Electronic AGMs and Voting

Several companies in which I hold shares are proposing to adopt new Articles of Association at their Annual General Meetings. These typically are amended to enable the holding of “virtual”, i.e. electronic ones, or “hybrid” meetings where a physical venue (or multiple ones) are also used. They can do that legally at present under the emergency regulations put in place by the Government but they are clearly anticipating a more common use of such capabilities now that everyone is more practised in using video conferencing.

But finding out what the proposed new Articles actually are is often not easy. I simply could not find the one for JPM European Smaller Companies Trust anywhere so I sent them an email. No response to date.

In the case of Telecom Plus, the AGM notice points you to their investor web site for the new articles, but they were difficult to find there and the changes were not clear. This is where they can be found if you scroll down far enough: https://uw.co.uk/investor-relations

You will find the changes very unclear and convoluted. They look like they were written in a hurry. This paragraph is particularly problematic: “59.1 Each Director shall be entitled to attend and speak at any general meeting of the Company. The chairman of the meeting may invite any person to attend and speak at any general meeting of the Company where he considers that this will assist in the deliberations of the meeting.”

This does not give shareholders the absolute right to speak at a General Meeting as is the current position in Company Law so far as I understand it. The Chairman clearly has the right under the proposed new Articles to invite shareholders to speak, or not. That is not the same thing.

So I will be voting against the new Articles.

You might think the wording of a company’s Articles is a very technical matter of little concern. But in reality it can be a quite critical issue when important votes are required or a company is in difficulties.

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

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Learning Technologies and Ten Entertainment AGMs

I “attended” the on-line Annual General Meeting of Learning Technologies Group (LTG) today. This was run using the GoToWebinar software. There did not appear to be many people on the call as only one shareholder asked a question. Perhaps this was because you had to register for the event in advance using your Investor Code – which only those on the register would have, not those in nominee accounts. This is deeply unsatisfactory.

The meeting was initially chaired by Andrew Brode who spoke some platitudes before handing over to the CFO Neil Elton. Brode’s comments were the same as published in an RNS announcement this morning I believe but he did thank shareholders for their support of the recent share placing.

Mr Elton reviewed the financial results from last year and said that the company had achieved compound annual growth of 61% per annum since listing. Net debt at the end of May was £4.5 million, and there was strong operating cash flow. The return on capital employed increased to 16.4% last year. But the final dividend payment had been delayed.

CEO Jonathan Satchell then covered the progress on corporate governance. He mentioned the “measures taken to shore up the balance sheet” which is what I suggested the placing was really for in a previous blog post. He suggested that was because the economic crisis could get much worse later this year.

On governance he said they go further than the AIM regulation requirements. All directors are up for re-election and there is a vote on remuneration. [Comment: these are certainly good points]. He also discussed diversity in the workforce and new initiatives in this area will be announced.

The company has increased the number of products sold per client. They have only 10-11% exposure to Covid affected sectors. They are currently bidding for a “gargantuan” contract for the Royal Navy. They expect a result before the year end.

He then discussed the recent LMS acquisition – they have great hopes for the future of this business which they hope to make a market leader by adding other similar acquisitions.

He discussed the recent share placing. The reason for it was that they did not feel they could use surplus funds for acquisitions as there may be a liquidity crisis later this year.  He expected the core business to return to growth next year.

Questions were then invited but as none had been received at this point, we went to the formal business with votes on a poll. The poll counts were then read out, as all proxy votes has previously been received. All resolutions were passed but I noted that two directors received relatively low votes in favour. That include Andrew Brode with only 90.8% FOR.

Questions were then invited and one shareholder suggested that private shareholders could be included in placings by using such organisations as Primary Bid. Andrew Brode responded that the way it was done was based on advice from their joint brokers. Shareholders could buy shares in the market afterwards at a tiny premium, he suggested.

[Comment: Primary Bid is one solution but it is far from ideal with shareholders being given minimal time to take up any offer and possibly being downsized as well. It is also only fortuitous that the shares could be picked up for near the placing price in the market later. There did not appear to be any real urgency to get the placing done so an open offer alongside should have been done. Regrettably there are too many such placings of late].

This “virtual” AGM worked reasonably well, but you could not see who else was attending and there was no real interaction with shareholders present. Also Andrew Brode’s speech was difficult to hear at times. This was not a good alternative to a physical AGM.

Note: the above report may be inaccurate because it’s even more difficult to make notes of a virtual meeting than it is in a physical one. Sometimes it was not even clear which director was speaking for example.

Another recent AGM of an AIM company was that of bowling alley operator Ten Entertainment (TEG) for which I hold all of 50 shares. I sold almost all my holding before they had to close all their venues. This was another company that did a placing recently but it is hardly surprising in this case that it was required to keep the business afloat until they can get back into operation.

I don’t think this company even offered virtual attendance at their AGM so only the poll results were subsequently announced. They collected over 20% of votes against both the Remuneration Policy and Remuneration Report and two directors including the Chairman also collected substantial votes Against. The company is to review its remuneration policy which I certainly did not like when I looked at it.

Virtual and Hybrid AGMs, and a solution

I have been discussing with other ShareSoc members how virtual and hybrid AGMs should operate – indeed how AGMs should generally function in future as it is quite possible that virtual or hybrid options may become the norm even after the epidemic has passed. For instance companies such as TEG are changing their articles to permit them in the long term even after the temporary authorisation to permit them has lapsed.

But it is clear that there are good and bad practices while attendance at a physical AGM is still clearly advantageous so it would be a shame if that is excluded in future. For example it gives you the opportunity to have informal discussions with directors before and after the meeting as well as with other shareholders which you can never do at virtual AGMs. It also gives some of us the rare opportunity to get out of our home offices – we are all suffering from cabin fever at present!

One somewhat archaic practice that is likely to disappear is the “show of hands” vote. This was always useful and appreciated by shareholders because it firstly allowed AGMs to be concluded rapidly if there was no significant opposition to resolutions, and secondly it allowed you to easily see the overall opinion of shareholders at the meeting. If there was any doubt of shareholders views, a poll can be called by the Chairman, or by shareholders. A poll often means that the vote outcome is not declared until much later – too late to ask about any opposition. If that tactic is used I always ask the question in the meeting of “were there any significant proxy votes against any of the resolutions” as the proxy votes are known well before the meeting.

But with hybrid meetings (those where a physical meeting is combined with a virtual one), I can see a number of practical difficulties with allowing a show of hands vote (and checking who is voting), so I think that will go the way of the dinosaurs.

I suggest also that presentations to shareholders, and discussion thereon, should preferably be separated out into a previous virtual event – sometime after the Annual report is issued and Notice of the AGM has been issued but before the proxy vote deadline. This would enable shareholders (and others as such as non-shareholders and nominee holders) to become informed before they vote. The formal AGM with voting on a poll could then be held later (as a hybrid meeting).

Does this idea make any sense to readers?

But it is clear that it would help to standardise the actual process for virtual meetings and the software that might be used for them – or at least to those that can support the facilities that are needed.

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

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The New Corporate Insolvency and Governance Bill

The Government has introduced the Corporate Insolvency and Governance Bill into Parliament. This is quite an important piece of legislation for share investors and for property investors. Insolvency practitioners will also be interested as it makes substantial changes to that area. It’s had very little media coverage though as the news channels are swamped by coronavirus news, debate over Dominic Cummings breaking the lock-down (or not depending on your point of view) and Brexit news.

The Bill is being “fast tracked” through Parliament as it is considered urgent. Some of the measures in the Bill cover practical problems arising from the epidemic crisis. Some are temporary but others are permanent.

As regards insolvency, the Bill introduces greater flexibility into the insolvency regime. For example, it provides greater powers to ward off creditors and enable directors to escape personal responsibility if they continue trading. It provides a “moratorium” to facilitate a rescue of a business via a company voluntary arrangement (CVA), or a restructuring or fund raising as opposed to it going into administration. The directors can remain in charge of the business while a restructuring plan is put in place, or a scheme of arrangement decided upon. A “monitor” (a licensed insolvency practitioner) has to oversee the process however and give consent to various matters.

It will provide more flexibility for companies in difficulties, while complicating insolvency law, which is complicated enough already. It also includes provisions for companies to ward off winding up petitions during the epidemic crisis which have apparently been used lately by landlords to get rent paid after a “statutory demand” has been issued. In addition while in a moratorium, the company is protected from termination of supply agreements.

In summary this new “moratorium” facility should be a big advantage to companies that are in financial difficulties, and may better protect the interest of shareholders than the existing provisions in insolvency law. Companies in difficulties are too often forced into administration where ordinary shareholders typically receive nothing when a temporary “stay of execution” might enable them to survive and subsequently prosper.

General Meetings

Another aspect of the new Bill are provisions to allow companies to hold General Meetings electronically. Investors will already have seen companies only permitting two shareholders to attend their Annual General Meetings because of the restrictions imposed on public meetings by the Government. The Articles of most companies do not provide for electronic meetings at present.

The new Bill enables any company to use an electronic general meeting, or a hybrid meeting (i.e. some people physically present and some accessing it electronically). Companies can also delay their AGMs. These provisions are only temporary. Companies can also delay their account filings.

The Bill gives companies the right to run meetings as they see fit. For example it says: “The meeting need not be held at any particular place; The meeting may be held, and any votes may be permitted to be cast, by electronic means or any other means; The meeting may be held without any number of those participating in the meeting being together at the same place; A member of the qualifying body does not have a right— (a) to attend the meeting in person, (b) to participate in the meeting other than by voting, or (c) to vote by particular means.”.

This may be acceptable in the short term, during the epidemic crisis, but I have suggested to the ShareSoc directors that the organisation should draw up some recommendations for how “virtual” or “hybrid” meetings should be held in future. The experience to date of such meetings is very unsatisfactory, with answers to questions not being given at the meeting for example. Not having the interactivity of a physical meeting with at least some members present is also a severe disadvantage.

Some bigger companies have already updated their Articles to permit such meetings but a recommended set of Articles should also be published that do not simply give the directors the power to run such meetings as they see fit.

For more details of the Bill’s provisions, see https://services.parliament.uk/bills/2019-21/corporateinsolvencyandgovernance.html.

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

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Unjustified Remuneration at Greggs and Avast

The markets seem to be settling down from the Covid-19 panic even if the impact on company results is far from clear. But it has given me time to read the Remuneration section of a couple of Annual Reports.

Firstly Greggs (GRG). Their Annual Report is a masterpiece of explaining why the company has been so successful of late – to quote from it: “Cheers to a record-breaking year. Since 1939 we have been on a roll….”. But it was clearly written before all their stores were closed.

Their Remuneration Report consists of 28 pages which is way too many. CEO total pay last year was £2.5 million – up by 46%. They did have a very good year but EPS was only up 32%. But the board appears to consider pay is inadequate so this is what the Chairman of the Remuneration Committee (Sandra Turner – why are they often women?) has to say:

Annual Bonus: The current policy allows for a maximum individual policy limit of 125 per cent of salary for the Chief Executive and 90 per cent of salary for other Executive Directors. It is proposed that the individual policy limit will be increased to 150 per cent of salary for the Chief Executive and 125 per cent of salary for the other Executive Directors. PSP: The current policy allows for PSP awards of 115 per cent of salary for the Chief Executive and 95 per cent of salary for other Executive Directors (150 per cent in exceptional circumstances). It is proposed that the new policy will provide for awards of 150 per cent of salary for the Chief Executive and 125 per cent of salary for other Executive Directors (with awards up to 150 per cent possible in exceptional circumstances)……

The Remuneration Committee is aware that the changes outlined above incorporate increases to reward opportunities under both the annual bonus scheme and the PSP, and that there are understandable sensitivities around increasing executive pay levels in the current political, economic and regulatory climate. However, the Committee wishes to ensure that the Executive Directors are appropriately rewarded for their contributions to the next stage of the Company’s growth, and we have been concerned that the pay opportunities under the existing policy no longer reflect what is appropriate or competitive for the leaders of a successful FTSE 250 company. We believe that the revised award levels are required to ensure that the policy is fit-for-purpose for the next policy cycle and will ensure that Executive Directors are appropriately incentivised to deliver and drive the business forward and are rewarded for success. As noted above, for 2020 we are not increasing all elements of pay for the Chief Executive and the Finance Director to the maximum levels permitted under the new policy, but we wish to retain a suitable level of headroom.

It is also important that we have the right structure in place as part of our succession planning processes. Should we need to recruit externally at senior levels during the policy period, we would like to have headroom in relation to the annual bonus and PSP opportunities in order to be sufficiently competitive in the market. Even taking into account the proposed increases, we believe that when compared against the market more broadly, the pay for the Executive Directors remains at below mid-market levels and total remuneration is positioned appropriately, thus demonstrating an ongoing focus on restraint”.

You can see how the pay is being ratcheted up and telling us it is below mid-market levels is no justification. No everyone can be above the average. Greggs undoubtedly employs many low-paid workers. Their figure for “All Colleague Costs” only went up by 11.4% last year. Clearly another example of the better paid getting richer, while the poorer are not equally benefiting from the success of the company.

Am I suggesting the lower paid in the company should be paid more? Not necessarily. But the increases at the top are not justified, however good a job they are doing. I suggest shareholders should vote against the new Remuneration Policy and Performance Share Plan (PSP) resolutions even if they consider last years Remuneration Report is acceptable.

The Remuneration Report of Avast (AVST) is only 16 pages. The total pay of the CEO, Andrej Vicek, in 2019 is given as $6,933,411 but he was only made CEO through part of the year. The vast majority of the total pay comes from the value of an LTIP. The former CEO received even more.

Some 95% of shareholders voted to support the Remuneration Policy in May 2019. The company’s excuse for the high level of pay is this: “Our Directors’ Remuneration Policy has been designed to incorporate the best practice features of the typical UK pay model while setting reward levels, particularly long-term incentive opportunities, at a level that recognises that we source talent in a global market and in particular from the US where pay models are different to the UK”. But this is a UK listed company and many of its operations are not in the USA.

But the CEO has made a token gesture by indefinitely waiving his annual salary and bonus (not including the portion related to his Board fee) for a nominal annual salary of $1. He has also notified the Board of his decision to donate 100% of his Board Directors’ fee ($100,000 per annum) to charity. He will continue to receive an annual LTIP award, calculated as a multiple of his (waived) base salary.

Avast was originally founded as a co-operative in Czechoslovakia but listed in the UK in 2018 after taking over AVG. How times change!

I will be voting against the Remuneration Report at this company and I suggest other shareholders should do the same.

 

 

 

 

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

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Long Serving Directors and Kings Arms Yard VCT

I have commented in the past on my objections to long-serving directors on public company boards. That included comments on the directors of Baronsmead Venture Trust (BVT) only a few weeks ago – see https://tinyurl.com/talr69o , particularly the Chairman Peter Lawrence.

The UK Corporate Governance Code contains specific provisions that indicate that directors who serve for more than 9 years cannot be considered independent. Therefore companies should provide good explanations as to why they wish to ignore this provision. This is not just an issue of “box ticking”. It is about ensuring that directors do not serve for too long and become stale. In the case of investment trusts, including VCTs, this also ensures that the directors do not become too close to the fund manager which long relationships can tend to encourage.

But now we have another VCT that wants to ignore this principle – namely the Kings Arms Yard VCT (KAY) who have their AGM on the 15th June. Robin Field, the Chairman, was appointed in January 2009 – over 11 years ago, and Thomas Chambers was appointed as a director in October 2011. There are only 2 other directors so there is no majority of “independent” directors.

This is what it says in the Annual Report about Mr Field’s position: “The Board does not have a policy of limiting the tenure of any Director as the Board does not consider that a Director’s length of service reduces their ability to act independently of the Manager. As such Robin Field, who has been Chairman of the Company for more than nine years, is still considered to be an independent Director”.

I do not consider this reasonable and therefore I will be voting against the re-election of Mr Field and Mr Chambers and I suggest other shareholders do the same.

You may consider this a trivial matter when the world is suffering from the coronavirus epidemic and the IMF is forecasting that the recession will be the worst global economic contraction since the depression of the 1930s. But good corporate governance is even more essential in bad times.

Attendance at the KAY AGM in person is being strongly discouraged but there is an easy way to submit your proxy votes electronically if you are on the share register. Just go to www.investorcentre.co.uk/eproxy to do so. All you need are the reference numbers from your paper AGM notice. Registrar Computershare therefore makes it very easy to vote unlike other registrars. You don’t need to register or give away your email address.

Note the history of Kings Arms Yard VCT is that it was previously called the Spark VCT and prior to that the Quester VCT. It had a quite appalling record prior to Robin Field taking over although it took him some time to change the fund manager. It has done better since but last year was not great – a total return of only 1.8%. Poor performance in VCTs seems to be becoming more common in reports by VCTs for last year. Baronsmead Venture Trust actually had a negative return last year (to end September).

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

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Avoiding Another NMC Debacle

Yesterday the shares in NMC Health (NMC) were suspended and a formal investigation by the FCA was announced. The suspension announcement said that the company has requested the suspension of its shares and that the company is focused on providing additional clarity to the market as to its financial position.

The events at NMC are hardly the kind of thing one expects from a FTSE-100 company with reported revenue of $2.5 billion and profits of $320 million. The company operates hospitals and other healthcare facilities in the Middle East – hardly a sector that should be particularly volatile. The company has of course been the subject of an attack by Muddy Waters and the share price was already down by 80% from their peak in 2018, before they were suspended.

There now seems to be considerable doubts about the accounts (the finance director is on long-term sick leave which is never a good sign), there are doubts about who holds the shares, and questions about related party transactions and debt. The founder and CEO have departed from the board leaving the COO as interim CEO.

I recall NMC being tipped in numerous publications before all this bad news came out and it certainly looked a good proposition at a glance. Both revenue and profits were rising at 30% per year driven by rising wealth in the Arab states. So why did I avoid it?

The key point I would make is that “financial numbers are not important when picking shares” which is the subtitle of my book “Business Perspective Investing”. The numbers alone cannot be trusted even if they have been audited by a big firm such as Ernst & Young.

The company is registered in London and listed in the UK but the company had a peculiar governance structure with two joint Chairman and an Executive Vice-Chairman. They had a large number of directors otherwise and at the last AGM actually approved a resolution to increase the maximum number to 14. That is way too large for any company and results in board meetings being dysfunctional. The Muddy Waters financial analysis clearly raised some concerns and it is well worth reading. It also raised issues about the level of remuneration of the board and share sales. These might be considered warning signs and there is the key issue that it might be very difficult for UK based investors to monitor the operations of the company.

These are the kind of issues that I suggested investors need to look at in my book.

What do investors do if they find they have been suckered into a company with dubious accounts and when other negative facts have come to light? The simple answer is to study the evidence carefully and if in doubt sell the shares. It is never too late to sell is phrase to remember. You only have to look at the share price graph of NMC to see that investors with a trailing stop-loss of 20% would have exited long ago and hence avoided the worse outcome.

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

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Venture Capital Trusts, the Baronsmead VCT AGM and Political Turmoil

Yesterday (26/2/2020) I attended the Annual General Meeting of the Baronsmead Venture Trust (BVT) held at Saddlers Hall in the City of London. It was reasonably well attended. I will just report on the major issues:

The Net Asset Value Total Return for last year I calculate to be -2.7% which is certainly disappointing. Note that it is annoying that they do not provide this figure in the Annual Report which is a key measure of the performance of any VCT and which I track for all my VCT holdings. I tried to get in a question on this issue but the Chairman (Peter Lawrence) only allowed 15 minutes for questions which is totally inadequate so I will be writing to him on that subject.

The company does give a chart on page 3 of the Annual Report showing the NAV Total Return for the last ten years. There was also a fall in 2018 according to that chart although I am not sure it is correct as my records show a 6.9% Total Return. I will query that as well.

The main reason for the decline in the return was a disappointing result from the listed company holdings – mainly AIM shares. However it was noted that there was an upturn after the year end and it is now up 17.2%. Major AIM company losses last year were in Crawshaw and Paragon Entertainment – both written off completely now – and a bigger loss in Staffline which was one of their major holdings. However they did realise some profits on Ideagen and Bioventix which were still their largest AIM holdings even so at the year end.

There was criticism from two shareholders about the collapse in Staffline with one asking why they did not exit from Staffline and Netcall (another loser) instead of following them down, i.e. they should have invoked a “stop-loss”. The answer from Ken Wotton who manages the listed portfolio was that there were prospects of recovery and they had sold some Staffline in the past so were still making 4 times the original cost. Comment: Losing money on an AIM portfolio in 2019 is not a great result – certainly my similar portfolio was considerably up last year. They seem to be selling the winners while holding onto the losers – not a sound approach. However it would certainly have been difficult to sell their large holding in Staffline after the company reported accounting/legal problems. Selling such a stake in an AIM company when there are no buyers due to uncertainty about the financial impact is simply impossible at any reasonable price.

One shareholder did question the poor returns from AIM companies when they might have made more from private equity deals. The certainly seem to have ended up with a rag-bag of AIM holdings which could do with rationalising in my opinion. The fact that the new VCT rules will impose more investment in early stage companies may affect the portfolio balance over time anyway.

Robin Goodfellow, who is a director of another VCT, asked why they are holding 20% in cash, and paying a management fee on it. Effectively asking why shareholders should be paying a fee on cash when the manager is paid to invest the cash in businesses. The Chairman’s response was basically to say that this is the deal and he did not provide a reasoned response. This is a typical approach of the Chairman to awkward questions at this company and I voted against his reappointment for that and other reasons. The Chairman is adept at providing casual put-downs to serious questions from shareholders as I have seen often in the past.

Another reason to vote against him was the fact that he has been a director of this company and its predecessor before the merger since 1999 (i.e. twenty-one years). Other directors are also very long serving with no obvious move to replace them. This is contrary to the UK Corporate Governance Code unless explained and likewise for the AIC Corporate Governance Code which says “Where a director has served for more than nine years, the board should state its reasons for believing that the individual remains independent in the annual report”. There is no proper justification given in the Baronsmead Annual Report for this arrangement.

I have complained to the Chairman in the past about them ignoring the UK Corporate Governance Code in this regard so that’s another item to put in a letter to him.

All resolutions were passed on a show of hands.

ShareSoc VCT Meeting

In the afternoon I attended a meeting organised by ShareSoc for VCT investors – they have a special interest group on the subject. VCTs have generally provided attractive and reasonably stable returns (after tax) since they were introduced over twenty years ago and I hold a number of them. In the early days there were a number of very poorly performing and mismanaged funds and I was involved in several shareholder actions to reform them by changes of directors and/or changes of fund managers. Since them the situation has generally improved as the management companies became more experienced but there are still a few “dogs” that need action.

Current campaigns promoted by ShareSoc on the Ventus and Edge VCTs were covered with some success, although they are still “works in progress” to some extent. But they did obtain a change to a proposed performance fee at the Albion VCT.

However there are still too many VCTs where the directors are long serving and seem to have a close relationship with the manager. Baronsmead is one example. It is often questionable whether the directors are acting in the interests of shareholders or themselves. There are also problems with having fund managers on the boards of directors, with unwise performance incentive fees and several other issues. I suggested that ShareSoc should develop some guidelines on these matters and others and there are many other minor issues that crop up with VCTs.

There also needs to be an active group of people pursuing the improvements to VCTs. Cliff Weight of ShareSoc is looking for assistance on this matter and would welcome volunteers – see https://www.sharesoc.org/campaigns/vct-investors-group/ for more information on the ShareSoc VCT group.

Political Turmoil Ongoing

Apart from the disruption to markets caused by the Covid-19 virus which is clearly now having a significant impact on supply chains and consumption of alcohol as reported by Diageo, another issue that might create economic chaos is the decision by Prime Minister Boris Johnson to ditch the political declaration which the Government previously agreed as part of the EU Withdrawal Agreement, i.e. that part which was not legally binding.

The Government has today published a 36 page document that outlines its approach to negotiations on a future trade deal and its ongoing relationship with the EU – see https://tinyurl.com/tlhr3pk . It’s worth a read but there are clearly going to be major conflicts with the EU position on many issues and not just over fish! Needless to say perhaps, but the Brexit Party leaders are happy.

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

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Should Companies, their Investors and Bankers Adopt Some New Year Resolutions?

Environmental concerns are all the rage at present. Indeed it’s become a new religion verging on paranoia. Some people believe that the world is going to become impossible to live in after a few more years, or that seas will rise enough to submerge many major cities. They ascribe the cause to global warming caused by rising CO2 emissions from the activities of mankind. Even if we are not all wiped out, the impact on the economy could be devastating due to mass migration and the costs imposed by decarbonising all energy production, food production and transport.

This article is not going to attempt to analyse whether global warming is a major threat, or what its causes might be, but simply what the reaction of companies, their investors and their bankers should be. Should company directors adopt a New Year’s resolution to divest themselves of all activities that might result in CO2 generation? Should investors who hold shares in such companies sell them and invest in something else, and should bankers stop lending money for projects such as creating new oil production facilities.

Even outgoing Bank of England Governor Mark Carney gave some dire warnings in a BBC interview a couple of days ago.  He suggested that the world will face irreversible heating unless firms shift their priorities soon and that although the financial sector had begun to curb investment in fossil fuels the pace was far too slow.

What do oil companies or coal miners do if faced with such rhetoric?  There is clearly a demand for their products and if one company closes down its activities then other companies will simply move in to take advantage of the gap. There will be a large profit incentive to meet the demand as prices will likely rise if some producers exit the market.

Companies also have the problem that they cannot close down existing facilities, or move into new markets such as wind or tidal energy in the short term without incurring major costs.

Famous investor Warren Buffett does not think they should do much at all. He has suggested that even if Berkshire’s management did know what was right for the world, it would be wrong to invest on that basis because they were just the agents for the company’s shareholders. He said “this is the shareholders money” (see FT article on 30/12/2019).

So long as the law of the land says it is OK to exploit natural resources even if they generate CO2, and the shareholders support a company’s activities then company directors should not be holding back he suggests.

But I suggest shareholders have other things to consider whether they believe in global warming or not. Investors clearly face a risk that even if they are happy to invest in coal mines, the Government might legislate directly or indirectly to put them out of business. As a result of Government policies in the UK, the amount of coal produced and consumed in the country, particularly for power generation has been going down. It’s now only about 5% of electricity generation, largely replaced by natural gas usage (with lower CO2 emissions) and renewables such as wind-power and hydroelectricity. Forget trying to get planning permission for any new coal-fired power stations even if very cheap coal can be imported.

As an investor, clearly divestment from coal mining and coal consumption is a worldwide trend in most countries with a few exceptions such as China. So any wise investor might simply look a few years ahead and take into account this trend. Investing in declining industries is always a bad thing to do. However well managed they are, companies operating in such sectors ultimately decline in profitability as revenue falls and competitors do not exit as the management has only expertise in that sector and won’t quit.

Investment is also not about what you believe but about other people believe because other people set the share prices of companies, not you. You might think that global warming is simply not true, but if the majority of investors believe it then they will sell the shares in companies that are involved in CO2 generation and drive down the share price. This is surely already happening to some extent with major oil companies. Shell and BP are on low p/e ratios no doubt because they are seen as having little future growth potential. You can of course become a contrarian investor if they become cheap enough but that is a risky approach because clearly these companies are facing strategic challenges.

Investment managers are divesting themselves of holdings in oil companies so as to please their investors. Both the managers and the investors have been subject to propaganda that has told them for the last few years that oil is bad and consumption needs to be reduced. They are unlikely to take a contrary stance. Once a religion becomes widespread, you have to follow the believers or be branded a heretic, whether the religion has any basis in reality or not.

There are not trivial sums involved. The Daily Telegraph suggests that UK shareholders are some of the most vulnerable in the world with about £95 billion invested in fossil fuel producers. If you consider that CO2 needs to be reduced, and choose your investments accordingly, then you need to exclude not just coal, oil and gas producers but a very large segment of the economy. All miners and metal producers are big energy consumers mainly from fossil fuels, and engineering companies likewise. And then one has to consider the transport sector and the producers of trains, planes and automobiles. Even producers of electric vehicles actually use large amounts of energy to build them although much of that is consumed in other countries such as China. Food production and distribution also consume large amounts of energy, and building does also. For example cement production uses enormous amounts of fossil fuel and actually generates about 8% of global CO2 production for which there is no viable alternative.

There are actually very few things in the modern world that don’t consume energy to produce them. That production can be made more efficient but decarbonising the economy altogether is simply not viable.

For investors, it’s a minefield if they wish to be holier than thou and claim moral superiority. There may be some simple choices to be made – for example why support tobacco companies where their products clearly kill people? But as an ex-smoker, I am more concerned about future Government regulation that will kill off or substantially reduce their business which is why I am not invested in tobacco companies.

Company directors, investors and bankers do not need to make moral choices. New year resolutions are not required. They just need to look to the future and the evolving regulatory environment and the court of public opinion.

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

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Brydon Audit Review and FRC Update

Readers probably don’t need to be reminded of the poor reputation of auditors and accountants. The announcement yesterday from Staffline Group (STAF) reiterates the point. They note the latest analysis indicates that 2018 profits were overstated by about £4 million. The CFO, Mike Watts, has left with immediate effect.

Sir Donald Brydon has published his review of the audit market and makes recommendations for significant changes. This is what he says in a preface:

“The quality and effectiveness of audit has become an increasingly contested issue, with the result that this Review has been commissioned. Some consider that audit is good enough but the starting place of this Report is that it is not.

At a time when information is everywhere and there is no obligation on users of the internet to be truthful, it matters even more that shareholders, and others, can trust what directors are communicating. Auditors have a unique advantage in having the right to see everything that goes on in a company and to assess whether that trust is deserved”.

The recommendations encompass:

  • A redefinition of audit and its purpose;
  • The creation of a corporate auditing profession governed by principles;
  • The introduction of suspicion into the qualities of auditing;
  • The extension of the concept of auditing to areas beyond financial statements;
  • Mechanisms to encourage greater engagement of shareholders with audit and auditors;
  • A change to the language of the opinion given by auditors;
  • The introduction of a corporate Audit and Assurance Policy, a Resilience Statement and a Public Interest Statement;
  • Suggestions to inform the work of BEIS on internal controls and improve clarity on capital maintenance;
  • Greater clarity around the role of the audit committee;
  • A package of measures around fraud detection and prevention;
  • Improved auditor communication and transparency;
  • Obligations to acknowledge external signals of concern;
  • Extension of audit to new areas including Alternative Performance Measures; and
  • The increased use of technology.

Comment:

Many of the proposals may improve the information available to investors and help prevent fraud or false accounts. But they will add a substantial burden on auditors, and hence costs on companies. I can see some opposition from the latter when the details are consulted upon.

Some of the proposals will increase engagement with shareholders and the role of the Annual General Meeting so are to be welcomed.

The proposals are likely to be taken forward by the new ARGA body which will replace the Financial Reporting Council (FRC) and which was included in the Queen’s Speech today.

You can read the Brydon Report here: https://tinyurl.com/t7va5fl – 120 pages of Christmas reading to fill the days when there is no news and little to do.

The FRC have also published a revised version of their “Ethical Standard” so as to strengthen auditor independence and ban conflicts of interest. See  https://tinyurl.com/soc8hq3 – that’s another 102 pages for Christmas reading although this may be more of interest to auditors than investors.

To conclude, Donald Brydon included this poem in his report just to amuse you, and to show that the concerns about audits are not new (it dates from the 1930s):

The Accountant’s Report

We have audited the balance sheet and here is our report:

The cash is overstated, the cashier being short;

The customers’ receivables are very much past due,

If there are any good ones there are very, very few;

The inventories are out of date and practically junk,

And the method of their pricing is very largely bunk;

According to our figures the enterprise is wrecked….

But subject to these comments, the balance sheet’s correct.

 

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

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Why Shareholders Have Little Influence

There was an article in The Times newspaper this morning by Mark Atherton which covers the subject of shareholder voting and the nominee system. I am quoted as saying “The nominee system needs a total rewrite to reflect modern reality and restore shareholder democracy”.

As is pointed out in the article, only 6% of private shareholders vote the shares they own. This is mainly because of the obstruction of the nominee system. The US system is not perfect but they get 31% of shares voted. Everyone agrees that ensuring shareholders in public companies return votes for General Meetings is important. This ensures good corporate governance and “shareholder engagement”. But very few people, and hardly any institutional investors, actually attend such meetings in person. So most votes are submitted via proxies.

Fifty years ago most shares were held in the form of paper share certificates which meant two things: 1) All shareholders were on the register of the company with a name and address recorded and 2) All shareholders would be issued with a copy of the Annual Report and a paper proxy voting form. This ensured a high turnout of votes.

Due to the growth of on-line trading via “platforms” and the “dematerialisation” of shares in Crest, most shares held by “direct investors” (see below for indirect holdings) are now held in electronic form. For retail investors this means a very high proportion are held in pooled nominee accounts. This has resulted in very low numbers of investors actually voting the shares that they “nominally” own. The problem is that the nominee system obstructs both the information flow to investors and their ability to vote easily and quickly.

For institutional investors the turn-out is higher – typically above 60% but such investors often have a low interest in the outcome so tend to vote in support of all the resolutions. Institutions suffer from the “agency problem”, i.e. they are commonly not owners in their own right and thus may have other motives. For example, they may not have the same interest in controlling the pay of directors in companies which has got out of hand of late for that reason. They are keen to retain access to management which can be made difficult if they oppose management proposals or pay.

The nominee system as operated in the UK also undermines the rights of shareholders, creates major problems when stockbrokers go bust (as they regularly do) simply because of the legal uncertainty of who owns the shares. The “pooled” nominee system is particularly dangerous because it means that it is impossible to know who owns which shares in a company.

The nominee system also undermines shareholder democracy (i.e. the influence of shareholders on companies). When every direct investor was on the share register of a company, under the Companies Act one has the right to obtain the register so as to write to all shareholders to raise your concerns or invite support or resolutions (e.g. if a requisition to remove or add directors has been submitted). This is now almost impossible to do as the register simply contains mainly a list of nominee names and the nominee operator will not pass on communications to their clients. The other problem associated with the current system is that it makes it very difficult for even the companies themselves to communicate with their own shareholders.

The high cost of postage also now frustrates communication with shareholders except for very wealthy organisations or individuals. The Companies Act has really not been updated to reflect the modern digital world and the reality of how markets operate and how shares are now held and traded via electronic platforms. It needs a total rewrite to reflect modern reality and restore shareholder democracy.

Many investors and savers now hold shares indirectly via their interest in pension funds, insurance funds or mutual funds of various kinds (OEICS etc).

At the end of 2014, and based on “beneficial” ownership, the Office of National Statistics indicated that individuals held 11.9% by value of shares listed on the LSE. That compares with 16.0% held by pension funds, insurance companies and other financial institutions. But 53.8% of shares were held by foreign investors, which presumably would also be mainly held by institutions. Direct ownership had been falling for many years but seems to have increased somewhat lately perhaps due to more interest in “self-select” ISAs.

Institutions do suffer from the “agency” problem mentioned above and the underlying investors have little influence over the actions of the investment managers. Indeed one problem with funds is that investors often know little about what the fund is invested in – see the recent problems at the Woodford Equity Income Fund for example which most holders of the fund simply did not know about until it was too late. Pension funds are even less “transparent”. This results in perverse outcomes. For example a trade union pension fund might have no influence on the affairs of companies in which the fund is invested even though that might be of very direct interest to the union members.

Mark Atherton suggests investors in funds should have the right to influence how fund managers vote the shares in the fund. But how to enable underlying investors in funds to influence how the fund manager votes their shares, or otherwise influences a company, is an exceedingly complex and difficult problem. Funds can own interests in hundreds of companies and have hundreds of thousands of underlying investors. The latter are never likely to understand or take a close interest in the affairs of individual companies held by a fund. One reason they are investing in funds is so they can ignore the details and rely on the fund manager to look after corporate governance issues.

Even direct investors often don’t bother to vote because they don’t wish to spend time considering the issues or filling out the forms. Making it easier to do the latter by providing on-line voting systems would help but would only be a partial solution. Some collective representation of private investors (such as by organisations such as ShareSoc) might be one answer. Investors would simply give ShareSoc a standing mandate to represent them. But that is currently impossible because of the nominee system as the investors cannot appoint proxies themselves – only the nominee operator can do so.

Clearly it would help to encourage direct investment rather than reliance on funds. This would reduce investors costs (intermediation costs take a very high proportion of investment returns in public companies). Note that the risk of amateur investors underperforming the professionals should be discounted. Professional fund managers mostly perform no better than a monkey with a pin and many funds are now “tracker” funds that simply follow an index. Tracker funds are particularly problematic regarding shareholder democracy as they have no interest in influencing management whatsoever. Their share trading is solely influenced by the market, not by their views on the merits of the company or its management.

The UK, although we have one of the largest stock markets in the world, has very poor legal and operational systems for recording and representing shareholder interests. This probably has arisen from our tendency to stick with Victorian traditions when we were the leader in such matters. The Companies Act, which was last revised in 2006, still primarily assumes paper processes with rather half-baked additions to support digital systems. Stockbrokers have avoided regulation and as a result have implemented electronic nominee systems that protect their own interests rather than that of their clients in ensuring shareholder rights and democracy.

Major reform is needed!

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

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