Woodford Legal Claims, But How Long to Settlement?

There is a good article in this week’s edition of the Investors Chronicle covering the various legal claims being pursued over the debacle of the Woodford Equity Income Fund. ShareSoc is backing a claim managed by solicitors Leigh Day but there are several other law firms competing to represent the 300,000 investors affected.

The article makes some good points and is certainly worth reading if you have suffered losses on any of the Woodford funds. But it suggests that the legal process could take as long as “two to three years” based on comments from the law firms. That’s presumably if the claim is successful.

In fact it might take a lot longer. For example, and coincidentally, my wife was a small claimant in the Royal Bank of Scotland Rights Issue case. That stems from 2008, and she has just received the second interim payment after the case was settled out of court. There may be more to come while the overall costs to be deducted are not yet clear but will obviously be substantial.

But twelve years to achieve a result is possibly a better estimate than two to three years. With many investors elderly, one wonders how many of them die before their claims in such actions are settled. It is a good example of the inability to obtain justice swiftly and at reasonable cost that is a major defect in the English legal system. Lawyers benefit greatly from the current system of course. In effect we have a Rolls-Royce legal system when we would be better served by a Ford version. Even the Rolls-Royce version does not necessarily provide justice as we have seen in other recent cases (e.g. the Lloyds/HBOS case).

Also coincidentally the Law Commission has just issued a call for ideas for the Law Commission’s 14th Programme of law reform” – see https://www.lawcom.gov.uk/14th-programme/ . Surely one idea worth suggesting is how to demolish the massively complex process of pursuing a commercial claim in the investment sphere.  We need much simpler law, simpler processes and quicker judgements.

Meanwhile although I have no interest in the Woodford claims as I was never invested in any of his funds, I would not wish to discourage any participation in legal claims so long as you study carefully any contract which may be proposed. The outcome may be uncertain and the process lengthy but success might discourage other similar cases and encourage the FCA to tighten up the rules for fund managers.

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

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Margin Calls Not Met – $Billions Lost

On the 23rd March I warned about the dangers of the rise in speculation among small retail investors. I said this: “I suggest that buying shares on margin should be accompanied by very strong health warnings to investors and tougher regulations. It was one of the reasons for the collapse of the US stock market in the 1930s. Too many folks geared up with broker loans that were unsupportable when the market headed down. Investors were unable to meet margin calls, and the lenders then went bust”.

But this is also a problem among larger investors. Today the FT reported that Credit Suisse and Nomura – two of the world’s largest banks – faced large losses after their client Archegos Capital Management, for whom they acted as prime broker, failed to meet margin calls.

Nomura said it estimated that its claim against the client might be $2 Billion or more if asset prices continued to fall. The share price of Nomura fell by 16% as these events might wipe out its second half profits. The losses at Credit Suisse might be even higher at between $3 Billion and $4 Billion it is suggested in the FT article.

Archegos, an investment company, has been dumping shares after sharp declines in ViacomCBS and Chinese technology stocks.

The problem is that whenever a few big players become over-leveraged their failure can have the effect of falling dominoes as they trigger the collapse of other players. Even if the lenders don’t fail, the sales of holdings when margin calls are not met depresses the share prices of those holdings. In summary there are too many people betting on rising markets and trading on margin. Financial market regulators seem to have taken no notice of the growing risks attendant on this structure.

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

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Restoring Trust, After Its Long Been Lost

The Government BEIS Department have published a white paper entitled “Restoring trust in audit and corporate governance”. It’s an acknowledgement that the trust of investors in directors who manage the companies they invest in has long ago been lost. And the trust in auditors that the accounts issued by companies are accurate and give a fair view of a company’s financial position has also been lost.

There are few stock market investors who have not been affected by one or more scandals or downright frauds in the UK in recent years. However diligent you are researching companies and checking their accounts, you are unlikely to have avoided them all. Examples such as Autonomy, BHS, Carillion, Conviviality, Patisserie Valerie and numerous small AIM companies give you the impression that the business world is full of shysters while auditors are unable to catch them out. The near collapse of the Royal Bank of Scotland and other banks in 2008 was symptomatic of the malaise that had crept into the accounts of companies that has still to be rectified.

Indeed in the first chapter of my book “Business Perspective Investing” I said accounts don’t matter because they cannot be relied upon. I suggested other aspects of a business that should be examined to pick successful investments and went through them in some detail in the rest of the book. But would it not be better if we could trust company directors and auditors?

The failures of the existing accounting standards and corporate governance, and enforcement thereof, has been recognised in previous Government reviews. For example the Kingman Review in December 2018 made a number of proposals to reform the Financial Reporting Council (FRC) and for a replacement body to be named the Audit, Reporting and Governance Authority (ARGA) with wider powers (see: https://roliscon.blog/2019/03/12/frc-revolution-to-fix-audit-and-accounting-problems/ ). The fact that it has taken 3 years to move one step further tells you about the glacial pace of reform.

The Government has accepted most of the recommendations in past reviews of this area. They plan to tighten up the accountability of company directors and propose “new reporting and attestation requirements covering internal controls, dividend and capital maintenance decisions, and resilience planning, designed to sharpen directors’ accountability in these key management areas within the largest companies”.

The audit profession, who have been one of the barriers to change, comes under attack with these comments: “Central to achieving [reform] is the proposed creation of a new, stand-alone audit profession, underpinned by a common purpose and principles – including a clear public interest focus – and with a reach across all forms of corporate reporting, not just the financial statements. Alongside this the Government is proposing new regulatory measures to increase competition and reduce the potential for conflicts of interest, by providing new opportunities for challenger audit firms and new requirements for audit firms to separate their audit and non-audit practices”.

The Government proposes new legislation to put the new ARGA body on a statutory basis with stronger powers to be financed by a new statutory levy. You may not believe it but the FRC is financed by a voluntary levy and has limited powers over finance directors (none at all if they are not members of a professional body).

There is a new focus on the “internal controls” in a business and proposals to ensure they are adequate. A lack of internal controls is often the reason why fraud goes undetected. These proposals are similar to the Sarbanes-Oxley regulations introduced in the USA.

For investors, a big change that might have an impact is: “Companies (the parent company in the case of a group) should disclose the total amount of reserves that are distributable, or – if this is not possible – disclose the “known” distributable reserve, which must be greater than any proposed dividend; in the case of a group, the parent company should provide an estimate of distributable reserves across the group; and directors should state that any proposed dividend is within known distributable reserves and that payment of the dividend will not, in the directors’ reasonable expectation, threaten the solvency of the company over the next two years”.

There are of course existing rules that should prevent dividends being paid out of capital, which incidentally was one of the common reasons for collapse of companies in Victorian times – the ability to continue paying dividends gave a false sense of all being well to investors. But clearly the current regulations are ineffective. The BEIS report actually says “high profile examples of companies paying out significant dividends shortly before profit warnings and, in some cases, insolvency, have raised questions about its robustness and the extent to which the dividend and capital maintenance rules are being respected and enforced”.

There is also the problem of big bonuses being paid to directors when they should have known the financial position of their company was precarious. This is tackled by new proposed rules to “strengthen malus and clawback provisions within executive directors’ remuneration arrangements”.

There are proposals to reduce the dominance of the “big four” accounting firms and introduce more competition which is seen by some as the reason for the poor quality of many audits. But it is not clear that the proposals will have a major impact.

In conclusion, there are many detailed proposals in the 226 page report, which is now open to public consultation. I may make more comments later, but overall I would support the main proposals as a step forward. I just wish the Government would get on with the proposed changes before investors lose the will to live.

White Paper: https://www.gov.uk/government/publications/restoring-trust-in-audit-and-corporate-governance

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

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UK Listing Review – What’s It All About?

You may have noticed in the Chancellor’s Budget speech that he announced that the FCA will be consulting on Lord Hill’s review to encourage companies to list in the UK and on changes to the listing and prospectus rules. This article gives a summary and some comments on what is proposed.

The reason for the review is given as a decline in the number of companies listed in the UK with many of those listed being “old economy” businesses. Too few world class technology or life science companies list in the UK. Reasons given for this are over-complex listing rules and long timescales that inhibit some companies from choosing London as a listing venue. There is also growing competition from financial centres such as Amsterdam.

Three particular issues for example are restrictions on dual share class structures that enable entrepreneurs to retain control of public companies they founded, minimum free float requirements and restrictions on SPACs (special purpose acquisition vehicles created to acquire businesses). The existing UK listing rules do protect investors, but as Lord Hill’s report says: “Our bottom line is this: it makes no sense to have a theoretically perfect listing regime if in practice users increasingly choose other venues”. Lord Hill suggests there is a general demand for change and reform.

Of course it is worth pointing out that many of the rules that govern listings, such as that for the content of prospectuses, were devised by the EU. But Lord Hill says this: “It is not, however, the case that simply leaving the EU will mean that all UK regulation will automatically become proportionate, adaptable and fleet of foot. British Ministers and regulators are just as capable of constructing over-complicated rules that discourage business investment as their European counterparts. It is, for example, a very widely held view that regulatory requirements on business and the liability profile of companies and their directors have increased significantly over time: indeed, this is one of the frequently cited reasons as to why there has been a trend of companies shifting from the public markets to private ones or never accessing the public markets at all”.

What are his specific proposals? I’ll cover some of them and add some comments:

  1. He proposes to permit dual-class structures, but with some safeguards. Comment: dual class structures enable directors to run the business as if it is a private company rather than a public one. Similarly low free float requirements inhibit minority investor protection. He suggests safeguards might include a maximum duration of 5 years but will that really satisfy entrepreneurs who wish to retain control? Giving control of a company to insiders is fine as long as the business is doing well, but when in difficulties it can obstruct change or enable a company to be easily delisted and taken private.
  2. He proposes to permit dual-class structures, but with some safeguards. Comment: dual class structures enable directors to run the business as if it is a private company rather than a public one. Similarly low free float requirements inhibit minority investor protection. He suggests safeguards might include a maximum duration of 5 years but will that really satisfy entrepreneurs who wish to retain control? Giving control of a company to insiders is fine as long as the business is doing well, but when in difficulties it can obstruct change or enable a company to be easily delisted and taken private.
  3. He proposes a complete rethink of prospectus regulations. That may include the provision of “forward-looking” financial information and the relaxation of prospectus exemption thresholds. But there is surely a big danger here that directors might make wildly optimistic statements about a company’s future prospects when there is no risk of liability for doing so. In addition he suggests “alternative listing documentation” where a further issuance from an existing listed issuer is being done. The latter is a very sensible change as it’s exceedingly bureaucratic and pointless to require a full prospectus when more shares are being issued to existing holders who are already familiar with a company. A complete review of the prospectus regulations is also a good idea after the recent Lloyds/HBOS judgement where the judge decided that the omission of very significant information did not matter as shareholders would have voted for it anyway (an unreasonable presumption).
  4. He also makes recommendations “to try to empower retail investors, recognising their changing expectations and the way that developments in technology create new possibilities of engagement”. He reminds readers of the problem of retail investors exercising their rights in intermediated securities. But all he says on this is: “Much as BEIS put forward a vision of how utility companies should collaborate to create common platforms and network protocols for the introduction of smart meters, a similar approach could be taken to develop technology solutions that would better enfranchise retail investors”. But he is certainly right in suggesting the “plumbing” is the problem which needs tackling.

In summary this is useful report but I am not sure it faces up to some of the real issues. Will companies flock to list in London simply because of the changes proposed? Companies list in markets which they perceive as attractive for a wide range of reasons. That includes perceptions of likely achievable share prices against comparable companies already listed in those markets. You can’t fix that problem by changing the listing rules. Another problem is the more onerous corporate governance requirements in the UK than in other countries, which can deter public listing, but it would be a pity to lose the good aspects of that.

You can read Lord Hill’s Listing Review here: https://www.gov.uk/government/publications/uk-listings-review

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

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The Courage to Act, or Not

Some of us have plenty of time to read good books while under house arrest. Here’s one I have been reading. It’s a memoir by Ben Bernanke, former Chairman of the Federal Reserve under the title “The Courage to Act”. It covers the major worldwide financial crisis of 2007/8 created by the defaults in sub-prime mortgages. The book includes a very good section on how that came about and how packaging up such mortgages eventually led to a complete lack of confidence in banks and other financial institutions.

Bear Stearns, a major US investment bank was one victim, but the failure of Lehman Bros which collapsed into bankruptcy had the worst impact. This was a “systemically important” bank because of its size and spread of activity and the US Government could not stop it. It demonstrated that the Federal Reserve (the US equivalent of the Bank of England), the US Treasury and other US institutions were powerless to prevent the debacle. Or at least did not have the courage to act in the face of public opposition to taxpayers bailing out financial businesses.

Another victim was AIG, the largest insurance company in the world but the reality of what happens when everyone becomes scared of the value of financial assets became very clear. Numerous “runs” on banks and savings institutions occurred.

The contagion spread worldwide and affected most large banks including those in the UK where Northern Rock had depositors queuing at their doors, and Royal Bank of Scotland and Lloyds were forced by the Government to take part in “recapitalisations”. It was clear that many financial businesses were grossly under-funded and had gone into more risky business sectors without increasing their capital to match.

The spectre of “moral hazard” reared its head both in the UK and USA, i.e. supporting companies that had pursued risky strategies might encourage others to do the same in future rather than discourage them. That seems to have been one reason why Lehman was abandoned to its fate, as was Northern Rock. That was despite the fact that Northern Rock appeared to have a positive asset position and hence should have qualified for “lender of last resort” loans from the Bank of England to cover a temporary cash flow shortage.

This is an interesting quotation from Bernanke’s book where clearly he changed his stance on the matter:

“You have a neighbor, who smokes in bed…..Suppose he sets fire to his house, I would say later in an interview. You might say to yourself….I’m not gonna call the fire department. Let his house burn down. It’s fine with me. But then of course, what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood? The editorial writers of the Financial Times and the Wall Street Journal [who had opposed bail-outs] in September 2008 would presumably have argued for letting the fire burn. Saving the sleeping smoker would only encourage others to smoke in bed. But a much better course is to put out the fire, then punish the smoker, and if necessary, make and enforce new rules to promote fire safety.”

The latter was what was subsequently done of course in the finance world.

Coincidentally I have seen an email from Dennis Grainger who is still campaigning for some recompense from Northern Rock shareholders who lost their savings in the nationalisation of the company. Apparently he wrote to the Prime Minister on the subject and got a response from the Treasury. You can read the letters here: https://www.uksa.org.uk/sites/default/files/2020-03/NRSSAG-letter-to-PM-28-2-2020.pdf and here: https://www.uksa.org.uk/sites/default/files/2021-01/Treasury-Response-20-March-2020.pdf

The gist of what Mr Grainger says is that bearing in mind that the Government subsequently made a large profit on the transaction the shareholders should be compensated. From my knowledge of events at the time I think it was clear that the Government always expected to make a profit. The response from the Treasury provides very poor excuses for not supporting private sector offers to rescue the company. The major reason was surely not financial, but that the Labour Government and its supporters were unwilling to see any taxpayers’ money rescuing a financial institution – just like the opposition in the USA. The Governor of the Bank of England, Mervyn King, also appeared to lack the “courage to act”.

The failure to support Northern Rock and subsequently Bradford & Bingley undermined the whole UK banking sector as the assets of all of them came under scrutiny and money markets closed. This caused a fall in the stock market and an economic recession.

This was indeed a very sad episode in the financial history of the world. I did of course lose money having invested in Northern Rock shares as I did not anticipate the Government and Bank of England would be so stupid as not to support the company, at least temporarily. But I probably recouped all my losses by picking up other shares that fell to very low levels and recovered in a few years (not banks though – I still do not trust their accounts!).

Bernanke’s book is well worth reading if you wish to understand the details of what happened. If anything it’s rather too detailed at 600 pages as if the author was writing for historians. But it does throw some interesting light on the events of 2008.

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

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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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