A New Consumer Duty from the FCA

Just before Christmas I wrote a critical blog post on the proposals by the Financial Conduct Authority (FCA) to reform the Financial Services Compensation Scheme. It generated a lot of supportive comments. At the same time the FCA published a consultation paper (CP21/36) on a “New Consumer Duty”. This seems to have similar objectives in that it is an attempt to stop consumers from being provided with misleading information, being provided with unsatisfactory support or buying products that are inappropriate or harmful.

For “consumers” read “individual investors” in the investment sector.

The FCA therefore is proposing a whole new set of rules to enforce a new Consumer Duty and the consultation paper alone consists of 190 pages of convoluted text, even though it is supposed to be principle based. It is also clear that there was considerable opposition from the financial services industry particularly as they will incur substantial costs in adapting to the new rules and maintaining them. There is also doubt as to whether it will result in any benefit as there is already an obligation to treat customers fairly and a multiplicity of other rules are already in place.

It might even increase costs to consumers as firms pass on their additional costs, and increase the risk of litigation. One aspect of the proposal is however not to provide a Private Right of Action (PROA) for a breach of the new rules or principles so consumers would have to rely on the Financial Ombudsman for any redress. This is very unsatisfactory as that organisation is hardly very effective at present and takes way too long to deal with complaints.

An example of the sophistry in this consultation paper is the discussion of two possible Consumer Principles to underpin the conduct of firms: Option 1 – A firm must act to deliver good outcomes for retail clients; or 2 – A firm must act in the best interests of retail clients. Can you divine any difference?

What are the likely costs of the adoption of this new Consumer Duty and associated rules? The paper says total one-off direct costs to comply will be in the range of £688m to £2.4bn. Annual on-going costs will be in the range £74m to £176m. The paper is remarkably unclear on the likely cost benefits to consumers.

I don’t know how much labour was put into writing this paper but it must clearly have been very considerable. I consider it a waste of effort. I doubt that consumers will be much better protected by adoption of the new Consumer Duty. The problem with the FCA is not lack of adequate rules, but an inability to enforce them vigorously. Firms devise new products that are too complex, badly understood by consumers and yet the FCA does not stop them being sold. They also approve firms and their management who should not be and fail to step in when matters are clearly going wrong.

It’s a management problem in essence and inventing new rules will not help.

My detailed comments in response to the consultation are present here: https://www.roliscon.com/Consumer-Duty-Consultation-Response.pdf

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

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Discrimination Against High Net Worth Individuals?

The cost of the Financial Services Compensation Scheme has been increasing substantially in recent years, as more mis-selling scandals have proliferated and firms have gone bust. This has led to complaints from those firms who fund the scheme and has led the FCA to undertake a “Compensation Framework Review”.

This includes looking at possible changes to the scope of protection such as limiting it to “mainstream” products. But a more serious proposal is that High Net Worth or Sophisticated Investors be excluded from compensation. The FCA suggests such individuals might be expected to absorb losses, might be able to take their own private action against a failed firm, or would have a better understanding of the risks they were taking when dealing with authorised firms.

But this is a very dubious argument when High Net Worth persons only need to have liquid assets of £250,000 or more to qualify. Many moderately wealthy individuals would have more than that in direct shareholdings, ISAs and deposit accounts. But they would hardly be in a position to finance complex legal actions and FSCS compensation is limited to £85,000 already.

It is not clear what moral principle is being invoked here except that it would potentially save the FSCS scheme money.

I suggest that high net worth or sophisticated investors send in a response to the FCA’s review – go to this link for information  https://www.fca.org.uk/publications/discussion-papers/dp21-5-compensation-framework-review and an online response form.

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

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Diversity – But at What Cost?

The Financial Conduct Authority (FCA) have published a public consultation on “Diversity and inclusion on company boards and executive committees”. This summer I seen to be spending a lot of my time responding to FCA consultations and this one seems to yet another that will impose costs on publicly listed companies with no clear benefit while diverting management time. As I pointed out in my response to the Primary Markets Effectiveness Review, the imposition of more corporate governance regulations is one reason why public listings are falling as company management decide that it’s easier to remain private. That is the negative outcome of over-regulation.

What’s the latest consultation proposing? They propose to change the Listing Rules so as to “require companies to disclose publicly in their annual financial report whether they meet specific board diversity targets relating to gender and ethnicity on a ‘comply or explain’ basis”.

They also propose that companies publish standardised data on the composition of their board and the senior levels of executive management by gender and ethnic background; and to encourage a broader consideration of diversity at board level, they are also proposing to amend the corporate governance rules to expand reporting requirements to wider diversity characteristics. This could include ethnicity, sexual orientation, disability and socio-economic background.

They may also “seek to widen the scope of the targets to levels below executive management”, i.e. This means not just the board and top management will be covered in future.

In the short term the rules will require:

  • At least 40% of the board should be women (including those self-identifying as women).
  • At least one of the senior board positions (Chair, Chief Executive Officer (CEO), Senior Independent Director (SID) or Chief Financial Officer (CFO)) should be a woman (including those self-identifying as a woman).
  • At least one member of the board should be from a non-White ethnic minority background.

Although there is wide acceptance that more diversity on some boards may be preferable. By avoiding the all-white, male and elderly boards that were so common in the past, one can ensure more understanding of the modern world. And it is certainly the case that there may be some social justice in avoiding unfair discrimination against some characteristics. But is there any evidence that more diverse boards actually improve company performance?

The FCA report covers this issue in Section 3.27 onwards where they review the evidence. The evidence is not clear so they say: “Our own literature review of academic and other research published alongside our DP concludes that, overall, the empirical evidence for the impact of diverse workforces and boards on financial performance is inconclusive”. In essence the imposition of more regulation in this area may have no benefit while the disadvantages of loading management with extra responsibilities is ignored.

What concerns me most is that instead of picking the best candidates for board or senior management positions, they may be selected based on sex or ethnicity, i.e. there will be discrimination against others, which is of course illegal.

There is also a rather peculiar focus on factors that have no obvious relevance to fitness for a role. One of the oddities of public companies is that anyone with no qualifications or experience can be appointed. There is no requirement to have a business or accounting qualification. No requirement to know the basics of company law or to have had any training for the role of being a company director. Is this not most perverse?

For example I have attended several General Meetings of companies in the past where it was clear that the directors did not understand the basics of company law.

You also get peculiar results at present where the keenness to appoint more females results in some directors with little obvious qualifications for anything. They tend to end up chairing remuneration committees for example where they are dominated by executive management.

Would it not be preferable to regulate to ensure directors had basic competence in law and finance rather than happening to have the right skin colour? That is likely to be much more effective in improving company performance.

One of the most laughable aspects of the proposed new regime is that to meet the new rules on gender diversity all that needs to be done is for a current male member to “self-identify” as female. Will management be required to inquire into the details of sexual orientation when recruiting?

If we are going to start regulating management composition based on their characteristics, should we also not be ensuring a balance of ages, heights, physical fitness (no fatties allowed) or other relevant characteristics?

There are better alternatives to improving the diversity of boards other than using quotas. Education and structured experience programmes are more likely to produce a better outcome.

In summary I suggest this proposal is a complete nonsense and should be withdrawn. Readers should submit their own responses to the consultation to avoid responses being biased by the thoughts of those who wish to be politically correct.

You can see my detailed responses to the consultation questions here: https://www.roliscon.com/Diversity-Consultation-Response.pdf  

FCA Paper: Diversity and inclusion on company boards and executive committees. Consultation Paper CP21/24: https://www.fca.org.uk/publication/consultation/cp21-24.pdf

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

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Comments on Primary Markets Effectiveness Review

The Financial Conduct Authority (FCA) have launched a public consultation on potential changes to the regulations regarding the listing of companies on public exchanges (see link below). This is in response to concerns about the fall in the number of companies listing (the number listed is down by 40% since 2008). There is particular concern that the UK regime is tougher than other international markets and particularly deters certain types of companies from listing.

You only have to read the consultation document to understand how complex the rules on main market listing are and they are surely due for simplification. Over complex rules not just deter companies from listing but add to the costs of doing so and those costs fall on investors.

A survey by PWC in 2018 indicated that regulatory burdens and costs are the main reasons for not listing as opposed to raising finance by other means. A fall in the number of listed companies particularly affects private investors who want to invest directly in companies and wish to have a direct connection with where their money is invested.

Other factors are also involved such as the low cost of debt at present and the ability of private equity firms to act quickly and provide a less onerous corporate governance regime. But it would certainly be a retrograde step if public stock markets fell substantially in size.

Among the proposals to make listing more attractive in the UK are 1) allowing dual class structures where some shareholders can have disproportionate voting rights; and 2) relaxing free float levels required. But there is also a proposal to increase the minimum market capitalisation substantially from the present level, which surely would not help.

There are also proposals to alter the primary segment qualifications or remove segments altogether which I favour.

I support the relaxation of free float levels but am opposed to dual class structures. Dual class structures enable founders to retain control but that is not necessarily a good thing. In practice there are other ways that founders can retain substantial influence – for example by retaining significant shareholdings and board seats. I do not see that permitting dual class structures (DCSS) is necessary to make listing in the UK more attractive.

What will make listing more attractive is a simplification of the listing rules and a reduction in cost plus a reduction in the regulations such as onerous corporate governance regulations (such as the recently proposed climate disclosure regulations I commented negatively upon).

You can read my detailed responses to the FCA consultation here:

https://www.roliscon.com/Primary-Markets-Effectiveness-Review-Response.pdf

The FCA Consultation is here: https://www.fca.org.uk/publications/consultation-papers/cp21-21-primary-markets-effectiveness-review

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

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Changes to KIDs Proposed by the FCA

Yet another public consultation issued by the Financial Conduct Authority (FCA) in mid-summer is one on KIDs (Key Information Documents). This is relevant to private investors and is designated CP21/23 – see link below.

KIDs are imposed and regulated under the PRIIPs regulation as devised by the EU for packaged investment products such as funds and trusts. KIDs give basic financial information, risk indicators and likely future performance based on past performance. Those who purchase investment trusts for example will be asked to confirm they have read the KID before purchasing a holding.

But in reality KIDs are grossly misleading for many investment trusts.  This is because their estimate of future returns are based on short-term historic data. This has caused many fund managers of investment trusts to suggest that they should be ignored and investors should look at the other data that the companies publish to get a better view of likely future returns. The AIC has also criticised them and this writer certainly ignores the KIDs for the investment trusts I hold.

The FCA says “Our proposals should address the existing conflict between PRIIPs requirements which on the one hand require PRIIPs manufacturers to ensure the information in the KID is accurate, clear, fair and not misleading while at the same time prescribing the production and presentation of information on performance and risk which, in some cases, can be seriously misleading”.

The production of KIDs does require substantial effort on the part of fund managers so they add to investors’ costs while not being of substantial benefit to investors in many cases. The intention might have been good but excessive complexity has undermined their usefulness. The FCA admits that the mandated methodologies for calculating performance can produce misleading illustrations across almost all asset classes.

The proposal is to remove performance scenarios from KIDs which seems a very good idea. Alternative performance information is suggested be provided., such as narrative about the factors that might affect performance.  But they have avoided providing past performance data which is what is likely to be most important to investors.  

The PRIIPs regulations required the publication of a Summary Risk Indicator (SRI). But the methodology to be used seemed to rate some trusts as low risk when they are not – for example Venture Capital Trusts. So it is proposed to introduce new rules requiring an updating of an SRI if it is obviously too low.

The proposals from the FCA seem generally sensible although the AIC is still not happy. They say in a press release that: “….the SRI methodology does not work properly and needs a complete rethink. We were raising concerns about KIDs even before the rules were finalised and we have been calling for changes since their introduction on 1 January 2018. Investment companies are still at a disadvantage in having to produce these toxic disclosures, whilst UCITS funds have repeatedly been let off the hook. It’s high time the Treasury conducted a comprehensive review of KIDs rather than relying on a piecemeal approach to their reform”.

Respondents to the consultation can give their own views of course. There is a simple on-line response form.

Reference: CP21/23 Consultation Paper:

https://www.fca.org.uk/publications/consultation-papers/cp21-23-priips-proposed-scope-rules-amendments-regulatory-technical-standards

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

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Preventing Fraud in Accounts – FRC Tightens Audit Rules

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

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

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

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

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

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

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

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

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

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

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Regulating Consumer Investments and Company Register Reform

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

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

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

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

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

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

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

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

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

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

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

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FCA Seminar and Property Funds Rule Change

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

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

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

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

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

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

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

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

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

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

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

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

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

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Why the FCA Did Nothing About the Lloyds TSB Abuse

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

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

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

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

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

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

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

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

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

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

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

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

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Panorama on Woodford – Expletives Deleted?

Panorama covered the Woodford debacle last night and the issue of conflicts of interest in fund managers. They tried door-stepping Neil Woodford to ask him some questions, but he just walked past them. I think the questions would have been rhetorical anyway, such as “why did he make so many duff bets on companies” and “why should he have made millions while investors in his funds lost money”?

The Financial Conduct Authority (FCA) came in for a lot of criticism for not intervening sooner and allegedly not enforcing the rules concerning the liquidity of holdings in open-ended funds.

My old sparring partner T** W** was interviewed in his new home in Wales – looks like he has a renovation project on his hands. I don’t like to mention his name in case it attracts readers to follow him when they might find his use of language somewhat offensive. But in this interview there were no expletives which is unusual for him – perhaps the BBC deleted them.  They also interviewed some investors in the Woodford funds and one of them definitely had her expletives deleted.

The programme also covered the issue of the conflicts of interest in fund managers such as the fact that as their fees are based on the value of funds under management, there are strong incentives to grow the assets and also an incentive to manipulate the share prices. For example, without suggesting that Woodford specifically did these things, if a fund manager buys more of a listed stock in the market then that can raise the price, particularly when the stock is a small cap one and relatively illiquid. In the case of unlisted stocks, investing at a higher price than any previous trades causes the whole company to be revalued upwards (see BVCA valuation rules). There is clearly the possibility of perverse incentives here.

The programme also mentioned the case of Mark Denning an investment manager for Capital Group who allegedly had been trading in stocks on his personal account that were also held by the fund he managed. He denies it, but clearly such activity could enable “front-running” of trades and other abuses. The Panorama programme argued that there was in essence very little oversight of fund managers.

In summary the BBC programme was a good overview of the issues and T** W** made a useful contribution. The FCA should certainly be tightening up on the oversight of open-ended funds and their managers, and should be reviewing the liquidity rules even if they are bound by the EU Directives in that regard at present.

As the FCA never acts quickly, which is of course part of the problem, in the meantime investors might like to consider what I said in my recent book in the chapter on Trusts and Funds. I repeat some excerpts here:

“A key measure of the merit of a fund is its long-term performance against similar funds or its benchmark”. [Woodford’s funds, after he set up his new management company. never demonstrated that].

“One issue to examine is whether a fund manager has a consistent and effective process for selecting investments if they are an active manager. It is important that they are not simply making ad-hoc decisions about investments however experienced they are”. [See my comments on City of London Investment Group in a previous blog post for an example].

“To judge whether a fund manager is competent it helps to look at the underlying companies in which they invest. Are they investing in companies that show a high return on capital while being on relatively low P/Es and with significant growth in earnings or are they investing in shares that appear to be simply cheap? Are they picking companies that are of high quality – in other words displaying the characteristics covered in the first few chapters of this book?” [Anyone looking at the holdings of the Woodford Equity Income Fund or Patient Capital Trust would have realised that many of the holdings were speculative].

One issue not raised in the BBC programme was that of the naming of the Woodford Equity Income Fund. Such funds typically focus on paying high dividends to investors and to do so they invest in high dividend paying companies. They therefore tend to hold boring large cap companies. But the Woodford fund was very different. It did have some high dividend paying holdings in the fund but not necessarily large cap ones and it also had a number of early stage companies that were unlisted. This was not a typical “Equity Income” fund. Investors might feel they were misled in that regard by the name.

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

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