economic growth areas, have remained relatively small.

The conclusions are simple. EU economies such as Germany would be severely hit by any trade disruption on Brexit. But opportunities in rapidly growing markets are currently being missed, perhaps hampered by inability to negotiate our own trade deals with them, and that might improve after Brexit.

Audit Market Review

The Competition and Markets Authority (CMA) have published an “Update Paper” on their review of the audit market. It contains specific recommendations on changes to improve competition and asks for comments. See https://assets.publishing.service.gov.uk/media/5c17cf2ae5274a4664fa777b/Audit_update_paper_S.pdf .

It mentions a long list of audit failings on pages 12 onwards including banks before the financial crisis of 2008, BHS, Carillion, Autonomy (covered in a previous blog post) and Conviviality which was mentioned above.

This paragraph in their executive summary is worth repeating: “Independent audits should ensure that company information can be trusted; they provide a service which is essential to shareholders and also serves the wider public interest. But recent events have brought back to the surface longstanding concerns that audits all too often fall short. And in a market where trust and confidence are crucial, even the perception that information cannot be trusted is a problem.”

One problem they identify is that “companies select and pay their own auditors” which they consider an impediment to high-quality audits. In addition choice is exceedingly limited for large FTSE companies, with the “big four” audit firms dominating that market.

Their proposals to improve matters are 1) More regulatory scrutiny of auditor appointment and management; 2) Breaking down barriers to challenger firms and mandatory joint audits; 3) A split between audit and advisory business within audit firms and 4) Peer reviews of audits.

Their review of FRC enforcement findings suggests that the most frequent findings of misconduct include:

(a) failure to exercise sufficient professional scepticism or to challenge management (most cases);

(b) failure to obtain sufficient appropriate audit evidence (most cases); and

(c) loss of independence (three out of a total of 11 cases).

That surely indicates a major problem with audit quality, and that is backed up by the FRC’s own analysis of audits that they have reviewed with only 73% being rated as “good or requiring limited improvement”.

Auditors are primarily selected via audit committees and there is a noticeable lack of engagement by shareholders in their selection. But that’s surely because large institutional shareholders have little ability to judge the merits of different audit firms.

Would more competition improve audit quality, or simply cause a focus on the lowest price tenders? The report does not provide any specific comment on that issue but clearly they believe more competition might assist. More competition does appear to drive more quality for a given expenditure in most markets however so it is surely sensible to support their recommendations in that regard. The report does emphasise that the selection and oversight of auditors would ensure that competition is focused on quality more than price which is surely the key issue.

A previous proposal was that auditors be appointed by an independent body but that has been dropped, partly due to shareholder opposition. The new proposal is for audit committees to report to a regulator with a representative even sitting as an observer on audit committees where justified. In essence it is proposing much more external scrutiny of audit committee activities in FTSE-350 companies and decisions taken by them.

The end result, at some cost no doubt, would be that both auditors and audit committees will be continually looking over their shoulders at what their regulators might think about their work. That might certainly improve audit quality so for that reason I suggest this proposal should be supported.

The requirement for “joint” audits where two audit firms including one smaller firm had to be engaged seemed to be opposed by many audit committee chairmen and by the big four accounting firms. Some of their objections seem well founded, but the riposte in the report is that evidence from France, where joint audits are compulsory, suggests they have a positive impact on audit quality. Moreover, it would clearly increase competition in the audit market.

In summary, the report does appear to provide some sound recommendations that might improve audit quality. But investors do need to respond to the consultation questions in the report as it would seem likely that the big audit firms will oppose many of them.

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

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Market Trends, Interest Rates, and Yu Group Accounts

Yesterday was another dismal day in the markets. The US fell significantly allegedly caused by the rise in interest rates announced by the Federal Reserve and the UK market followed it down this morning. The US rate rise was widely expected although perhaps slightly lower estimates for US economic growth had an impact. But when the markets are in a bear mood, excuses for selling abound. Meanwhile the Bank of England has announced today that their base rate will remain at 0.75%. The UK market recovered somewhat after it’s early fall, even before that announcement at 12.00 am. Did it leak one wonders, or is it those city high fliers with big bonuses stimulating the market before it closes for Xmas? Or was it the news from GlaxoSmithKline (GSK) that a de-merger was to take place? Many market trends are unexplainable so I won’t say any more on that subject.

The general state of markets was highlighted in a recent press release from the Association of Investment Companies (AIC). They represent investment trusts and reported that the industry’s assets hit an all-time high of £189 billion in September but pulled back subsequently. At the end of November the average investment company returned 1.3% over the prior year they said, but that suggests that when the year ends most will be lucky to show any return at all. Investors who manage to beat zero for 2018 should consider themselves either lucky or wise.

But the good news the AIC reported was that many investment trusts, 37 of them, have reduced fees in 2018. Even better news was that 9 of them abolished performance fees which I believe is a good move for investors. There is no evidence that performance fees improve investment managers’ performance and they just lead to higher fees. Needless to point out that the lack of returns in 2018 might have encouraged the trend to cut performance fees!

Not only that but the average return of 1.3% by investment companies beat that of the average of open funds who showed a loss of 2.6% and the FTSE All-Share with a loss of 6%. Perhaps this is because there are more specialist or stock-picking investment trusts as opposed to the many open-ended index trackers and heavy weighting in a few large cap dominated sectors in the FTSE. That shows the merits of investment trusts (I hold a number but very few open-ended funds).

Coming up to Xmas and the New Year, it’s worth warning investors about share trading in small cap stocks and investment trusts though. Both often have low liquidity and this is exacerbated over the holiday season as active investors take a break. The result is that such stocks can spike or decline on just a few trades. Might be a good time to take a holiday from following the markets even for us enthusiastic trend followers.

Yu Group (YU.) is the latest AIM company to report fictitious financial accounts. Yu Group is a utility supplier to businesses and only listed on AIM in March 2016, reached a share price peak of 1345p in March 2018 and is now 68p at the time of writing, i.e down 95% – ouch!

An announcement by the company yesterday, following a “forensic investigation” of its past accounts, reported more bad news including serious deficiencies in the finance function. They are now forecasting an adjusted loss before tax of between £7.35 million and £7.85 million for the year ending December 2018, but that excludes lots of exceptional costs including possible restatement of prior year accounts. Future cash flow is also called into question. In summary it’s yet another dire tale of incompetent if not downright fraudulent management in AIM companies which it seems likely the auditors did not spot. The FCA and FRC should be investigating events at this company with urgency. The AIM Regulatory and NOMAD system has also again failed to stop a listing or what clearly has turned out to be a real dog of a business.

Let us hope that the mooted changes to financial regulation in the UK bear some fruit to stop these kinds of disasters in future years. Risks of business strategy failures and general management incompetence we accept as investors. Likewise general economic trends, even Brexit risks, and investor emotions driving markets to extremes we accept as risks. But we should not need to accept basic accounting failures.

On that note, let me wish all my readers a Happy Christmas and a prosperous New Year.

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

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