Response to Financing Growth Review

The Government is currently consulting on “Financing Growth in Innovative Firms” (otherwise known as the Patient Capital review). It covers the perceived problems in building world-beating companies from a small size in the UK, and the ways the Government provides support to early stage companies. That typically means the VCT, EIS and SEIS schemes with their associated tax reliefs and other possible “support” programmes where the Government funds them directly.

Anyone who invests in this area, directly or indirectly, should respond to the public consultation – the deadline is the 22nd September to do so. That is particularly so because reading between the lines it seems that some folks in the Government feel the tax reliefs are too generous and even suggest that investment would take place even without the tax reliefs. But my view is very different – I certainly would be very unlikely to invest in VCT and EIS funds without generous tax relief. They frequently generate dismal investment returns and have very high management fees plus administration costs. In reality, the historic record has been very patchy and the tax reliefs only help to offset the duds (which were difficult to identify in advance).

As someone who has experience of this sector both as an investor and a director of companies needing to raise capital, I have put in a personal submission on the topic. It is present here: Financing-Growth

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

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Barclays Stockbroking Complaints

Several newspapers and on-line news services have reported this week on the debacle at Barclays. They launched a new “Smart Investor” site to replace their Barclayshare share trading service. The complaints range from failure to advise new account log-in details, support service uncontactable, old features missing (or perhaps simply moved elsewhere and not easily found in some cases), higher charges (fees restructured), to some account types or share holdings being no longer permitted.

Barclays have integrated it with their on-line bank account service which probably makes sense, but they clearly got some basic things wrong with this kind of migration which are:

  1. Beta testing of the new software on real customers must have been limited in scope, if done at all.
  2. All clients were moved at the same time and forcibly. No parallel running, no options for clients to choose when to migrate, etc.
  3. If possible, avoid “big bangs”. Changes to systems should be done gradually and in stages to avoid massive new learning processes by clients.

When will IT teams learn that folks get “habituated” to software and get very unhappy when it’s changed, even when the new system works well and has more features (and in Barclays case, it obviously had some problems). It’s like moving the products on the shelves of supermarkets so the customers can’t find their favourite foods any more. Now Paypal did a similar migration recently, and the new menus were hopeless to begin with, but they allowed you to drop into the old menus for some time. So only some minor cursing was the result. But Barclays may lose some of their 200,000 stockbroking clients from this debacle it seems.

Stockbroking platforms are really important to get right as they involve large value transactions by often sophisticated traders but there have been several examples over the years of new platforms failing to meet the basic needs of clients.

What do you do when this happens? Move your account to someone else? If only it was that simple.

From several experiences of doing this, all I can say is that you won’t have much difficulty finding someone to take it on, but the process often takes months with endless hassles along the way.

Indeed I have complained to the Financial Conduct Authority (FCA) about this in the past – see https://www.sharesoc.org/blog/regulations-and-law/stockbroker-transfers-more-evidence-of-unreasonable-delays/

Anyone who meets this problem should also complain to the FCA and encourage them to tackle it. If you can switch a bank account in 7 days (and that’s mandated), why not a stockbroking account?

The complexity partly arises from the use of nominee accounts and the problems with funds rather than direct shareholdings, but these difficulties are surely fixable if we had a decent share and fund registration system and stockbrokers were motivated to get the issue sorted out. Needless to point out that stockbrokers don’t like to make it easy to switch so won’t do so unless pushed because they like to lock their clients in (hence the use of nominee accounts also of course).

In the meantime, if you do decide to switch you may find it easier to move all your holdings into cash first – but you need to be wary about the tax implications of doing so.

This FCA web page tells you how to complain about Barclays new service, and about delays in transfers, here: https://www.fca.org.uk/consumers/how-complain . But if you wish to complain about the general lack of action on broker transfers, you could write to David Geale, Director of Policy, FCA, 25 The North Colonnade, London, E14 5HS.

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

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Sophos, Interquest and the Government

Yesterday I missed the Sophos (SOPH) AGM due to having a clashing engagement, but I noticed that in the announcement of the voting results that there were substantial votes against the Remuneration Report (29.8% against) and also high votes against most of the directors. One only needs to glance at the Remuneration Policy to see why.

The maximum bonus opportunity is 200% of salary, and the maximum LTIP award is 500% of salary in normal circumstances and up to 750% in exceptional circumstances. So total incentive payments can reach nearly 10 times normal salary. That’s the kind of scheme I always vote against.

For what is actually a relatively small company that has never reported an annual profit, the actual pay figures are way too high – CEO got a base salary of $695,000 last year and total single figure remuneration of $2.32 million. Other directors, even the non-execs, have similar generous pay figures. It might be a rapidly growing company in a hot sector (IT security) but I am beginning to regret my purchase of a few shares.

Although I missed the AGM, I did “attend” the previous days Capital Markets Day. I was refused physical access but anyone could log into the web cast of the event. Not quite the same thing but it was exceedingly boring with a lot of the time spent on the wonders of their technology rather than important business questions. Is it not despicable though that companies and their PR advisors try to keep such events solely to institutional investors?

Interquest (ITQ) is an AIM listed company that received an offer for the company from some of the directors but they only got 58% committed support. That’s not enough to delist the company under the AIM Rules which requires 75% so the offer was abandoned. What did the directors do then? They notified their Nomad of termination of their contract and subsequently said they would be unlikely to appoint another Nomad within the one month period allowed. This means the shares will automatically be suspended from AIM and subsequently delisted if no Nomad is appointed.

The moral is that if directors or anyone else control 58% of the company then minority shareholders are in a very difficult position because they will have the ability to do lots of things that prejudice the minority shareholders – for example pay themselves enormous salaries. A legal action for prejudice of a minority is available but as my lawyer said yesterday, these are complex cases, as I well know from having run one myself in the past, and successfully (we were discussing my past legal cases). It’s difficult enough in a private company, and even more so in a public one. In summary, having an AIM Rule about delistings may not help if one cannot win a vote of shareholders on other matters that require just 50%.

Having control of a public company in the effective hands of a concert party of a few people is something to be very wary about, and something all AIM company investors should look at.

Government policy on tackling excessive pay levels for the directors of public companies has taken a step backwards this week. Tougher measures which Theresa May threatened have been watered down, and the core of the problem – the fact that Remuneration Committees consist only of directors, whose appointment and pay is controlled by other directors, has not been tackled. In addition, the potential to control pay by votes at General Meetings has been undermined by the disenfranchisement of private shareholders as a result of the prevalence of the nominee system and the dominance of institutional voters who have little interest in controlling pay.

Another bit of news from Government sources this week is that the hope of some change in shareholder rights that might have improved private shareholder voting is fading away after a decision to postpone yet again the issue of “dematerialisation”. The staff involved in that project have been moved and expertise will be lost. This is likely to be the result of both lack of interest in tackling a difficult and complex problem, and the need to put in effort on Brexit matters at the BEIS Department.

Will we ever get a proper shareholder system where everybody is on the share register and automatically gets full rights, including voting rights? It remains to be seen but I will certainly continue to fight for that. Without it we will never get some control over public companies and their directors. I suggest readers write to their Members of Parliament about this issue.

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

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AIM Rules – Response to Consultation

The London Stock Exchange (LSE) is currently undertaking a consultation on the AIM Market Rules (see http://www.londonstockexchange.com/companies-and-advisors/aim/advisers/aim-notices/aim-discussion-paper-july-2017.pdf ).

Anyone can respond to this and the deadline is the 8th September. Those who invest in AIM shares will be aware of some of the past problems in AIM companies and tightening up some of the Rules that apply to AIM companies may surely help to improve the quality of the market. For example, it covers new rules that might help AIM to be more selective in regard to the companies that list on the market.

I have submitted a response to this consultation which is here: http://www.roliscon.com/Roliscon-Response-AIM-Rules-Review.pdf

Investors in AIM should do likewise, otherwise the responses will be dominated by Nomads and company promoters.

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

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Northern Rock 10 Years After

Both the Times and Financial Times covered the tenth anniversary of the nationalization of Northern Rock today. Dennis Grainger is still fighting to get some compensation for shareholders from the nationalization and says the Government stands to make billions of pounds profit from the bank after paying zero compensation to shareholders. He is undoubtedly right that the Government will turn a good profit on these events, as they always planned to do.

He and others such as Pradeep Chand described in an article in the FT Weekend supplement lost hundreds of thousands of pounds. Was the bank a basket case, or do they have a genuine grievance? The fact that they and other investors are still fighting for compensation ten years later tells you how aggrieved they feel. Mr Grainger hopes to put his case to Theresa May.

Incidentally the shareholders in Bradford and Bingley (B&B), led by David Blundell, are also still fighting a similar case over the nationalization without compensation of that company. The same legislation was used to do so.

As I was involved in the campaign and subsequent legal case, let me give you a few simple facts about the case:

Northern Rock was not balance sheet insolvent, but ran out of cash after a run on the bank by depositors (driven by media scare stories) and their inability to raise more money market funds (nobody was lending to anyone else at the time).

This would normally have caused the Bank of England to step in as “lender of last resort” to provide liquidity but then Governor Mervyn King declined to do so because of the “moral hazard” risk. That was a fatal mistake not likely to have been made by his predecessors.

The then Labour Government subsequently passed legislation to nationalise the bank and ensured there was no independent and fair valuation of the shares by writing the Nationalization Act with wording that ensured an abnormal and artificial valuation process which guaranteed a zero valuation. So the ensuing claims that it was a “fair and independent” valuation are nonsense. The Treasury is reported as repeating that claim in the FT article today.

In reality Labour politicians decided to ensure that two large hedge funds who had invested in the company and were willing to support it should get nothing because they were the kind of people they hated. Smaller shareholders in Northern Rock were not recognized as being of importance.

The nationalization legislation used against Northern Rock and B&B ensures that if the Government has lent any sum of money to a bank, then they can nationalize it without compensation. This made UK banks untouchable by many foreign lenders or investors with dire consequences later for other banks such as RBS. In the case of B&B they even concealed that they had lent it money until much later so as not to scare investors. Incidentally while that legislation is still available to the Government, that is one reason why I won’t be buying shares in UK banks – it increases their risk profile very substantially.

A legal case was pursued to the Supreme Court on the nationalization (a Judicial Review), but they would not overturn the will of Parliament. A claim to the European Court of Human Rights was submitted but they refused to even hear the case which was very unexpected as they had ruled in other nationalization cases that fair compensation should be given.

Those are the key facts and all the other mud that was slung at Northern Rock claiming it was a dubious business by a concerted campaign of disinformation was most unfortunate, and basically inaccurate.

A company that cannot meet its debts when they become due, and is hence cash flow insolvent, can be argued to be worth little. But there was funding available to Northern Rock (it was trading for months after the “run” and before it was nationalized). But salvage law sets a good precedent for what is fair compensation when someone rescues a sinking ship. The same should have applied to a sinking bank.

So in summary, I support the efforts of Dennis Grainger and others to get compensation to the ordinary shareholders out of the profits that have accrued to the Government as a result.

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

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Hate Crime, Fake News and Market Abuse

Yesterday saw a lot of media coverage after the Crown Prosecution Service announced that online offences of “hate crime” would in future be treated as seriously as offline offences. This is in response to the rising volume of such abuse on social media.

What is a “hate crime”? In summary, it is abuse based on race, ethnicity, religion, disability, sexual orientation or gender identity. Why just those categories? Don’t ask me – I am looking forward to abuse of baldies and fatties being made hate crimes. But this is just one aspect of the problems created by social media where anonymous posters can attack anyone whose views they do not like. Anyone in public life now regularly suffers the most vile comments from people who do not like their opinions – just ask any Member of Parliament who can tell you about it. Indeed, I have suffered from it myself.

Sometimes they do this because they know they can hide behind an anonymous google or hotmail account on the net, or by using a fictitious name. But even when it is clear who they are, there is little legal or social pressure to inhibit them. Indeed a new word has been invented to cover such behaviour – internet “troll”, which Wikipedia defines “as a person who sows discord on the Internet by starting quarrels or upsetting people, by posting inflammatory, extraneous, or off-topic messages in an online community (such as a newsgroup, forum, chat room, or blog) with the intent of provoking readers into an emotional response or of otherwise disrupting normal, on-topic discussion, often for the troll’s amusement.”

In extremis this can degenerate into “harassment” which is now a criminal offence in the UK, in addition to being subject to civil claims. For example, repetition of false allegations that cause alarm or distress is harassment. Again this is so much easier to propagate on the internet and in social media. Indeed one problem is that it can be going on without the victim being aware of it because there are now so many different platforms on which it can appear that even monitoring for it is not easy.

Another very topical subject which is linked to the above is that of “fake news” which allegedly had an impact on the US Presidential election and the Brexit vote in the UK. In effect, social media can be used maliciously to distribute false information with the intention of changing public opinion.

This can also be seen in financial markets where fake news can be used to affect share prices. Just create a rumour about a takeover bid on social media and the share price of a company will take off before the company can even deny it. Profits can be made from such behaviour, and even if the company denies it they may not be believed. Now simple cases like this are undoubtedly offences under the Financial Services and Markets Act but there are very few convictions for it. Social media have become impossible to police by the authorities in practice.

A Commons Select Committee was inquiring into fake news before the General Election caused the inquiry to be abandoned (along with all other business in Parliament). See https://www.parliament.uk/business/committees/committees-a-z/commons-select/culture-media-and-sport-committee/inquiries/parliament-2015/inquiry2/ . No report will be produced, but there was a substantial number of submissions to the inquiry. One that is particularly worth reading as it covers the abuses of financial commentators is present here: http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/culture-media-and-sport-committee/fake-news/written/48219.html

For example, it says: “Short selling and market abuse – FN (Fake News) is a short sellers dream.  Before the advent of online FN short sellers had to rely on word of mouth rumour and the occasional share tipster. Today the magnification possible wields instant and widespread damage.”

Note that I see no problem with short selling so long as it is not “naked” and where the seller has a genuinely held view on the financial prospects of a company. But the ability to affect market activity by issuing slanted news commentary from the market operator is surely dubious.

Bloggers and other “financial journalists” who comment on companies are often not regulated by the FCA, can operate behind anonymous front operations or from foreign jurisdictions that are not subject to UK libel laws. In any case UK libel laws are ineffective in tackling the abuses that can be propagated as the aforementioned article explains.

Such writers and their publishers actually have a financial motive sometimes to generate the most debate by making the most outrageous claims because this will generate more hits and links to their web site. That helps to sell advertising on the site, to attract more visitors, which generates more publicity and so the circle continues.

Regrettably the law is only slowly catching up with the problems created by social media. A story put on social media can get around the world several times in a few hours, while any legal action can take months.

These problems created by “fake news”, or simply somewhat inaccurate news, might be helped if there was some way to get the news corrected. But try asking Google to remove a false story or outrageous claim. They are unlikely to do so. They even resisted strongly the EU demand to support the “right to be forgotten” about the past history of individuals (even when palpably false) and even as implemented it is of limited use.

Now the defenders of this new world argue that it is necessary to avoid regulation so as to preserve free speech. But we have surely reached the point where fuller consideration of these issues needs to be undertaken. At present, the risk of abusive attacks is likely to inhibit people getting involved in public life so free speech and democracy will be undermined rather than protected.

These are undoubtedly complex issues, difficult to cover in a short article, let alone suggest some solutions. But what do readers think, without getting into a debate on the merits of short selling?

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

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ETFs and Index Trackers – More Dangerous Than You Think

Lots of financial pundits have encouraged investors to be “passive” investors rather than try to pick stocks, or invest in funds that do that latter (“active” funds). Even the FCA has recently criticised active funds for being more expensive and the additional management fees end up impacting negatively on overall returns over time. So persuasive writers such as John Bogle have convinced many to take the “no brainer” route of buying Exchange Traded Funds (ETFs) or other index tracking funds.

But there are surely dangers creeping up on all of us from this approach evidenced by several interesting articles in the Financial Times and Investors Chronicle in the last week.

On the 7th August John Plender in FTfm showed how index tracking funds break prudent portfolio rules. He warned about the concentration of holdings in Nasdaq stocks where the top five holdings (Apple, Google (Alphabet), Microsoft, Amazon and Facebook) represent 41 per cent of the index. He said “Concentration risk that is forbidden to an active manager is considered reasonable if it happens to be an index. This is dangerous nonsense”.

The Editor of Investors Chronicle published an editorial that warned that one of his worries was the huge inflows to passive funds and said “But I am concerned at the presentation of ETFs as an investment panacea because it has created the impression that investing is easy and riskless”. That is surely very true as private investors have simply bought more and more lately in a steadily rising market in recent years, driven by “momentum” trading styles. They don’t look at the valuations of what they are buying (hey – the index must be the best valuation is it not), they just buy and sell regardless based on trends. As the IC editor also said “What happens when the US bull market comes to an end?”. A good question indeed to which there is an obvious answer – a market crash as investors who have never been through a bear market capitulate.

Just today we have a front page article in the FT headlined “surging flows into exchange traded funds drive US stocks bubble anxiety”. It covers the record breaking in-flows into ETFs this year so far. It includes a good quote from Howard Marks of Oaktree Capital: “When the management of assets is on autopilot, as it is with ETFs, then investment trends can go to great excess”.

I certainly agree that investors need to examine very carefully the costs of the funds they invest in, if they do not wish to invest directly in shares. There may even be a place for index trackers in a portfolio – not that I hold any. But the real worry is that ETFs are now distorting the market and protecting yourself against that distortion, or from the likely collapse when everyone realises the emperor has no clothes, is not easy. It has led to a general rise in asset prices, in particular share prices, while simply staying out of the market while this is going on does not make much sense either.

The situation is surely analogous one of the causes of the great Wall Street crash of 1929 where “trusts” dominated the market and were sold to investors on the basis that they only went up. That was not helped by trusts investing in other trusts in a kind of pyramid scheme, and by low cost finance to purchase shares on margin – and we surely cannot get much lower interest rates than we have now. Restrictions on credit was one immediate cause of the 1929 crash, causing margin calls to be invoked and a spiral down.

There is no simple solution to protect oneself against the hysteria of momentum investing and index tracking, but the most vulnerable shares are undoubtedly those that form a large part of any index. Those are the ones where valuations may become unrealistic and where active traders may not feel it wise to try to sail against the wind. So the message is surely to look askance at unreasonably high valuations in relation to earning or cash flows in companies. Simply “buying the index” when everyone else is doing so is not a sound approach.

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

Disclaimer: Read the About page before relying on any information in this post.