New Corporate Governance Code – It Could Be Improved

I commented briefly earlier on the public consultation on a new UK Corporate Governance Code (see here: https://roliscon.blog/2017/12/05/new-corporate-governance-code/ ). I have now submitted a detailed response to the public consultation which you can read here: http://www.roliscon.com/Roliscon-Response-Corporate-Governance-Code.pdf

The main points I made therein are:

  1. I supported the inclusion of Chairmen in the 9-year rule after which they are no longer considered independent. But I think that period should also apply to tenure to avoid directors sticking around for too long.
  2. I am concerned about the wording that promotes diversity of gender, social and economic backgrounds in new board appointments. It appears to conflict with the requirement in law not to show any bias in selection (and quite rightly). Positive discrimination is as just as illegal as negative discrimination.
  3. I doubt that appointing a non-executive director to engage with the workface would be nearly as effective as the other two suggested methods of improving engagement.
  4. I question the approach to executive remuneration. It still does not discourage aggressive bonus schemes such as LTIPs and the ability of boards to retrospectively review awards (e.g. when the pay-outs turn out to be excessive) I consider to be quite unlikely to be effective in practice. The changes in this area are unlikely to stop the ramping up of pay levels to excessive levels.
  5. It perpetuates the myth that when companies need to engage with shareholders they can simply contact a “few major shareholders” to get their views. This does not work in most public companies nowadays because of the very diverse shareholder base, and also ignores all the private shareholders who could be the largest bloc. It should have proposed a more formal process such as a Shareholder Committee and disclosure on who has been consulted.
  6. It does not introduce restrictions on the appointment of directors with no knowledge of the sector in which the company operates. It perpetuates the English preference for “amateurs” versus “professionals”, i.e. assumes those who know less might be wiser.
  7. Likewise, it does not impose restrictions on the number of roles that directors should have.

In summary there are some improvements in the new Code, but more could have been done to improve the Governance of companies and toughen up the Code. Although I do not object to the principle of “comply or explain”, as there are always exceptions that justify some anomalies, I suggest there should be a requirement to provide more specific justifications for such exceptions. The excuses we get at present are often way too weak.

Readers are welcome to submit their own responses to the consultation. The more they receive from individual shareholders, the better. Feel free to “copy and paste” from my own submission.

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

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ADVFN AGM – How to Disenfranchise Shareholders, and OFCOM Interest

I was surprised yesterday to pick up an RNS Announcement from ADVFN Plc (AFN) stating that the company’s Annual General Meeting had taken place on that day and all resolutions were duly passed. I was surprised because as a shareholder in the company (and on the register), I had received no notification of the AGM and no proxy voting form either of course.

In addition there is no notice of the AGM given in any RNS announcement, and there is no information on it on the company’s web site. It’s an easy way to avoid folks from voting or turning up at the AGM – you simply don’t tell anyone about it!

Now admittedly I don’t hold many shares. I only bought a few in early 2017 because ADVFN were peripherally involved in a libel suit I was pursing (settled in the High Court on Thursday to my satisfaction – more on that another time). I thought it would be helpful to attend any General Meetings of the company to learn more about the business.

This might be one of my best investments in 2017. Share price when purchased was 27.4p, share price now is 39.5p (i.e. up 44%). But the price did fall 9% yesterday, so perhaps other folks did attend the AGM and asked some awkward questions. If any readers of this blog did so, a report on the meeting would be helpful.

ADVFN run investment information platforms including a popular bulletin board. Profits have been non-existent for most of the last few years, but revenue was £8.2 million last year so the current market cap of £10.5 million is not totally bonkers. The company also indicated it was now focusing on profits rather than growth so results might improve – or at least they might not run out of cash and need to do more fund raising although the picture is not totally clear. One reason for the share price rise was probably the announcement by the company of a cryptocurrency project, using blockchain technology. The application is for a digital wallet to support a social media cryptocurrency. Although it is not altogether apparent who might use that and what the benefits might be, it appears to possibly be a way to support micropayment services for blog contributions. Any company that can claim involvement in the blockchain/cryptocurrency world gets their share price inflated it seems. It’s another “bubble” just like the Bitcoin price.

There has been a lot of public debate about the problem of “fake news” on social media and the failure to remove abusive content or more generally censor irresponsible stories. Financial bulletin boards and blogs are one part of this world of dubious content often posted by anonymous contributors who frequently get their facts wrong. And sometimes possibly deliberately so.

One interesting comment last week was from the Chairman of OFCOM, the media regulator. Patricia Hodgson said internet businesses such as Google and Facebook are “publishers” and not simply “platforms”. In other words, they might be responsible for their content after all. Ofcom are considering the issues although she indicated it was for Government to decide on any action in this area and OFCOM probably do not have the resources at present to cover it. But businesses such as ADVFN might find they are caught up with any general media regulation even though they have so far avoided interference from financial regulators such as the FCA – why that is so I have never understood.

Freedom of the press is a meritorious policy, but the internet has introduced numerous problems such as “trolls” who abuse folks in public often for dubious motives. Politicians are frequently attacked now (death threats are common for example) so we might see some action from them once the politics of Brexit are out of the way.

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

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Standard Life UK Smaller Companies and FRC Meetings

Yesterday I attended two meetings in the City of London. Here are brief reports on each.

Standard Life UK Smaller Companies Trust Plc (SLS) held a meeting for investors to “meet the manager” in London as their AGM was in Edinburgh this year – only about 10 people attended the latter so there were more in London. I have held this trust for some years and the manager, Harry Nimmo, who has been with the company for 33 years has been a consistently good performer. The management company has recently merged with Aberdeen and is now called Aberdeen Standard Investments but apparently there have been no significant changes internally as yet. Mr Nimmo’s comments are summarised below.

He said they have a discount control policy which is unique to UK smaller companies trusts. They buy back shares if the discount gets about 8%. The investment policy is unchanged and they are not keen on blue-sky or concept stocks. AIM is now a better place than 5 years ago as it is now more broadly based and no longer dominated by mining stocks and blue sky tech stocks.

They have put a new debt facility in place which will ultimately replace their CULS (Convertible Unsecured Loan Stock). The final date for conversion is coming up and investors need to pay attention to that as they are “well in the money”.

The trust shows a ten year CAGR dividend growth of 23.7% and the capital return since 2003 is 851% (plus dividends of course). But there have been some bear markets during his management which one needs to allow for as investors. However, if you had sold the trust after the Brexit vote you would have made a terrible mistake – the company is up 54% since June 2016.

The trust looks for companies that can grow irrespective of the economic cycle, and those with good cash flow and strong balance sheets. Mr Nimmo covered their investment process which is somewhat formulaic using a screening process (I have covered it in past articles) but they do meet investee companies twice a year. They have about 50 holdings in the fund which is a “bottom-up” stock selection actively managed fund.

He mentioned they have 10% in animal care and still hold NMC although as it is now a FTSE-100 stock they have been selling out. They still have a large holding in Abcam and have bought RWS recently. Their second largest holding is First Derivatives where most profits come from outside the UK. They generally do not hold oil/gas/mining stocks and are very light on real-estate [note: I agree with the former and many of my individual holdings overlap with the trusts but I do hold some real estate companies]. An exception though is Workspace who recently produced an excellent set of results with a rapid growth in dividends.

They have also been selling Fevertree as it exceeded 5% of their portfolio value.

I did not manage to stay until the Q&A session as I had to go to a meeting organised jointly by ShareSoc and UKSA with the Financial Reporting Council (FRC). This was a long meeting and I hope one or other organisations will produce a lengthier report on it because it was an exceedingly useful meeting. I will simply highlight a few points of particular interest.

FRC Meeting

The FRC is responsible for audit policy, standard setting and audit quality including investigation and enforcement of past transgressions. So it is a rather important body for those private investors who have come unstuck on an investment because the accounts of the company turned out to be misleading – for example the recent debacle at Carillion was mentioned by one attendee, but I can think of numerous other examples.

The speakers covered the role of audits, both currently and how they might develop in the future (partly as a result of technology changes such as the use of data analytics). After Brexit it is likely there will be a broadly equivalent regime as investors are opposed to “unpicking”.

The FRC reviews about 150 audits every year and grades them into four categories (the reviews are listed on the FRC web site). By 2019 they want 90% to be in the top two ratings which they are not at present. It was noted that KPMG come out worse of the big audit firms. A common reason for audits falling short are lack of professional scepticism.

The FRC also undertakes thematic reviews of particular issues. I raised the issue of the lack of common standards for “adjusted” data commonly reported by companies (such as earnings, or return on capital that I mentioned in previous recent blog posts). The response was it was mandated to explain the definitions of such adjustments but I pointed out this did not help with comparability (e.g. of broker forecasts). The FRC said they will be consulting on this issue shortly, which is good news.

The role of the FRC in “enforcement” was covered. They stressed that their remit does not cover crime, they merely regulate accountants and actuaries although it is of course true that the failure of auditors to identify false accounts is one area they often investigate. It was mentioned that the size of the team on this had grown from 11 people in 2013 to 30 now and they are still looking for more bodies. This really just shows how under-resourced the FRC has been in the past. A total budget of £15m per year was mentioned. Comment: this seems hopelessly inadequate to me bearing in mind the number of public companies (and other organisations) and the number of auditors they have to monitor. It explains partly why complaints to the FRC often seem to disappear into a black hole, or why investigations often take so long as to be pointless. A list of cases under formal investigation is on the FRC web site (See here for that and two linked pages for the full list: https://www.frc.org.uk/auditors/enforcement-division/current-cases-accountancy-scheme which of course will tell you that Globo was commenced in December 2015 and Quindell in August 2015 and have yet to report).

I did suggest to the speaker that the FRC should be a party to the Code of Practice for Victims of Crime (as some audit failures involve the crime of fraud) as the Police, the SFO and FCA are, and which has improved their disclosure culture. This might assist those who report failings to get some feedback on the progress of a case. But the FRC argue that their role is not to investigate crime as such and they are inhibited by legislation/regulation on what they can disclose. However it is very clear to me that too often complaints get made to the FRC, but the complainants are not advised of progress and often have no idea on the outcome. This is an issue they will be looking at.

They hope the extra staffing will speed up investigations. The investigation process was discussed, but for example, Carillion had not even been placed under formal investigation as yet. It was suggested by audience members that the FRC was quite ineffective but recent cases such as AssetCo and Healthcare Locums were mentioned as demonstrating strong action and they have issued fines of £12 million in the last year which is the biggest ever. It was mentioned that fines go to the Treasury which is not ideal.

Confusion between the different regulatory bodies (e.g. the FRC, FCA, SFO, etc) was mentioned by attendees and the speakers, not helped by similar three letter acronyms. One attendee suggested that a unified regulatory body would help (such as the SEC in the USA). Comment: I agree at present it is unclear except to experts on who is responsible for what and the accountability of these bodies to the Government or to any democratic body of investors.

The FRC also has an interest in the UK Corporate Governance Code and the Stewardship Code. A consultation on a new Corporate Governance Code is imminent. There was also a session on the role of the Financial Reporting Lab where both ShareSoc and UKSA members have been involved in the past.

I’ll have to stop here because the budget speech by the Chancellor will commence soon and I wish to listen to it as there may be some major changes on investment tax reliefs. I’ll do another blog post later on it.

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

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National Grid, Johnston Press, Crown Place VCT, Lloyds Bank, LoopUp and Brexit

I had a busy day yesterday, but let me first comment on the news today. National Grid (NG.) published their half year results this morning. They reported “Adjusted operating profit, excluding timing up 4%….” but statutory earnings per share were down by 12%. What exactly does “adjusted for timing” mean? I have no idea because the announcement does not explain it in any sensible way. For example, it says under “UK Timing”: “Revenues will be impacted by timing of recoveries including impacts from prior years”. Why are these revenues not being booked in the relevant period? Why are they not being recognised as revenues in the period concerned? Looks like a simple “fudge” to me as “adjustments” to reported figures in accounts often are. Many analysts seem to have a negative view of the stock, and I am coming to the same conclusion. I sold some of my holding in the company this morning.

I have previously mentioned the requisition of an EGM at Johnston Press (JPR), but the company has rejected this on the basis that it is “not valid”. It seems this is because the shareholder who requested it holds their shares in a nominee account (i.e. are not on the register). Yet another example of the obstruction caused by the use of nominee accounts. Changes to the law in this area are required to fully enfranchise all shareholders. See the ShareSoc Shareholder Rights campaign for more information: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Yesterday morning I attended the AGM of Crown Place VCT, managed by Albion Capital. No excitement there. Just a competently managed VCT and a well run AGM with a presentation from one of their investee companies (PayAsUGym) who have developed an innovative business selling gym sessions. Crown Place made a total return of !4% last year and currently provide a tax free dividend yield of 6.9% which is covered twice by earnings. The expense ratio is 2.4% which is certainly better than many of the VCTs I hold. Previously this company had a strong focus on “asset-based” investments but they are now restricted by the new rules for VCTs so they are moving into more “exciting” fields. There are also concerns about further rule changes or removal of tax reliefs in the budget next Wednesday. Investors in tax incentivised vehicles seem to be getting nervous.

After lunch with representatives of AGMInfo, I filled an hour or so before the ShareSoc AGM by dropping into the Lloyds Bank legal action nearby which I have mentioned in previous blog posts. On the witness stand was former CEO of Lloyds TSB Eric Daniels being cross examined by the littigants QC. He gave a confident performance and was clearly well prepared. He said he was “bitterly disappointed” over the need to raise £7 billion in capital and was also disappointed that they would end up more highly capitalised than other banks. It was clear from his other comments that there was a certain momentum to go through with the deal (the acquisition of HBOS) and that they did not revisit the benefits of the transaction at every turn (e.g. as more information came out of the due diligence work for example).

He disclosed that in a conversation with the FSA there were real concerns that they could lose the vote of shareholders. This could be because there were views that HBOS could remain independent, although the Government had already indicated that it was promptly going to be nationalised if no rescue deal could be done; and because Lloyds TSB shareholders might vote against it.

The case continues. Lloyds Bank and the former directors continue to say that the claims have no merit of course.

It was then onto the ShareSoc AGM. Again no great excitement there. Mention was made of a possible merger with UKSA and as a former director of both I spoke in favour of that. Spreading the fixed costs over two organisations of a similar size makes a lot of sense. It should never have been necessary to set up a rival organisation to UKSA, but interesting to note that ShareSoc has more members now so my efforts in recent years were not in vain.

The ShareSoc AGM was followed by one of their company presentation seminars. Of interest to me (being current holders) were the two by LoopUp (LOOP) and Ideagen. I reported on Ideagen recently on coverage of their AGM so will only cover LoopUp herein. The presentation by their joint CEO Steve Flavell was slick but it was more a sales pitch for the product/service to customers than one to investors. The issue of them having two joint CEOs was raised in a question later.

The emphasis was on the simplicity of the service, so anyone could take it up easily and quickly. This is the major USP as there are lots of other conferencing products around. Most interesting was his explanation that they leapfrogged the “chasm” by ignoring the early adopters (who often like techy products) by aiming straight for the “mainstream majority”. His reference to “Crossing the Chasm” is from a book of that name by Geoffrey Moore which is essential reading for all sales/marketing executives in the software field, or investors in early stage technology companies likewise. Just had a chat with an Uber driver about this book – he has a degree in marketing – that’s the modern world for you. It will be a great shame if Sadiq Khan manages to put Uber out of business – might miss out on intelligent conversations with cab drivers. I read the book when it first came out back in the 1990s and Mr Flavell had read it also. I highly recommend the book. LoopUp is clearly a sales/marketing driven organisation but the technology is sophisticated enough to make it all look simple.

On the current valuation, the company has obviously a long way to go to grow into that valuation. Questions were raised about whether growth could be accelerated (revenue only up 39% in 2016m and 44% in the interims this year). But I expressed scepiticsm on attempts at a faster growth rate to Flavell after the meeting.

The Financial Times continue to publish anti-Brexit stories and editorial every day. My letter to the editor on the dubious bias, which they published, has obviously had no impact whatsoever. Tim Martin, CEO of JD Wetherspoon, had a lot to say about the subject of the impact of Brexit on food costs in his latest trading statement. He accused the media, and the Chairman of Sainsburys and that of Whitbread, and the head of the CBI, for completely distorting the facts. Rather than food prices rising after Brexit, he suggests they will fall. For his arguments see:

https://www.investegate.co.uk/wetherspoon–jd–plc–jdw-/rns/fy18-q1-trading-update/201711080700068513V/

My conclusion is quite simply that some foods might become more expensive, others might become cheaper, and home-produced products might also be cheaper; plus the Government might be able to save a lot of money on contributions to subsidising inefficient farmers. But that of course means that food buying habits might change as consumers react to price changes. Is that a bad thing? Readers can ponder that question.

Whether the Chairmen or CEOs of public companies should be making comments on essentially political issues, one way or the other, is also a question to consider. I suggest that might best be left to bloggers like me. Sainsburys and Whitbread (Costa, Premier Inns) might find they disaffect half their customers while having minimal impact on public opinion.

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

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On-Line AGMs and City of London IT

I mentioned in a previous article the growing concerns about the use of “virtual” Annual General Meetings (AGMs) in the USA. There are not many on-line AGMs yet in the UK but yesterday there was a good example at the City of London Investment Trust (CTY). I actually had to complain to the company last year about the defects when I attempted to attend it on-line rather than in person – it did not work on the day, plus a later recording that was available had all the Q&A part cut out.

This year it was better, but a long way from perfect. Parts of fund manager Job Curtis’s presentation could not be heard. But at least it gave shareholders the opportunity to attend in person, or attend on-line. Questions could be submitted on-line.

Here’s a brief report on the company and the AGM:

The City of London IT is probably the most boring holding in my portfolio. It invests mainly in large cap UK listed companies. Top ten holdings are British American Tobacco, Royal Dutch Shell, HSBC, Diageo, Unilever, Vodafone, Prudential, GlaxoSmithKline, Lloyds Banking Group and BP, totalling 32% of the portfolio. It’s in the “UK Equity Income” sector for trusts. So you can see it’s not going to be any racehorse as these are quite defensive stocks. However the performance over many years has been good and it tends to outperform its benchmark. Not last year though where it underperformed the benchmark but still managed to achieve a total return of 14.5% (All-Share was up 18.1% for example with growth and smaller cap stocks more in fashion in a buoyant market). The current yield is 3.9%.

Here’s a few comments from fund manager Job Curtis from his presentation who has been with the fund management company (Henderson) for 26 years. He mentioned the fact that dividends have grown every year for more than 50 years. They manage this by keeping some cash back in revenue reserves in good years, which are then used to pay dividends in the bad years.

They use gearing and last year moved up the gearing to 7% by taking advantage of the very low interest rates – they are now borrowing at 2.4% over 32 years. (Note: have mentioned before how astonishing it is that such trusts can borrow at rates lower than inflation and for long periods).

Job Curtis said their on-going charge figure was now 0.42% which is the lowest in the equity income sector.

Positive contributors to performance last year were housebuilders (they hold three – Persimmon, Taylor Wimpey and Berkeley) and pharmaceuticals (Glaxo and AstraZeneca, but they also hold Merck, Johnson & Johnson and Novartis). They also benefited from a below average exposure to oil and gas producers. Detractors from performance were banks, mining companies and a holding in Provident Financial which they have now sold.

There were few questions in the Q&A session (a good indication that shareholders are happy), and you can hear those and the rest of the event by going to this web site: www.janushenderson.com/trustslive .

Certainly this format provides a good approach for those investors who cannot easily get to AGMs, while not prejudicing those who wish to attend in person and chat to the directors. They do need to iron out the technical glitches though.

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

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Lloyds Case Impressions, Ideagen AGM and Return on Capital

Yesterday I attended the Annual General Meeting of Ideagen (IDEA) at 12.00 noon in the City of London – see below – and afterwards spent an hour in the High Court listening to one of the witnesses being cross-examined in the Lloyds Banking Group case. What follows is just an impression of the scene because the whole case is running for months so in no way can this be considered a comprehensive report. I have covered some more details of the case in previous articles, but to remind you the litigants are suing Lloyds and the former directors of the company over the takeover of HBOS which they declare was contrary to their interests as shareholders in Lloyds TSB. Lloyds deny liability.

The case is being heard in the Rolls Building in New Fetter Lane – a modern building very different to the ultra Victorian main Courts of Justice building in the Strand. See this link for a video tour of the building: https://www.judiciary.gov.uk/you-and-the-judiciary/going-to-court/high-court/the-rolls-building/virtual-tour/

The witness being cross-examined on the day was Tim Tookey, the former Finance Director of Lloyds TSB. Richard Hill QC was undertaking the task for the litigants under the eyes of a single judge, Mr Justice Norris (sans wig). It was a pretty impressive scene with at least 6 barristers in wigs and gowns plus about another 10 supporting legal staff. Why do barristers still wear wigs? To quote from the web: “The courts didn’t officially add wigs to the legal dress code until the 18th century when they became culturally chic. … They continue to wear them because nobody has ever told them to stop”.

It was a pretty impressive scene, somewhat lost on the few members of the public present – half a dozen litigants and members of the press. But the court was digitally up to date with every desk holding a screen on which the written evidence was displayed as it was invoked. However the witness being cross examined still referred to a paper copy, extracted from 150 large A4 binders stored in shelves on the left hand side of the court – filling almost the whole wall.

Mr Tookey gave his responses to questions firmly and without emotion. A confident witness giving clear answers. He was questioned about the events leading up to the announcement of the acquisition of HBOS and over how much capital Lloyds anticipated would be required to ensure the deal was “bullet-proof” (i.e. not creating unacceptable risks if the economic circumstances worsened). He was questioned about the extent the risks had been considered and whether enough due diligence on HBOS had been done before the decision was taken to proceed. Apparently it came down to a decision at 4.00 am on a Monday morning to proceed. They we being forced to decide to proceed or not by the Government before the markets opened on Monday. But he said that he thought all the risks had been considered and the board was supportive of the deal because of the strategic advantages of the HBOS takeover in the longer term. Recapitalisation involving the Government was necessary because there was no way it was possible to raise even £3 billion (underwritten) by the Monday, which was the minimum requirement. Government involvement “de-risked” the deal. The case continues….. for another dozen weeks.

One can see from the above exactly why the costs of such cases are so enormous.

Ideagen AGM

Ideagen (IDEA) is a software company in the Governance, Risk and Compliance sector. I have held the shares for some years when it has grown revenue and profits considerably, both from acquisitions and organic growth. They have a strong emphasis on the importance of recurring revenue. They are presenting at the ShareSoc Seminar on the 8th November, although that event is fully booked I understand.

There were fewer sharesholders at the Ideagen AGM than members of the public at the Lloyds hearing, but that’s not exceptional for small companies. But it was still a useful event – a brief report follows.

One question I raised was about return on capital. Now you might think this was prompted by an interesting article on that subject by Leon Boros in the latest ShareSoc Newsletter, but I did not get around to reading that until later in the day so it’s somewhat of a coincidence. Leon compared the return on capital at Bioventix (one of his favourite stocks which he likes to talk about regularly), and YouGov. He pointed out that not only are measures such as Return on Equity (ROE), Return on Capital Employed (ROCE) and Return on Assets (ROA) better at Bioventix calculated on the headline numbers, but that those for YouGov are somewhat doubtful because they capitalise and amortise the cost of recruitment of their survey panels. Plus they capitalise and amortise software development costs. But they then produce adjusted earnings figures that excluded the amortisation of both those costs, effectively pretending they are not real costs. He has a point.

Now I always look at returns on capital when I am investing in new companies because I consider it one of the most important measures of a company’s performance – as I told the directors of Ideagen. Hence at the Ideagen AGM I asked a question on that subject. On page 18 of their Annual Report they give the “Key Performance Indicators”, 9 of them, that the directors use to monitor the performance of the company. They all look good, but none of them measure return on capital. Should they not include a return on capital measure?

In reality the headline figures for ROE, ROCE and ROA reported by Stockopedia for Ideagen are all less than 2%, and that ignores even the large number of shares under option that the company has that would dilute the earnings. The reason for this is partly the fact that the profit measures used are “unadjusted” and as the company has very substantial amortisation of goodwill from past acquisations, and £1.2 million of share-based payment charges, these distort the numbers. The CEO David Hornsby, responded with “what measure would I like to use?” to which I responded that I did not mind so long as it was consistent from year-to-year. Companies often publish such figures, which are frequently based on “adjusted” profits. I also suggested cash return on assets might be a good measure, something I also look at.

The company actually generated Net Cash From Operating Activities of £8.3m last year which on Net Assets of £30m at the start of the year is very respectable, although technically one should probably write back the cost of past acquisitions that have been written off. In addition some of the cash generated was spent on contingent consideration on past acquistions and on “development costs” which they class as “investing activities”. This demonstrates that for some businesses, looking at headline return on capital figures or those reported by financial web sites can be misleading. One needs to look at the detail to get a real understanding on what is going on in such a business.

A short debate on the issue followed. Otherwise after a couple of other questions, the CEO mentioned the half year for the company ends today, and shareholders should be very pleased with the results.

In summary, a short AGM meeting, but a useful one. And the ShareSoc newsletter is well worth reading – it even includes some articles from me.

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

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Lloyds Litigation, Collective Redress, and CLIG AGM

I went to the High Court in London this morning to hear the grilling of witnesses in the case brought by shareholders over the acquisition of HBOS by Lloyds. But I was disappointed to find when I got there that the first session was to be held in private – presumably the judge wants to discuss some legal issues with counsel for both sides. So I went to the AGM of City of London Investment Group (CLIG) instead where I hold shares.

The aforementioned legal case will be running for some weeks yet to hear various witnesses – it’s being held in Court 15 at the Rolls building in Fetter Lane if anyone cares to drop in. I shall try to visit another day when I am in London.

This was the first opportunity I had to attend the Lloyds hearing but the national media have reported the opening submissions by the respective QCs. To remind you this is a case where disgruntled former Lloyds TSB shareholders are suing the former directors (Sir Victor Blank, Eric Daniels, Truett Tate, et al), and Lloyds Banking Group as a company, over the takeover of HBOS in 2008. This resulted, directly or indirectly, in a massive share price decline and the cessation of dividends. The commercial loan book of HBOS turned out to be very poor quality, and Lloyds had to take on more capital to meet its capital ratio requirements.

What’s the legal basis of the claim? Simply that the prospectus issued to Lloyds TSB shareholders at the time was defective. Among other things that it failed to disclose the true position of HBOS and the fact that the company had received emergency funding in the form of secret loans from the Bank of England, the US Federal Reserve and Lloyds. A prospectus needs to be honest, not misleading and not omit significant information. The litigant’s QC, Richard Hill, said that “shareholders were indeed mugged”. He also argued that Lloyds was under pressure from the Government to conclude the deal, otherwise HBOS would have had to be nationalised because it was on the verge of collapse, when the directors of Lloyds loyalties should have been to their shareholders.

The defendents QC argued the claims have no merit because it was in the best interest of shareholders. In addition, that they would have voted for it regardless if they had been aware of the aforementioned loans. Bearing in mind that a lot of institutional investors held both Lloyds and HBOS, you can understand that point perhaps. The usual defence of the directors having taken expert advice on the matter from a host of advisors has been invoked, but how they can overcome the defective prospectus argument remains to be seen.

Now one topical item of news today is the disclosure that the EU is looking at establishing a pan-European framework for collective redress. See this press release from shareholder representative organisation Better Finance for more details: http://betterfinance.eu/fileadmin/user_upload/documents/Press_Releases/en/Financial_services_users/PR_-_COLLECTIVE_REDRESS_-_231017.pdf

There are many difficulties in the way of shareholders pursuing litigation or enforcement action over investment abuses. One just has to look at the HBOS/Lloyds case and the Royal Bank of Scotland (RBS) cases to see how difficult and expensive they are. The RBS case, which was a similar claim over the prospectus issued in 2008, has recently been settled. But only a minority of shareholders affected are likely to get compensation, and it will only be a small proportion of their losses. Legal and other costs will consume a large proportion. One only has to look at the time these cases have taken to get into, or near, a Court (nine years) that tells you there is something seriously defective in the process. Many of the claimants are likely to have died in the meantime as the shares of these banks were typically purchased by pensioners for retirement income.

The problem is the UK has no direct equivalent of a US “class action”, or the arrangements for collective cases as operates in Holland. There are “Group Litigation Orders” in the UK, but these are not directly equivalent and the Lloyds and RBS cases have relied on a representative group of litigants. Many other European countries have similar problems. So this initiative looks potentially useful, although if Brexit proceeds, the UK might miss out on participating in this concept, albeit that it might be many years before it progresses into reality because changing legal systems in a country can be complex and is often resisted by vested interests. Simplifying legal processes is not always in the interests of lawyers for example.

The complexity and length of the legal processes, and the difficulty in raising funds to finance such cases, as evidenced by the Lloyds and RBS cases, surely demonstrates that reform is necessary. But it will be interesting to see the outcome of the Lloyds case.

Just brief coverage of the CLIG AGM follows. There were about half a dozen shareholders present, but the company was also holding a seminar for investors (current and potential) in the afternoon so I presume most people would have gone to that instead.

CLIG is an investment company that specialises in holding closed end investment companies (e.g. investment trusts), with a large exposure to the far-east. The CEO is long standing director Barry Oliff who is finally planning to retire in a couple of years time, so one question raised was about succession planning – it is in motion apparently. As one shareholder intimated, it will be important to maintain the culture that Barry Oliff has established where there is great openness about the performance of the company (comprehensive disclosure of the business model and the likely outcome of profit trends). Barry even tells shareholders at what price he will be selling some of his large shareholding and when.

This company regularly gets substantial votes against its Remuneration Report, and it was no different this year. Two million proxy votes against, no doubt by institutions prompted by proxy advistors because they have a bonus scheme which does not follow the normal rules. It is more group performance related, than individual person related. They choose to be “different”. Barry explained that he thought individual targets provided the wrong incentives and that group bonuses encourage staff and customer retention. Another director said it was more like a traditional “partnership”.

Anyway the shareholders are probably happy because the share price has increased over the last year and the dividend (already high) has been increased for the first time in five years.

As I intimated in another recent blog post, it is always useful to attend AGMs, and this one was no different. According to a report in the FT, a number of US companies are moving to “virtual” AGMs, but are getting some objections from shareholders. Surely the best solution is to combine the physical meeting with an on-line equivalent so you get the best of both worlds. A virtual on-line meeting can be usefui for those shareholders who have difficulty in attending in person, but certainly actually meeting the directors is more useful in many ways.

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

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