Stock Market Rally and Improving Market Regulation

The free trade deal with the EU has finally been settled. It just needs passing in the UK Parliament and ratification by the EU which is expected to occur without difficulty. Boris Johnson has good reason to celebrate because he has achieved almost all his objectives and got a deal that many thought would be impossible. From the 1st January, when the EU exit “transition period” ends, we will no longer be subject to EU laws.

This is a very satisfactory outcome so far as I am concerned as we will escape the horrible bureaucracy of the EU and once again be a truly independent nation. EU laws will not automatically be translated into UK law. We will maintain alignment on some matters such as labour rights, but we will have the ability to diverge to some extent. And there is an agreement on a new framework for the joint management of fish stocks which was being argued about until the last minute apparently.

For the UK, it gives us potential opportunities such as trade deals with other countries that we could not do as part of the EU. This is truly a historic moment in history and should reinvigorate UK politics. 

All we need now is to get the Covid-19 pandemic under control. To quote Judy Garland from the film “Meet Me in St. Louis” which I watched yet again over Xmas: “Have yourself a merry little Christmas, next year all our troubles will be out of sight…”. Let us hope so.

The AstraZeneca vaccine has been approved by the UK regulator so a massive expansion of vaccinations is now expected to commence. It is hoped this will control the epidemic by the spring. The stock market continues to rise based on the positive Brexit free trade deal, the vaccine news and a massive stimulus to the US economy by the Government sending cheques to everyone. My portfolio is now ahead of where it was at the start of the year which is somewhat surprising after such a turbulent year – more analysis may follow when I have done my full end of year analysis which takes me some time. Some shares were so buoyant of late, particularly investment trusts where discounts have narrowed, that I sold a few shares this morning. (P.S. – only from ISAs where no tax on the gains will be payable. Trading investment trust shares on short term horizons is rarely a good idea).

On the issue of stock market regulation, there was an article in this week’s Investors Chronicle by James Deal, the COO or Primary Bid. That company aims to enable private shareholders to take part in share placings from which they are normally excluded. As such placings are often at substantial discounts to the market share price, private investors miss out. They also get diluted.

The article mentions the £8 million cap on “undocumented” deals (i.e. ones without a prospectus) imposed by the EU’s Prospectus rules. The writer says “Brexit affords policy makers an opportunity to revisit this cap”. That’s one of many EU Directives that have been translated into UK law in the last few years. The Shareholder Rights Directive is another one that has been poorly thought through in terms of applicability to UK investors.

EU Directives are frequently excessively complicated as a result of trying to meet the needs of 27 EU countries all with different financial traditions. Let us hope that Brexit enables the UK to look again at many aspects of stock market regulation and the rights of individual shareholders.

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

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Boom and Bust Book Review

Avoiding buying into the peak of booms and selling at the bottom of a bust is one of key skills of any investor. But what causes them? The recently published book entitled “Boom and Bust” by academics William Quinn and John D. Turner attempts to answer that question by a close analysis of historical market manias.

I found it a rather slow read to begin with but it proved to be a very thorough and interesting review of the subject. It covers bubbles through the ages such as the Mississippi and South Sea schemes back in the seventeen hundreds, through the railway and cycle manias plus Australian land boom of Victorian times to those in more living memory. That includes the Wall Street boom and 1929 crash, the Dot.com bubble of the 1990s and the sub-prime mortgage crisis in 2007/8.

The latter resulted in a world-wide financial crisis with particularly damaging effects in the USA and UK. Banks had to be bailed out and bank shareholders lost their lifetime savings. But the dot.com bubble had relatively minor impacts on the general economy.

I managed to sell a business and retire as a result of the dot.com bubble at the age of 50 because it was obvious that IT companies in general had become very highly valued. Software and internet businesses with no profits, even no sales, had valuations put on them that bore no relation to conventional valuations of businesses and forecasts of future profits were generally pie in the sky. One of the things the authors point out is that insiders generally benefit from booms while inexperienced retail investors and unwise speculators with little knowledge of an industry are often the losers.

How are bubbles caused? The authors identify three big factors which they call the “bubble triangle” – speculation, money/credit and marketability. The latter is very important. For example, houses owned by occupiers tend to be part of markets that are sluggish and not prone to volatility as buying and selling houses is a slow process. But when sub-prime mortgages were created a whole new market was brought into being where mortgages could be easily traded. At the same time, the finance for mortgages was made easier to obtain.

The latter was by driven by political decisions to encourage home ownership by easier credit and by the relaxation of regulations. Indeed it is obvious from reading the book that politicians are one of the major sources of booms. Governments can easily create booms, but they then have difficulty in controlling the excesses and managing the subsequent busts.

The Dot.com boom was partly driven by technological innovation that attracted the imagination of the public and investors. It might have contributed positively to the development of new technologies, new services and hence to the economy, but most companies launched in that era subsequently failed or proved to be poor investments in terms of return on capital invested. Amazon is one of the few success stories. As the book points out, market bubbles tend to disprove the theory that markets are efficient. It is clear that sometimes they become irrational.

There are particularly good chapters in the book on the Japanese land bubble in the 1980s and the development of China’s stock markets which may not be familiar to many readers.

The authors tackle the issue of whether bubbles can be predicted and to some extent they can. But a good understanding of all the factors that can contribute is essential for doing so. Media comments can contribute to the formation of bubbles by promoting companies or technologies but can also suppress bubbles if they make informed comments. But this is what the authors say on the Bitcoin bubble and the impact of social media and blogs: “The average investor was much more likely to encounter cranks, uninformed journalists repeating the misinformation of cranks, bitcoin holders trying to attract new investors to increase its price and advertisements for bitcoin trading platforms”. They also say: “Increasingly the nature of the news media is shifting in a direction that makes it very difficult for informed voices to be heard above the noise”.

Incidentally it’s worth reading an article by Phil Oakley in the latest issue of Investors Chronicle entitled “Tech companies still look good”. He tackles the issue of whether we are in another Dot.com era where technology companies are becoming over-valued. His conclusions are mixed. Some big established companies such as the FANGs have growing sales and profits and their share prices are not necessarily excessive. But some recent IPOs such as Airbnb look questionable. Tesla’s share price has rocketed up this year but one surely needs to ask an experienced motor industry professional whether the valuation makes sense or not.

The authors suggest that buying technology shares can be like a casino. Most of the bets will be losing ones but you may hit a jackpot. I would suggest you need to pay close attention to the business and its fundamentals when purchasing shares in such companies.

In conclusion the book “Boom and Bust” is well worth reading by investors, and essential reading for central bankers and politicians!

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

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Seminar on Woodford Legal Case

Yesterday evening I attended a webinar hosted by ShareSoc on a proposed legal action over the substantial losses suffered by investors in the Woodford Equity Income Fund (WEIF). It was chaired by Mark Northway and Cliff Weight with other speakers being Boz Michaelowska from legal firm Leigh Day and David Ricketts. The latter is a financial journalist who has written a book entitled “When the Fund Stops” which covers the past events at the Woodford funds and which will be published in the New Year. It is already available to pre-order.

Leigh Day have identified a case against Link Fund Solutions, the Authorised Corporate Director (ACD) for the fund and which is part of a large financial group (Link).  Leigh Day’s investigations lead it to believe that Link allowed WEIF to hold excessive levels of illiquid or difficult-to-sell investments, and that this caused investors significant loss. In doing so, they consider Link breached the rules of the FCA Handbook and failed to properly carry out the management function of the Woodford Equity Income Fund.

This writer never personally held any of the Woodford funds, but having been involved in two previous large legal actions (over Northern Rock and the Royal Bank of Scotland), it was interesting to hear about this one. ShareSoc is endorsing and supporting the Leigh Day case and is providing a discussion forum for investors – see https://www.sharesoc.org/campaigns/woodford-campaign/ . They are taking up other issues not covered by the legal claim such as the failure of regulation to prevent the collapse of WEIF.

Some 600,000 investors were affected by the closure and wind-up of WEIF and have lost very substantial sums of money – over 25% of what they invested based on some calculations over a few years, in a period when the stock market was otherwise booming. As much as £1 billion in losses were suffered. The decline and eventual closure of WEIF was driven by investment in small cap, often unlisted, companies which proved very difficult to sell and could be considered unwise investments to begin with.

Leigh Day seem to be putting together a sound legal structure required for such an action – a Group Litigation Order, with after the event insurance to protect claimants with a “no win, no fee” financial structure and support from litigation funders. The latter and the associated costs mean that claimants, even if the case is won, will only receive about 70% of the proceeds, even assuming Link can pay which is not clear.

However, investors in WEIF have little to lose from supporting this legal claim although Leigh Day have not yet disclosed the details of their claim.

Note that they are not at present pursuing Neil Woodford, nor his fund management company, nor Hargreaves Lansdown who actively promoted the Woodford funds. Nor are they pursuing a case over investment in the Woodford Patient Capital Trust now taken over by Schroder (NAV down 73% in the last 5 years).

But there are several other legal firms mounting cases over the Woodford funds who might be covering other claims. As I experienced in the past legal cases in which I was involved, lawyers are keen to get involved as they see potential fees of several millions of pounds in the pipeline from pursuing such cases.

Note that investors might also consider a complaint to the Financial Ombudsman which might be an alternative route to redress.

Comment: The ShareSoc seminar provided a very clear exposition of the legal case and past events. It is good to see that ShareSoc is not backing off from involvement in legal claims where they have examined the case carefully and have some assurance that it is being well managed.

My view is that investors in WEIF should support the Leigh Day claim and should register their interest, but they need to be aware that such legal actions are always uncertain and can take many years to come to a conclusion. But if the case focusses on the role of Authorised Corporate Directors (ACDs) that might ensure that they take more care in future to monitor the activities of individual fund managers.

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

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Companies House Changes – 3 Consultations, and Banning Short Selling

The Government has issued three public consultations covering these subjects:

  1. Improving the quality and value of financial information on the UK companies register.
  2. Enhancing the powers of the registrar.
  3. Implementing the ban on corporate directors.

These follow on from a previous consultation entitled “Corporate Transparency and Register Reform” which contained proposals to reduce fraud and improve transparency, and which I reported on here: https://roliscon.blog/2019/05/11/changes-proposed-at-companies-house/ and you can see my response to that consultation here: https://www.roliscon.com/Corporate-Transparency-and-Register-Reform.pdf

The latest consultations can be found here: https://www.gov.uk/government/news/government-launches-consultations-to-crack-down-on-company-fraud-and-improve-corporate-transparency

These proposed changes will certainly improve the quality of information on the Companies House Register and in general should be welcomed, but they will impose more obligations on smaller companies. The consultations may be of particular interest to company directors and those who file information with Companies House such as accountants and company secretaries. But they ask a lot of questions, so perhaps best to review and respond to these consultations over Xmas. There are easy on-line questionnaires to which you can respond.  

Banning Short Selling

There was an interesting article in the Financial Times on short selling yesterday. It reported that South Korea is to attack those who bet against companies by short selling and is threatening jail and hefty fines. They are particularly concerned about “naked” short selling where stock is sold when not owned (e.g. rather than by borrowing it first), but they have also extended a ban on all short selling. Similar bans are in place in Malaysia and Indonesia.

The intention appears to be to halt speculative trading. Is it wise to do so? My view is that short selling as such can assist markets to identify a realistic price on stocks, but the problem is that it can also be associated with abusive practices where those doing so do not just keep their opinions to themselves but broadcast negative comments on a stock. Those comments can be sometimes fair and accurate but at other times they are not. It is very difficult for companies to respond to such comments and get them corrected or removed.

Of course one can argue that this sometimes happens in reverse, i.e. stocks are promoted by puffs or ramping to drive the price higher. Company directors themselves can be the source of such activity. The real issue is about media regulation where in the modern world both positive and negative commentary can be widely promoted on the internet without any regulation whatsoever.

That is the problem that needs tackling in essence, and banning short selling is at best a temporary measure that does not attack the underlying issue and in particular the excessive speculation that can take place in stock markets.  

Naked short selling might reasonably be banned though on the principle that nobody should be trading shares in which they do not have a financial interest. At least if they have a long holding, they may take the interest of the company into account. But if they have a short holding, their interest may be solely in damaging the company.

It is a long-standing principle of insurance that you cannot insure something in which you do not have an interest – for example someone else’s life unless you might suffer financial loss as a result of their death. Why? Because it is widely acknowledged it could lead to abuse, or in the case of life insurance that death might be hastened! You have to have an insurable interest to obtain insurance. That I suggest is a good principle to follow on share trading.

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

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FRC Seminars, Lookers Results, Caparo Judgement and Autonomy Case

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Preventing Fraud in Accounts – FRC Tightens Audit Rules

There have been repeated examples of the accounts of public companies being fraudulent in recent years. Wirecard was probably the latest and biggest example. I have seen examples of such misdeeds twice in my investment career in my own holdings although losses have been minimal in both cases, the last example being Patisserie (£95 million missing from their accounts). But I have avoided a lot of others where the losses to some investors have been enormous. There have simply been too many such cases for investors to avoid them all however careful you are in analysing the accounts of companies. There can often be hints that something is wrong, but in many cases the fraud is so well concealed it is very difficult to detect. In both the examples I mention, the cash that was claimed to be on the balance sheet was not there, which should be a simple thing for auditors to verify.

The Financial Reporting Council (FRC)) have announced that they are tightening up the rules followed by auditors to impose more responsibility on them for detecting fraud. In the past it was unclear that auditors had any responsibility to detect fraud and some have even denied it.

The FRC claim they are making the auditor’s obligations clearer – specifically to try and identify fraud. The FRC is running a public consultation on the proposed new audit standard which you can read about here: https://www.frc.org.uk/news/october-2020/consultation-on-revised-auditing-standard-for-the

It makes for interesting reading and it actually spells out the kind of problems that auditors should be looking for. In general the proposed changes to the audit standard make sense.

Will it solve the problem of too many frauds altogether? No for three reasons:

  1. Because audit work is bid for by audit firms, while companies pay their fees, there is a strong incentive by both parties to keep the cost of the audit as low as possible. This brings pressure to bear to not do more work than is absolutely necessary.
  2. Auditors cannot challenge management too much if they are going to retain the audit brief, and there is a tendency to build a cosy trusting relationship.
  3. Auditors are protected from being sued by shareholders for incompetence by the Caparo legal judgement, and their liability even to the company can be undermined by the contracts they require signing. In other words, the legal framework under which they operate enables them to escape responsibility for incompetence.

How might these problems be solved? It has been suggested that auditors be appointed by an independent body rather than by the directors of a company. Perhaps another solution might be to set up an independent fund that rewards auditors when they identify and report fraud, with big bonuses for the individuals that do so. That would give them a strong financial incentive to discover it.

That would provide a carrot. But the stick needs to be change in the regulatory framework and the law so that auditors cannot escape financial penalties when they do not do a competent job. A simple change would be to require audit contracts to be based on a standard set by an independent body such as the FRC and not written by auditors as at present.

I hope readers will respond positively to the consultation because I can see many objections from audit firms to the imposition of new obligations, however reasonable they appear to investors.

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

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Regulating Consumer Investments and Company Register Reform

 The Financial Conduct Authority (FCA) have launched a consultation on the Consumer Investment Market. They consider it a priority to reduce the harm that many consumers suffer from fraud in this sector. The FCA has this to say:

“We have made significant improvements to this market to protect consumers. But there are over 5,000 financial adviser firms and more than 27,000 individual advisers acting as intermediaries between the consumer and their investment. Dominated by small firms, these complex chains of interdependent products and services – some of which are beyond our regulatory remit – make it easy for bad actors to ‘hide’ and challenging for us to oversee. The consumer investment market is not working as well as it should. Too often consumers receive lower returns than they should because of unsuitable products with high fees. Too often there have been scams and scandals in this market leading to consumer loss. Too often consumers leave their savings in cash because they don’t have confidence in the alternatives. That’s why we have made Consumer Investments a priority in our current Business Plan”. They also say:

“Some of the most serious harms we see relate to investments outside our regulatory perimeter and online scams, many based overseas. We have limited powers and capabilities in this space, in particular in our ability to deal with online promotions”. This is now a major problem that the FCA has been particularly poor at dealing with as Mark Taber regularly points out.

The “Call for Input” document only has 38 complex questions so I suspect they are unlikely to get many responses from real consumers, but those interested in financial markets may care to read it. See here:  https://www.fca.org.uk/publications/calls-input/consumer-investments

The Government BEIS Department consulted previously on modernising Companies House who maintain the register of companies. The Government’s response to the consultation has now been published. You can read it here: https://www.gov.uk/government/consultations/corporate-transparency-and-register-reform

Company registration, and the identification of company directors is clearly a very essential element in preventing frauds of all kinds, but has been woefully inadequate in the past. The identify of directors is not checked and Companies House even has very limited abilities to query new applications. So you could probably set up a company called Mickey Mouse Ltd with the sole director named as Mickey Mouse. Indeed I did check to see if there was such a company registration. Yes there is a company of that name, although the sole director’s name is different.  

The report even says: “There are benefits to the UK’s fight against crime: these reforms will increase the accountability of those few that transgress. As noted, the volume of economic crime in the UK is immense and growing. It accounts for almost one third of all crime experienced by individuals. The Home Office estimates that the social and economic cost of fraud to individuals in England and Wales is £4.7 billion per year and the social and economic cost of organised fraud against businesses and the public sector in the UK is £5.9 billion.

We will be able to trace and challenge those who misuse companies through the improved information on those who set up, own, manage and control companies. In partnership with others, our improved analytical capacity will use this information to detect suspicious activity earlier and hold those responsible to account”.

The recommendation to tighten up on the identities of directors has been generally supported so that is likely to be progressed. The ability to suppress some personal information will also be enhanced to improve security over that.

In general I suggest company directors and shareholders should welcome the proposals as a step forward in modernising Companies House, but you may care to review the details.

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

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FCA Seminar and Property Funds Rule Change

The Financial Conduct Authority (FCA) is consulting on a rule change for open-ended property funds. The problem of such funds holding illiquid investments in direct property are well known. If investors want to sell when property goes out of favour, the funds simply cannot sell their underlying holdings fast enough. It can take months to do so when investors in the funds expect their cash immediately. Or as the FCA puts in, there is a mismatch between the liquidity offered to investors in the funds, and the liquidity of the fund’s holdings.

This problem has resulted in the funds having to be “suspended” or “gated” to stop redemptions, and many still are after the March crash this year.

The FCA’s solution is to require investors to give notice before they can get their cash – potentially up to 180 days. But this would probably mean that investors would not be able to hold such funds in ISAs, unless their rules are changed. Needless to say, investors who currently do so are not going to be best pleased as they would have to sell them.

This is a very simplistic solution to a long-standing problem, and to my mind may not solve the problem as disposing of property can take longer than 180 days if you want to obtain a fair value for it. Permitting illiquid investments of any kind to be held in open-ended funds is simply wrong.

Such funds should be wound up, or converted to investment trusts which is surely not impossible. Meanwhile I won’t personally be responding to this consultation as I am not so daft to hold such funds, only property investment trusts.

See the FCA press release here for details: https://www.fca.org.uk/news/press-releases/fca-consults-new-rules-improve-open-ended-property-fund-structures  and for how to respond to the consultation.

Yesterday the FCA presented at a seminar hosted by ShareSoc and UKSA as a webinar. Mark Seward was the speaker from the FCA but he did not cover the above issue at all (he is responsible for “Enforcement and Market Oversight”).

He did cover the outcome of the Redcentric case where grossly misleading accounts were published. He said the investors had “purchased a lemon”. They did not fine the company, but the company is compensating the shareholders affected and 3 former executives are awaiting trial. He explained the reasons for the FCA’s actions which seemed reasonable to me (I never held the shares though – those more familiar with the case might have a different view). He also mentioned the Burford case and the legal decision re disclosure of trading data and made some uncalled for derogatory remarks about the comments made on it by some ShareSoc members.

He covered the emergency measures introduced by the FCA for the Covid-19 epidemic which he said enabled the UK markets to raise 3 times more capital than any other European market in the first half of the year. But Mark Northway raised the issue of the problems of private investors participating in these fund raisings. I would also have liked to see the issue raised of companies not providing access to AGMs nor any other means for shareholders to talk to the directors while the epidemic rages.  

Another issue discussed was the outright refusal of the FCA to provide any information on the progress of an investigation. This is exceedingly frustrating for investors as it means after a complaint is made, there is no apparent action for many months if not years. When many of the facts are reasonably well known and in the public domain already (as in the Redcentric case, or in other cases such as those of Globo or Patisserie) this can appear quite unreasonable.

Mark Seward suggested that no regulatory body (for example, the Police) discloses anything about their investigations, partly because the evidence might disappear if they did. But this is simply not true. The Police often inform victims of crimes about the progress of a case, sometimes albeit on a confidential basis. Victims and the police are also entitled to follow the “Code of Practice for Victims of Crime” published by the Government which the police have to adhere to (but not the FCA who are specifically excluded for no good reason).

The seminar was not altogether a waste of time, but could have had a much sharper agenda.

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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Why the FCA Did Nothing About the Lloyds TSB Abuse

Those who were Lloyds TSB shareholders back in 2009 when they merged with HBOS to form Lloyds Banking Group (LLOY) thought it was bad deal at the time and it certainly turned out to be so. HBOS had many dubious loans to property companies and when the banking crisis arose they were in deep financial difficulty. There seemed very little benefit in the merger for Lloyds shareholders

Subsequently a legal action was launched by the disgruntled Lloyds TSB shareholders which was lost in the High Court in late 2019. I wrote the following to the Financial Conduct Authority (FCA) soon after:

“I refer to the recent judgement in the High Court in the case of SHARP and Others v BLANK and Others (the case concerning the takeover of HBOS by Lloyds TSB). Although the judge in the case rejected the claim by shareholders in Lloyds, he made it clear in his judgement that there were significant omissions from the prospectus that was issued at the time.

Specifically he says in his Executive Summary: “But I consider that the Circular should have disclosed the existence of the ELA facility, not in terms such as would excite damaging speculation but in terms which indicated its existence”; and “Likewise, I consider that the board ought to have disclosed the Lloyds Repo. The board assumed that because at the time of its grant it had been treated by the authorities as “ordinary course” business that provided an answer to all subsequent questions. But whether it should be disclosed in the Circular as material to an informed decision was a separate question. The Court must answer that question on an objective basis. The size of the facility, the fact that it was extended in tight markets, the fact that it was linked to the Acquisition and was part of a systemic rescue package showed that this was a special contract which ought to have been disclosed”  (see paragraphs 46/47 of the Executive Summary which can be obtained from here:  https://www.judiciary.uk/judgments/sharp-others-v-blank-others-hbos-judgment/

There were also possible other omissions from the disclosures which the judge did not consider but the above does provide prima facie evidence of a breach of the Prospectus Rules.  The directors of the company (Sir Victor Blank and others) would certainly have been aware of this funding and failing to disclose it was negligent.

Investors in Lloyds TSB (I was one of them) were misled by these omissions and the subsequent outcome was financially very damaging to those investors.

I suggest your organisation needs to look into these matters as a breach of the Prospectus Rules surely is a matter that makes the culprits liable to sanctions under the Rules and there is no statute of limitation in regard to these matters.”

Their response after 5 months delay can be summarised as follows:

  1. The Lloyds Circular was subject to the Listing Rules, not the Prospectus Rules. The FSA approved the Lloyds Circular under those rules.
  2. In the Judgement by Sir Alastair Norris he did not consider whether they breached the FSA rules.
  3. We will not be opening an investigation into these allegations as we are time barred from taking enforcement action (there is a 2-year limit for enforcement action).

In summary therefore, the shareholders were unable to obtain redress by civil action and the FCA proved to be toothless to deal with this matter also. It is very regrettable that the protection that shareholders believed they had against the abuse of directors not acting in their interests proved to be imaginary.

Shareholders were not given all the information to which they were entitled and that fact alone merited action by the FCA. But they have declined to pursue it. Considering the similar case of the Royal Bank of Scotland Rights Issue in 2008, it is very clear that shareholders should not rely on what is said in prospectuses or circulars.

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

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