Burford, GE and Media Regulation

As most readers will be aware, Burford Capital (BUR) has been under attack by Muddy Waters over its accounts, corporate governance and other matters. Muddy Waters, led by Carson Black, has been shorting the stock. Now we have a similar attack on venerable US company General Electric (GE) who have been accused by Harry Markopolos of false accounting over liabilities on long-term care insurance policies. This caused the share price of GE to drop by 11% on one day last week. You can see Harry talking about his report on CNN here: https://www.youtube.com/watch?v=MGvsXPY26KI

As in the Burford case, the accusers have not bothered to contact the companies they are attacking before publishing their accusations. I have previously pointed out this is bad journalistic practice because it’s easy to make mistakes over simple facts particularly when relying on third party sources who can often be unreliable.

The Problem

These are just two of numerous such examples over the last few years including some in which I had an interest. Sometimes the allegations escalate to the point that a company is severely damaged and never recovers. Or the business is revealed to be a simple fraud – as in the case of Globo. But sometimes the allegations go nowhere and the companies recover. For example, Carson Black attacked a number of Chinese companies listed in the USA before 2012 including Orient Paper. The company hired third parties to investigate the claims and showed they were of little substance and the SEC took no action although the company did settle some civil claims against it over the matter.

A similar UK case was that of Blinkx – subsequently renamed RhythmOne (RTHM) and recently taken over by Taptica. The allegations here were that video advertising revenue was often fictitious in that and other similar companies and the whole sector came under suspicion although many of the allegations were false or based on innuendo. A lengthy period ensued of claim and counter-claim but no action arose by the regulatory authorities – the FCA or AIM regulators. The share price did recover but only after a long period and after significant changes at the company. Investors in the shares were unable to quickly separate fact from fiction about the allegations and hence many investors sold out – that is similar to events in the Burford case where it might be many months before any conclusions are reached by the relevant regulatory authorities and the share price remains depressed.

These attacks on companies are often publicised by the media – both the traditional paper press and by on-line news sites of which there are many in the financial world (this blog alone might be considered one such of course). As any journalist will tell you, “bad news” stories tend to gain more public attention than “good news” stories. Exaggeration and hyperbole are common because by doing so the web sites attract attention and hence more readers or subscribers – in effect these stories are often “clickbait” in current parlance.

Clearly the motive for many of these attacks, and why the attackers do not contact the companies concerned before promoting their stories, are financial. The attackers hope to make money from shorting the stock, or advising others to do so. In the case of Blinkx, the attack was based on evidence provided by a third party who had a direct financial interest in supplying the required information.

Needless to point out perhaps that the traditional national media such as newspapers have always paid for stories although paying criminals or police officers for stories is viewed with disdain. But newspapers do usually try to corroborate facts before they publish and usually invite comments from those attacked.

Which brings us on to how the more traditional media are regulated to avoid the abuses that one sees in the blogosphere.

OFCOM regulates television and radio, including “catch-up” services, i.e. “broadcast” media. It now covers the BBC although one sometimes might not realise it. OFCOM requires programme makers to show “due impartiality and due accuracy” without “undue prominence of views and opinions”. See https://tinyurl.com/mazam3q where there is extensive guidance.

OFCOM does not regulate on-line media so video programmes on YouTube are not regulated in any way by an independent third party. YouTube only has its own guidelines which it tries to enforce against harmful content, but it has opposed any suggestions of outside regulation. As OFCOM says in its own report on Addressing Harmful Online Content, “While regulation has evolved, most online content is subject to little or no specific regulation”. In reality such media of all kinds and covering so many subjects have grown at an enormous rate in recent years and have reached the point that regulating it as is done with broadcast media would be very difficult.

The traditional paper press are regulated by either IPSO or IMPRESS which were set up relatively recently (by 2016) after the Leveson Inquiry. IPSO has a Code of Practice for Editors for example that covers such matters as accuracy. It includes these requirements: “(i) The Press must take care not to publish inaccurate, misleading or distorted information or images, including headlines not supported by the text; (ii) A significant inaccuracy, misleading statement or distortion must be corrected, promptly and with due prominence, and — where appropriate — an apology published. In cases involving IPSO, due prominence should be as required by the regulator; (iii) A fair opportunity to reply to significant inaccuracies should be given, when reasonably called for; and (iv) The Press, while free to editorialise and campaign, must distinguish clearly between comment, conjecture and fact”. IMPRESS has a similar “Standards Code”.

IPOS and IMPRESS are effectively voluntary schemes unlike OFCOM which was created by an Act of Parliament. As a result they are often seen as relatively toothless and the printed press have more ability to promote comment and less necessity to be “fair” than the broadcasting organisations. So for example the Daily Telegraph ran the GE story under the headline “Did Jack Welch build his GE house on sand?” with a sub-title of “A financial investigator has accused America’s best known industrial giant of accounting jiggery-pokery” with extensive coverage of the allegations although they did cover some of the rebuttals from the company. But asking loaded questions that promote the allegations is simply a rhetorical way around the rules. Such questions are similar to that of the question, “when did you stop beating your wife” which is difficult to answer without acknowledging the allegation.

What other things might inhibit on-line media? Libel law is one although few companies will pursue that avenue because: 1) It is very expensive; 2) It takes many months, if not years, to conclude such legal actions and 3) the associated negative publicity can simply compound the problem. In addition UK companies would have great difficulty pursuing those based in the USA or in other foreign countries where libel laws are less strict about the burden of proof. As the internet is a global service and content can be published and hosted on servers in numerous countries, that compounds the difficulties faced by the accused.

Financial regulators have some capabilities to stop market abuse. The Financial Conduct Authority (FCA) has powers under the Market Abuse Regulations (MAR) to prevent Market Abuse. To quote from the FCA: “Market abuse is a concept that encompasses unlawful behaviour in the financial markets and, for the purposes of this Regulation, it should be understood to consist of insider dealing, unlawful disclosure of inside information and market manipulation”. That covers a wide spread of media and covers the use of bulletin boards to disseminate false information. In reality although the FCA’s Handbook would appear to give it powers over market manipulation where false or inaccurate information is being published with the purpose of affecting share prices, the FCA seems remarkably reluctant to use those powers. In addition, there is the question where the story is complex (as most financial ones are), whether the treatment is fair or not. That is often a matter of judgement and can be disputed for a long time before any conclusion is reached. Financial regulators are typically unwilling to get into such minefields. Investigating such matters can take large resources in any regulator when they often have more obvious and urgent frauds to deal with, and very limited resources to pursue them.

You can see from all of the above that there are very limited deterrents to those seeking to profit from alleged failings in companies, and even fewer deterrents to ensure that what they promote to the public is always accurate, fair and reasonable.

Discouragement in advance of publication of articles on the internet is not there and penalties afterwards are non-existent except in very rare circumstances. Internet publishers are simply not regulated in any meaningful sense and you or I could publish pretty well anything on the web so long as it was not criminal (e.g. “hate speech” or “extreme pornography”). Criminal libel was removed from UK law in 2010, when the Coroners and Justice Act 2009 came into effect and abolished the offences of sedition and seditious libel, defamatory libel and obscene libel. Libel can only now be pursued in the UK under civil law by the offended with only damages being awarded if the complaint is upheld. Such actions have to take place in the High Court which means they are very expensive even for trivial complaints. Newspapers appear to be willing to afford the risk of large damages they sometimes incur for the sake of a “good story”, and many on-line bloggers have few financial resources that would even cover the legal costs of a successful case.

Fixing the Problem

What could be done to improve the situation and bring more morality back into this area of the financial markets? I suggest the following should be considered:

  1. An offence of criminal libel be introduced where any person or organisation makes false allegations from which they or associates may financially benefit directly or indirectly (e.g. by boosting readership), or when they repeat such allegations made by third parties.
  2. The above offence would impose an obligation on publishers to check their facts with third parties including a company which is the subject of the story before publication while allowing the company reasonable time to respond.
  3. Where an organisation is the publisher of financial commentary, rather than an individual, then they would be required to be licensed by a body such as OFCOM and be required to adhere to a code of conduct laid down by that body. This would need to cover those who run financial information web sites, bulletin boards and chat-rooms. The code of conduct would need to be similar to that for broadcasting organisations and would require an obligation to quickly remove for review any article that was the subject of a complaint. It would need to be made clear that reference to “publishers” would need to encompass those who not just had editorial responsibility and control over content but also those who simply hosted comments or stories from others, i.e. Facebook and most bulletin boards and blogging sites would be treated as publishers and not be able to use the excuse that they were simply technically hosting a service and not providing content.
  4. There should be a specific obligation imposed on directors of companies, and on their auditors, to investigate allegations of fraud or misconduct when it is brought to their attention whether or not there is an intention to publish the information. The directors should also immediately request suspension of the shares when serious allegations are made until some clarity on the credibility of the allegations is reached (this is so as to avoid sales by directors before publication of the claims, or share trading by those making the claims).

Note that such laws and regulations would not necessarily totally prevent those based overseas from publishing false allegations but it would certainly inhibit the circulation of the allegations within the UK and hence reduce the impact on financial markets in this country.

Would it allow frauds to remain undiscovered, and shareholders to remain in the dark about misleading accounts? If the allegations were true then clearly not as truth would be a good defence, and investigations by company directors and their auditors would reveal truths that could not be concealed.

Could it inhibit individuals from posting their comments or opinions on the web? It would be unlikely to do so but any organisation that published the comments on a financial subject would need to take responsibility for the content, and have systems to ensure very quick review and removal of offending items – most financial web sites already have such systems in place. But they might take steps to ensure they know who is publishing the information whereas at present anonymous malicious posts are common. Anyone who repeatedly makes false allegations could then be blacklisted.

Is introducing the criminal law into libel a disproportionate remedy? When the amount of money that can be made by financial market abuse is so large, and the alternative remedies so ineffective, it is surely appropriate to toughen up the regime. The penalties for abuse need to be substantially increased. Would the police or regulatory authorities have the resources to pursue such matters? Probably not but the solution to that might be to permit private prosecutions.

It is interesting to note that the Daily Telegraph reported recently (on 17/8/2019) on a private prosecution by Steve Egan against brothers Jason and Justin Drummond over alleged fraud at a company called Media Corporation (MDC) where they were directors. That company’s shares were delisted from AIM in 2013 and the company ceased its internet and gaming operations soon after and transmogrified in an investment company. I covered the events at this company for ShareSoc in their newsletters and the last one called the company a “comic turn”. The events at the company certainly inspired no confidence in the directors from me and I considered the accounts of the company were questionable.

Common Abuse

What I have not discussed in the above is the publication of abuse without any factual allegations being involved. Such comments about individuals such as is a “sender of fascist lawyer’s letters” when a victim complains or simple derogatory comments such as “fatty” aimed at ladies can be both extremely annoying to the recipient and damage their reputation but can be difficult to pursue under libel law. Good manners have simply disappeared in the modern world. Readers of such comments might be amused by them but the victims are not.

Many politicians and media personalities now suffer from such abuse without any recourse and so do companies. I have been on the receiving end of such comments personally in the past as is well known. It is a fact of life that standards in public life have gone significantly downhill in the last few years. This is partly due to the ease of distribution of such comments at trivial cost using the internet, the lack of practical and effective remedies and the fact that it is easy for the abusers to hide behind anonymity.

Even such reports as that on Burford by Muddy Waters are riddled with abuse. They don’t just present facts from which the readers can draw their own conclusions. They mix comment with the facts in derogatory form so as to strengthen their arguments.

If OFCOM licensed and regulated financial news/commentary web sites, it would be easy for them to put a stop to such behaviour by suitable regulations and prevent the “monetisation of abuse” that currently happens. By stimulating debate and response, web sites can generate traffic and hence gain financial benefit. It’s the equivalent of “trolling” on social media where perpetrators gain notoriety and personal satisfaction from upsetting others and starting arguments.

It would not be my intention to outlaw the making of derogatory comments about companies in the financial world. Most companies would not be damaged by such comments and not suffer any financial losses even if the shareholders might, which incidentally is another problem with current UK libel law. But individuals might suffer for no good reason. Restoring good manners to modern society is an impossible task for the law, but stopping market abuse is not.

It is of benefit to maintain an orderly market in company shares that companies can still come under criticism from investors. This helps to prevent the various “manias” that can sweep the market for company shares in hot sectors such as internet companies in the dotcom era. But it is surely the case that the pendulum has swung too far in favour of laissez-faire regulation of such matters.

Company directors may be expected to be thick-skinned but we now have a situation where company investors can suffer very substantial financial losses from the activities of professional doomsayers. That includes not just individual investors but institutional investors including pension schemes.

It is market abuse however you look at it.

Conclusion

No doubt this article will stimulate some active debate from readers. It is important to state that I am not opposed to people shorting stock as such although I would like to see tougher regulation of stock-lending which often supports it. In particular the institutional holders who lend stock without the knowledge or consent of the beneficial holders and who gain little benefit need to be restrained I suggest. But shorting stock might contribute to better market liquidity and price stability. Any market only works if there are people with contrary opinions on whether a stock is a fair price – for every buyer there needs to be a seller. What is surely wrong is that shorters can magnify their gains by making public allegations that are poorly grounded in sound evidence and on which the target companies have had no opportunity to comment before publication.

This is surely an area of the financial markets where more regulation is required.

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

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Burford Governance Changes

Burford Capital (BUR) have announced a number of changes to their board to meet the concerns of investors about corporate governance at the company. It includes the CFO (wife of the CEO) moving to another role, and refreshing the board in due course.

This is what Chairman Sir Peter Middleton had to say: “Companies are owned by their shareholders, and when the shareholders speak, it is the role of boards and management to listen.  While we may take a different view on some of these points, shareholders have clearly spoken and we have listened, just as Burford has throughout its existence.  We trust that these governance enhancements operate to bolster investor confidence in Burford as it enters its next era of growth and success.”

I hope the directors of the Ventus VCTs (see previous blog post) are listening also.

Burford is also looking for a US listing (on the NYSE or Nasdaq) as investors have made it clear they do not support Burford being solely listed on AIM.

These changes will help to make the company more of a sound investment proposition but the question remains over whether their financial accounting is prudent, and has been historically accurate. Muddy Waters clearly suggested otherwise. The key question for investors is whether a new CFO will take a different approach to their accounting and decide it should be done differently.

Unfortunately the new CFO, Jim Kilman, was the former investment banker at Morgan Stanley for the company and has been acting as an advisor to the company since 2016. It hardly looks like they undertook a formal recruitment process but have just appointed someone they already know, and who knows them, to the position as a stop-gap measure. That is not the best way to reassure investors on financial prudence.

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

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Burford – Illegal Market Manipulation?

Burford Capital (BUR) have issued an announcement that makes a number of allegations about the events surrounding the recent shorting attack involving Muddy Waters. It includes:

  • Spoofing and layering to move the share price, e.g. putting in numerous share sales on the order book and cancelling them before they can be filled.
  • That includes numerous such transactions just before Muddy Waters issued a tweet giving Burford as the target, and as that tweet was delayed only Muddy Waters or its associates could have known of the timing.
  • Exiting their short position by buying Burford shares at the same time as continuing on the same day to make their allegations.
  • Falsely alleging the company was “insolvent” which would have been picked up by algorithmic traders.

They allege these activities are simply illegal and have informed the regulatory authorities on the matter, plus hired three large law firms (Quinn Emanuel Urquhart & Sullivan LLP, Freshfields Bruckhaus Deringer LLP and Morrison & Foerster LLP) plus a Professor at New York’s Columbia University who is an expert to look into the trading activity.

For those not familiar with market manipulation techniques, just read the Burford announcement for a good explanation: https://tinyurl.com/y6xrs38h.

Let us hope that the UK’s Financial Conduct Authority (FCA) promptly looks into these complaints, and that the Financial Report Council (FRC) also investigates the accounts and past audits of the firm. Despite Burford being a very large company, it is listed on AIM so the AIM regulators (i.e. the LSE) and its NOMAD should also be looking into the matter surely?

As I said in a previous blog post here: https://tinyurl.com/yy9pamh5, one of the problems in most shorting attacks is the mixture of possibly true and false allegations, which the shorter has not even checked with the target company, along with unverifiable claims and innuendo. The shorter can make a lot of money by such tactics while it can take months for the truth or otherwise of the allegations to be researched and revealed. By which time the shorter has long moved on to other targets.

Shorting is not wrong in essence, but combining it with questionable public announcements is surely market manipulation which is covered by the law on market abuse.

To remind you, I have never held any position in Burford Capital, short or long, and there are good reasons why not which I give below. But I have held shares in other companies which have been the victim of shorting attacks – in one case justifiable in another not, so I would like to see some reform of this area of the market.

As regards Burford, just reviewing this company against the check lists given in my new book, it would have failed as an investment proposition on several counts. These are:

  • Smaller transactions (Chapter 2). Burford’s profits are very dependent on a few large legal cases. Any problems in such cases could wipe out the profits whereas companies who have many smaller contracts rather than a few large ones are less vulnerable to surprises.
  • Repeat business (Chapter 2). Every legal case they pursue is a “one-off” transaction which means there is no certainty of future such business.
  • Short term contacts (Chapter 2). The legal case the company pursues can take years to finally resolve, i.e. they are long-term contracts rather than short-term ones. This means they are complex in accounting terms and risky.
  • No risk of Government regulation (Chapter 4). This area of legal practice is very much subject to Government regulation and has significantly changed in recent years.
  • Applicable listing rules (Chapter 7). The company is listed on AIM which is a much lighter touch regulatory regime than that for fully listed companies despite the fact that it is a very large business (market cap still £1.8 billion even after recent share price falls).
  • Adhere to corporate governance code (Chapter 7). Corporate governance at this company is odd to say the least with directors serving for more than ten years and no executive management on the board. In addition the CFO is married to the CEO.
  • AGMs at convenient time and place (Chapter 7). The company holds its AGMs in Guernsey where it is registered.
  • Accounts easy to understand and accounts prudent and consistent (Chapter 8). I would certainly question whether both the recognition of the value of on-going legal claims in the accounts is prudent. It is also very difficult for any outsider to judge the merits of the claims.
  • Do profits turn into cash (Chapter 10). From the 2018 accounts: Pre-tax profit was £307 million while Cash Outflow from Operating Activities was £233 million. Enough said.

The above are just a few easy points to pick out, but I could go on at some length on why I would not have invested in Burford and did not despite it being regularly tipped in the financial press.

See here for the book details that includes the checklists used in the above analysis: https://www.roliscon.com/business-perspective-investing.html

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

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Burford Response and Shorting Regulation

Burford Capital (BUR) have issued a response to the allegations of false accounting from Muddy Waters. It goes into some detail and appears to at least contradict some of the allegations, if not all. It could take some weeks to analyse and verify who is correct but it leaves outstanding the basic issue of whether the accounting treatment of on-going law suits is prudent. My view is not simply because the outcome of any law suit is basically uncertain. Even if the case is won, there is no certainty that the litigants will get paid.

But there is one law suit that looks fairly certain to proceed. US lawyers Rosen Law Firm are already lining up folks to join a class action over the matter against Burford Capital Ltd. See https://www.rosenlegal.com/cases-register-1647.html . More background information is available here: https://tinyurl.com/yxvnc3yj .

Burford are also threatening legal action against Muddy Waters. So it looks like another lawyers’ beanfeast.

As one commentator said, those aiming to profit from shorting a stock tend to throw all kinds of mud at their target in the hope that some of it sticks. The target company is often unable to respond quickly and the issues are often so complex (as in the Burford case), that investors don’t know who to believe. So the damage is done, the share price collapses and the shorter makes an immediate handsome profit. Is this morally sound? I think not.

As I said in a previous blog post, “it is surely wrong for anyone to make such allegations and publicize them with the objective of making money from shorting the stock without first asking the company concerned to verify that what they are alleging is true – at least as far as the facts they report are concerned rather than just their opinions”. Muddy Waters did not apparently do that in this case and most shorters do not.

As someone who writes frequently on companies, it is good journalistic practice to verify with the company what you are about to publish. It is so easy to make simple factual errors or misinterpret the facts. There is nothing wrong per se in shorting as it can help to ensure that stock valuations are fair and reasonable and maintain liquidity. Most shorters do not publicise what they are doing.

Paul Scott of Stockopedia did a good analysis of the allegations and counter allegations at Burford. This is what he also said: “My feeling is that short sellers should be required to submit such a dossier to the target company, and give them say 7-days to respond privately. This would allow companies to point out the mistakes in the draft report. It does appear that the MW report might have misinterpreted some of the cases it comments on. Or at least, Burford seems to have provided reasonable explanations in most cases”. But Paul was also critical of their accounting policies and reliance on a few big cases.

I agree with him that such a regulation would be a good idea. It would stop a lot of wild and inaccurate allegations being published and at least give the target company the opportunity to issue a quick rebuttal if the allegations were still published.

The difficulty might be in framing such a regulation to cover those publishing a critique on a company at the same time as shorting the stock while excluding general market commentary and company analysis. But it would not seem impossible to do so.

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

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Burford Capital, Goals Soccer Centres, Carillion, and Why Numbers Are Not Important

To follow on from my previous comments this morning on Burford Capital (BUR), this is a typical “shorting” attack where the shorter (Muddy Waters) and their supporters make a lot of allegations which investors are unable to verify in any useful time frame. I certainly questioned the accounting approach used by Burford and other litigation finance firms as I commented on it back in June, but disentangling the factual accusations in the Muddy Waters dossier from innuendo and comment is not easy.

It is surely wrong for anyone to make such allegations and publicize them with the objective of making money from shorting the stock without first asking the company concerned to verify that what they are alleging is true – at least as far as the facts they report are concerned rather than just their opinions.

The company may threaten legal action for libel where misleading or inaccurate information is published but in practice such law suits take so long to conclude, with major practical problems of pursuing those who are resident overseas while actually worsening the reputational damage rather than improve it that few companies take that route.

This is an area of financial regulation that does need reform. In the meantime the damage to Burford is probably likely to persist for many months if it ever recovers.

What is the real moral of this story so far as investors are concerned? Simply that trusting the financial accounts of companies when picking investments is a very poor approach. This was reinforced by more news about the accounting problems at Goals Soccer Centres (GOAL) which I also commented on previously. Apparently a report to the board by forensic accountants suggests that the former CEO corroborated with the former CFO to create fictitious documents including invoices (see FT report on 3/8/2019). Clearly the audits over some years failed to pick up the problems. In addition it looks like the demise of Carillion is going to be the subject of a legal action against their former auditors (KPMG) by the official receivers. Financial accounts, even of large companies such as Carillion, simply cannot be trusted it seems.

This is not just about poor audits though. The flexibility in IFRS as regards recognition of future revenues is one of the major issues that is the cause of concerns about the accounts of Burford, as it was with Quindell – another case where some investors lost a lot of money because they believed the profit statements.

This seems an opportune moment to mention a new book which is in the process of being published. It’s called “Business Perspective Investing” with a subtitle of “Why Financial Numbers Are Not Important When Picking Shares”. It’s written by me and it argues that financial ratios are not the most important aspects to look at when selecting shares for investment. Heresy you may say, but I hope to convince you otherwise. More information on the book is available here: https://www.roliscon.com/business-perspective-investing.html

There are some principles explained in that book that helped me to avoid investing in Burford, in Quindell, in Carillion, in Silverdell and many of the other businesses with dubious accounts or ones that were simple frauds. These are often companies that appear to be very profitable and hence generate high investor enthusiasm among the inexperienced or gullible. It may not be a totally foolproof system but it does mean you can avoid most of the dogs.

With so many public companies available for investment why take risks where the accounts may be suspect or the management untrustworthy? One criticism of Neil Woodford is that his second biggest investment in his Equity Income Fund was in Burford. If you look at his other investments in that and his Patient Capital Trust fund they look to be big bets on risky propositions. He might argue that investment returns are gained by taking on risk which is the conventional mantra of investment professionals. But that is way too simplistic. Risks of some kinds such as dubious accounts are to be avoided. It’s the management of risk that is important and size positioning. The news on Burford is going to make it very difficult for Woodford’s reputation as a fund manager to survive this latest news.

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

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Market Crashes and Burford Capital

Investors might have been panicked by the recent market falls driven by the US/China trade wars, Brexit and gloomy economic forecasts. As usual, the UK market is led by the US markets. The S&P 500 is down 5% since the 26th July even though there was a slight bounce upwards yesterday. There can be few readers portfolios which have not suffered some impact because there were few stocks that did not fall.

Now I am an inveterate trend follower so how did I react to the falls? I did nothing because a few days is too short a period to determine whether it is a short-term panic or a real change in the trend. I am not convinced that we have moved from optimism about shares, to a real bear market. I’ll wait and see whether a trend develops because responding to short term share price fluctuations can be an expensive mistake.

One big faller this morning was Burford Capital (BUR) – down 60% at the time of writing. This is a litigation funding business that has come under attack for alleged dubious accounting by Muddy Waters in a report published this morning. I do not hold the stock and made some somewhat negative comments on their revenue recognition on June 12th – see https://tinyurl.com/y3ljqqvr . You can see Carson Block of Muddy Waters describing some of the issues in a video here: https://tinyurl.com/yxcq24ol or you can read the full report here: https://tinyurl.com/y6arozr9 .

I have read the report and I think it makes some valid points. The company issued a statement this morning calling it a “shorting attack” which it undoubtedly is, i.e. Muddy Waters have taken a position that might motivate them to exaggerate as shorters invariably do. For example they say Burford is a fund that “invests in an illiquid and esoteric asset class” and suggests they are using a “mark to market” accounting model of “Enron fame”. But they highlight the fact that the CFO is the wife of the founder/CEO which I find somewhat surprising, and the long service of all the directors which is not good corporate governance.

I remain skeptical of the accounting treatment of litigation funding by this company and others. Burford is of course one of the big investments made by Neil Woodford which will not enhance his reputation for prudence.

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

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Paying Illegal Dividends, Burford Capital, Woodford Patient Capital Trust and Zero Carbon Objective

A group of investors including Sarasin, Legal & General, Hermes and the UK Shareholders Association (UKSA) has written to Sir Donald Brydon who is undertaking a review of the audit market. They have yet again raised the question of whether the International Financial Accounting Standards (IFRS) are consistent with UK company law. In particular they question whether profits are sometimes being recognised, thus allowing the payment of illegal dividends. The particular issue is whether profits can arise on certain transactions under IFRS from transactions between parent and subsidiary companies or by the use of “mark to market” accounting. The problem is “unrealised profits” that might turn into cash in the future, but may not.

This may appear a somewhat technical question, but it can in practice lead to over-optimistic reporting of profits, leading to excessive bonus payments to managers, and the general misleading of investors. Actually calculating when a dividend can be paid as dividends are not supposed to be paid out of capital is not easy and is not self-evident to investors. The published accounts do not make it obvious. Regular mistakes are made by companies requiring later “whitewash” resolutions to be passed by shareholders. The ICAEW has previously rejected complaints on this issue but it is surely an area that requires more examination.

Incidentally I was reading a book yesterday entitled “White Collar Crime in Modern England” (from 1845-1929) which is most enlightening on common frauds that arose when limited companies became popular – many of the frauds still persist. In the “railway mania” of the 1840s it was common to set up companies and raise the capital to build a railway when the chance of it operating profitably was low. To keep the share price high, and the directors in jobs, dividends were paid out of capital. To quote from the book: “unscrupulous directors could easily pay dividends out of capital undetected – projecting a false image of profitability and enticing further investment in their lines”. That was an era when auditors did not have to be accountants and were often simply the directors’ cronies. Standards and regulations have improved since then, but there are still problems in this area that need solving.

There was an interesting discussion on Twitter recently on Burford Capital (BUR) with regard to their accounting methods. Not that I am an expert on the company as I do not hold shares in it, it but as I understand it they recognise the likely future settlements from the litigation funding cases they take on. In other words, they estimate future cash flows based on projections of likely winning the case and the possible settlements. As I said on Twitter, lawyers will often tell you a case is winnable but they will also tell you the outcome of any legal case is uncertain.

It’s interesting to read what Burford say in their Annual Report under accounting policies where it spells it out: “Owing to the illiquid nature of these investments, the assessment of fair valuation is highly subjective and requires a number of significant and complex judgements to be made by management. The exit value will be determined for each investment by the contractual entitlement, the underlying risk profile of the litigation, a trial or an appellate outcome or other case events, any other agreements in respect of settlement discussions or negotiations as well as the credit risk associated with the investment value and any relevant secondary market activity”.

The auditors no doubt scrutinise the reasonableness of the estimates but any outside investor in the shares of the company will have great difficulty in doing so.

Neil Woodford’s Equity Income Fund has a big holding in Burford Capital. I commented on the Woodford Patient Capital Trust yesterday here: https://roliscon.blog/2019/06/11/woodford-patient-capital-trust-is-it-an-opportunity/ and suggested the Trust made a mistake in naming the Trust after him. It makes it more difficult to fire the manager for example. But the FT reported this morning that the Trust has indeed had conversations about doing just that. Woodford’s firm has a contract that only requires 3 months’ notice which is a good thing. At least they can keep the “Patient Capital” moniker because investors in this trust have already had to wait a long time for much return and it could take even longer to improve its performance under a new manager. But as Lex in the FT said, “patience is now in short supply” so far as investors are concerned.

Another major item of news yesterday was soon to be ex-Prime Minister May’s commitment to enshrine in law a target for net zero carbon emissions in the UK by 2050. This is surely a quite suicidal path for the UK to follow when most other major countries, including all the big polluters, will be very unlikely to follow suit. Even Chancellor Philip Hammond has said it will cost about £1 trillion. It will effectively make the UK completely uncompetitive in many products with production and jobs shifting to other countries. We might become the first really “de-industrialised” country which is not a lead that many will follow, and it will actually be practically very difficult to achieve if you bother to study what is required to achieve zero emissions. It will completely change the way we live with the transport network being a particular problem (trains, planes and road vehicles).

As I have said before, if we really want to cut air pollution and CO2 emissions, then we need to reduce the population as well as rely on such wheezes as electrification of the transport and energy systems. Mrs May’s last act as Prime Minister might be to commit the UK to economic suicide. It might not be a good time to invest in UK manufacturing companies.

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

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