Blancco AGM and Regulatory Landscape

Today I attended the Annual General Meeting of Blancco Technology Group (BLTG). This technology company is now focused on the data erasure market which is surely a growing one. I have commented on this company before (see links below), particularly as the company, and its shareholders, seemed to be a victim of false accounting – an issue that is way too prevalent of late.

The legal framework under which companies, their directors and the regulatory bodies operate just seems to be too weak to bring errant directors and auditors to account. This is not just obvious from this case but from the discussions at the recent ShareSoc/UKSA sponsored meeting with the Financial Reporting Council (FRC). See my previous comments on the Autonomy case in addition. As you will see below, no action seems to be being taken against the former directors of Blancco by the company, although complaints have been made to the FRC and to the Financial Conduct Authority (FCA) about past events and the latter may still be investigating – but as usual feedback is non-existent. As regards the complaint to the FRC, they have passed the buck to the ICAEW (the regulatory body for accountants) on the basis that it is too small a company to be bothered with.

There were about a dozen shareholders at the Blancco AGM in the City of London. The Chairman, Rob Woodwood, opened the meeting by introducing the board. That included new CEO Matt Jones who joined in March and new CFO Adam Maloney. Rob said the last year was a period of positive change for the company, which one can hardly dispute. He said after a turbulent year, they are on a positive track.

Shareholder Bruce Noble, first queried comments on the impact of currency movements (see page 9 of the Annual Report). The CFO admitted it could perhaps have been explained better.

Bruce then pointed out that the report made it clear that management controls had been avoided in the past as a result of which the accounts were false. This resulted in the management obtaining £400,000 and shareholders losing £135 million. The board responded that investigations were on-going and as result they were unable to comment about what is being done due to “legal privilege”. Both Bruce and I complained that we did not understand that comment, and I said that they were in breach of their legal obligations to answer questions put by shareholders at a General Meeting (see my past articles on similar issues at Abcam and Patisserie). As usual they refused to respond further due to “legal advice” so I suggested they should get better advice.

As I said to the Chairman after the meeting ended, we don’t expect him to disclose their conversations with the FCA or FRC, but there is no reason why they cannot pursue a civil case against the former management if there are justifiable grounds. They need to give reasons if they choose not to do so and simply saying they wish to concentrate on rebuilding the business is not good enough. I suggested I would be voting against his re-election in future (not on the agenda at this meeting) if he failed to take action on this matter.

The above is an abbreviated summary of what was a rather long discussion on this issue.

Bruce Noble also criticised the proposed re-election of Frank Blin, who was Chairman of the Audit Committee when the past events occurred. He asked him to do the “honourable” thing and step down, which Mr Blin refused to do. Bruce also criticised the appointment of PWC to take over from the former auditors (KPMG) when Mr Blin had a previous relationship with PWC and PWC had received criticism about other audits. Mr Blin responded that the relationship mentioned was more than 6 years ago and PWC had been appointed after an open tender process. Another shareholder suggested they might get better attention from a smaller audit firm but Blin responded that they did need a firm that could cover a complex international business particularly their operations in Finland and India. Comment: I don’t think having a smaller audit firm would help – Grant Thornton has had similar problems to larger firms. There is a more general problem with the overall quality of audits which has been recognised in the national media and by many investors.

I questioned the presentation of the income statement in the Annual Report, where “adjustments” are mixed in with normal “reported” figures and confuse the reader. They will look at this issue.

We then had a brief presentation from the new CEO Matt Jones. He is clearly an experienced manager of IT businesses. He said they have good customers and good staff but were spread too thinly. They need to focus more. He will be focusing on those with good growth opportunities, namely ITAD, mobile and enterprise solutions (note: they each represent about one of current revenue).

There was a question about cash flow and operating margins. The response was that they are making investment this year to increase growth and hence margins will come down this year, but will grow thereafter. It was noted later that the investment will be mainly in R&D and to a lesser extent in sales and marketing. The CFO said the key was to avoid major exceptionals and improve cash flow.

One shareholder raised the issue about reliance on one customer at 11% of turnover but the board expressed no concerns and it might fall slightly this year.

I asked about the competitive landscape. Answer given was the main area for that was in mobile and they are working to improve their offering to meet that.

Another shareholder questioned their presence in 26 countries – are they spreading themselves too thinly? The answer was they are not planning any cut back in the geographic perspective. It transpired later than some of their locations are only very small sales operations, even though the CEO clearly spends a lot of time on planes (incidentally he mentioned he is based in California and works from home with an office above his garage). Modern communications methods assist a great deal.

The CEO said they have adequate sales/marketing staff and productivity is improving.

Lastly a question was raised as to the apparent votes from large shareholder M&G who abstained on some of the resolutions. Does the board know why? The answer was no, and it was not clear whether they had even been asked why although the Chairman did say he had been in communication with them and other large shareholders. Could it be I wonder that they were also unhappy with the openness of the board and their apparent failure to pursue past wrongdoing?

In conclusion, it does seem that the Chairman and the rest of the board are at least taking sensible steps to rebuild the company. The new executives seem to be good appointments but we will have to wait and see whether they can actually produce the goods. In the meantime, investor confidence in the company may take time to rebuild but even so it’s still quite highly rated on the normal financial ratios. My concern is that revenue growth does not seem particularly high for this kind of business and the current valuation. But there is certainly business opportunities to pursue given the growing populations of IT and phone equipment that need erasure or disposal at some point.

https://roliscon.blog/2018/01/15/sharesoc-takes-up-blancco-complaints/ https://roliscon.blog/2017/12/20/lse-general-meeting-and-blancco-agm/

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

You can “follow” this blog by clicking on the bottom right.

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

Autonomy, FRC Meeting, Retailers and Brexit Legal Advice

The big news last Friday (30/11/2018) was that former CEO Mike Lynch has been charged with fraud in the USA over the accounts of Autonomy. That company was purchased by Hewlett Packard who promptly proceeded to write off most of the cost – see this blog post for more information: https://roliscon.blog/2018/06/02/belated-action-by-frc-re-autonomy/. As this was a UK company, are we anywhere nearer a hearing in the UK over the alleged “creative accounting” that took place at the company and the failure of the auditors to identify anything amiss? That’s after 8 years since the events.

As I was attending a meeting held by the Financial Reporting Council (FRC) for ShareSoc and UKSA members yesterday, I thought to review the past actions by the FRC on this matter. In February 2013 they announced an investigation but it took until May 2018 to formally announce a complaint against auditors Deloitte and the former CFO of Autonomy Sushovan Hussain who has already been convicted of fraud in the USA. On the 27th November, the action against Hussain was suspended pending his appeal against that conviction, but other complaints were not. But why the delay on pursuing the auditors?

The FRC event was useful in many ways in that it gave a good overview of the role of the FRC – what they cover and what they do not cover which is not easy for the layman to understand. They also covered the progress on past and current enforcement actions which do seem to have been improving after previous complaints of ineffectiveness and excessive delays. For example PWC/BHS was resolved in two years and fines imposed are rising rapidly. But they still only have 10 case officers so are hoping the Kingman review of the FRC will argue for more resources.

It was clear though that audit quality is still a major problem with only 73% of FTSE-350 companies being rated as 1 or 2A in the annual reviews when the target is 90%. The FRC agreed they “might be falling short” on pursuing enforcement over poor quality audits. So at least they recognise the problems.

One useful titbit of information after the usual complaints about the problems of nominee accounts and shareholder rights were made (not really an FRC responsibility) was that a white paper on the “plumbing” of share ownership and transactions will be published on the 30th January.

There were lots of interesting stories on retailing companies yesterday. McColl’s Retail Group (MCLS) published a very negative trading update which caused the shares to fall 30% on the day. Supply chain issues after the collapse of Palmer & Harvey are the cause. Ted Baker (TED) fell 15% after a complaint of excessive hugging of staff by CEO Ray Kelvin. This may not have a sexual connotation as it seems he treats male and female staff similarly. Just one of the odd personal habits one sees in some CEOs it seems. Retail tycoon Mike Ashley appeared before a Commons Select Committee and said the High Street would be dead in a few years unless internet retailers were taxed more fairly. He alleged the internet was killing the High Street. But there was one bright spark among retailers in that Dunelm (DNLM) rose 14% after a Peel Hunt upgraded the company to a “buy” and suggested that they might be able to pay a special dividend next year. There was also some director buying of their shares.

Before the FRC meeting yesterday I dropped in on the demonstrations outside Parliament on College Green. It seemed to consist of three fairly equally balanced groups of “Leave Means Leave” campaigners, supporters of Brexit and those wishing to stay in the EU – that probably reflects the composition of the Members in the House across the road. You can guess which group I supported but I did not stay long as it was absolutely pelting down with rain. There is a limit to the sacrifices one can make for one’s country.

But in the evening I did read the legal advice given to Parliament by the attorney-general (see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/761153/EU_Exit_-_Legal_position_on_the_Withdrawal_Agreement.pdf

Everyone is looking very carefully at the terms of the Withdrawal Agreement that cover the Northern Ireland backstop arrangements. The attorney-general makes it clear that the deal does bind the UK to the risk of those arrangements continuing, although there is a clear commitment to them only lasting 2 years when they should be replaced by others. There is also an arbitration process if there is no agreement on what happens subsequently. However, he also makes it clear that the Withdrawal Agreement is a “treaty” between two sovereign powers – the UK and the EU.

Treaties between nations only stick so long as both parties are happy to abide by them, just like agreements between companies. But they often renege on them. For example, the German-Soviet non-aggression pact in 1939 was a notorious example – Hitler ignored it 2 years later and invaded Russia. Donald Trump has reneged on treaties, for example the intermediate nuclear weapons treaty last month. Similarly nations and companies can ignore arbitration decisions if they choose to do so.

What happens after 2 years if no agreement is reached and the UK insists on new proposals re Northern Ireland? Is the EU going to declare war on the UK? We have an army but they do not yet have one. Are they going to impose sanctions, close their borders or refuse a trade deal? I suspect they would not for sound commercial reasons.

Therefore my conclusion is that the deal that Theresa May has negotiated is not as bad as many make out. Yes it could be improved in some regards so as to ensure an amicable future agreement but I am warming to it just like the Editor of the Financial Times recently. He did publish a couple of letters criticising his volte-face when previously he has clearly opposed Brexit altogether, but changing one’s mind when one learns more is just being sensible.

Note: I have held or do hold some of the companies mentioned above, but never Autonomy. Never did like the look of their accounts.

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

You can “follow” this blog by clicking on the bottom right.

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

Quindell and the FRC’s Role

There was a very good article written by Cliff Weight and published on the ShareSoc blog yesterday about the fines on KPMG over the audit of Quindell. Cliff points out the trivial fines imposed on KPMG in that case, the repeated failings in corporate governance at large companies and he does not even cover the common failures in audits at smaller companies. The audit profession thinks they are doing a good job, and the Financial Reporting Council (FRC) which is dominated by ex-auditors and accountants, does not hold them properly to account.

Perhaps they lack the resources to do their job properly. Investigations take too long and the fines and other penalties imposed are not a sufficient deterrent to poor quality audits when auditors are often picked by companies on the basis of who quotes the lowest cost.

Lots of private investors were suckered into investing in Quindell based on its apparent rapid growth in profits. But the profits were a mirage because the revenue recognition was exceedingly dubious. One of the key issues to look at when researching companies is whether they are recognizing future revenues and hence profits – for example on long-term contracts. Even big companies such as Rolls-Royce have been guilty of this “smoke and mirrors” accounting practice although the latest accounting standard (IFRS 15) has tightened things up somewhat. IT and construction companies are particularly vulnerable when aggressive management are keen to post positive numbers and their bonuses depend on them. Looking at the cash flow instead of just the accrual based earnings can assist.

But Quindell is a good example where learning some more about the management can help you avoid potential problems. Relying on the audited accounts is unfortunately not good enough because the FRC and FCA don’t seem able to ensure they are accurate and give a “true and fair view” of the business. Rob Terry, who led Quindell, had previously been involved with Innovation Group but a series of acquisitions and dubious accounting practices led to him being forced out of that company in 2003. The FT has a good article covering Mr Terry’s past business activities here: https://www.ft.com/content/62565424-6da3-11e4-bf80-00144feabdc0 . They do describe Terry as “charismatic” which is frequently a warning sign in my view as it often indicates a leader who can tell a good story. But as I pointed out in a review of the book “Good to Great”, self-effacing and modest leaders are often better for investors in the long-term. Shooting stars often fall to earth rapidly.

One reason I avoided Quindell was because I attended a presentation to investors by Innovation Group after Terry had departed. His time at the company was covered in questions so far as I recall, and uncomplimentary remarks made. They were keen to play down the past history of Terry’s involvement with the company. So the moral there is that attending company presentations or AGMs often enables you to learn things that may not be directly related to the business of the meeting, but can be useful to learn.

The ShareSoc blog article mentioned above is here: https://www.sharesoc.org/blog/regulations-and-law/the-quindell-story-and-the-frc/

Note though that subsequently the FRC have taken a somewhat tougher line in the case of the audit of BHS by PWC in 2014. Partner Steve Dennison has been fined half a million pounds and banned from auditing for 15 years with PWC being fined £10 million. But the financial penalties were reduced very substantially for “early settlement” so they are not so stiff as many would like. I fear the big UK audit firms are not going to change their ways until their businesses are really threatened as happened with Arthur Anderson in the USA over their audits or Enron. That resulted in a criminal case and the withdrawal of their auditing license, effectively putting them out of business. The UK needs a much tougher regulatory regime as they have in the USA.

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

You can “follow” this blog by clicking on the bottom right.

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

Belated Action by FRC Re Autonomy

I commented previously on the conviction of former Autonomy CFO Sushovan Hussain for fraud in relation to the accounts of Autonomy Plc (see https://roliscon.blog/2018/05/02/they-do-things-differently-in-the-usa/ ). Just to show that this was not solely a case prompted by Hewlett Packard over their disastrous acquisition of the company and supported by a partisan California court as some have alleged, the Financial Reporting Council (FRC) have now announced formal complaints over the conduct of auditors Deloittes and senior finance staff of Autonomy – including Mr Hussain.

Allegations include: failings by the auditors to adequately challenge Autonomy’s accounting and disclosure of its purchases and sales of computer hardware; adequately to challenge Autonomy’s accounting for transactions with value added resellers (“VARs”) and to correct false or misleading communications made by Autonomy to the Financial Reporting Review Panel (“FRRP”) of the FRC.  Sushovan Hussain and Stephen Chamberlain are alleged to have breached the fundamental principle of integrity by acting dishonestly and/or recklessly when preparing and approving Autonomy’s Annual Report and Accounts for the years ended 31 December 2009 and 31 December 2010 and related charges.

There will be tribunal hearing to hear these complaints for which a date has not yet been set. It seems likely that the claims will be defended.

So 8 years later we have a non-criminal action by the regulatory authorities in the UK over accounting and audit failures while the US prosecuted for fraud. Surely this is not good enough if the allegations are true? Plus it’s been too long before action has been taken. If the claims are upheld then the accounts were wrong and sufficiently wrong not just to mislead the investors in Autonomy but to prompt Hewlett Packard to purchase the company at a grossly inflated price – that is their claim which is the subject of an on-going civil action. But it could also be seen as a fraud on stock market investors which is a criminal offence in the USA but not the UK. That is what needs changing.

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

You can “follow” this blog by clicking on the bottom right.

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

 

They Do Things Differently in the USA

Former Autonomy CFO Sushovan Hussain has been found guilty of 16 counts of fraud in a Federal Court in California. He was convicted on all 16 counts of wire and securities fraud. This case was based on allegations of false accounting to ramp up the value of the Autonomy business prior to its acquisition by Hewlett-Packard. The latter subsequently wrote down most of the $10.3 billion cost of that acquisition.

More background on this case is given in a previous blog post here: https://roliscon.blog/2018/02/26/autonomy-legal-case-and-revenue-recognition/

Although Autonomy was a UK public company, and the Serious Fraud Office did look at the case they decided to do nothing. However a civil action against Mr Hussain and the former Autonomy CEO, Mike Lynch (who was not indicted in the US case), is still being pursued in the English courts. This decision will clearly strengthen that action.

The US prosecutor suggested in court that the accounts were a façade and eventually proved to be an “unsustainable Ponzi scheme”. Mr Hussain is apparently likely to appeal the verdict, but he faces a prison sentence of up to 20 years – sentencing will take place on Friday.

How different to the UK where prosecutions for fraud based on false accounting almost never take place. Questions were raised about the accounts of Autonomy by investors and a whistle blower also raised issues before the sale to H/P but the UK authorities did nothing. The FRC did announce an investigation into the accounts of Autonomy in 2013. It is still listed as a “current” case on their web site, i.e. no report and no conclusions as yet. Why the delay?

This case demonstrates the typical sloth and inaction of the UK regulatory authorities in comparison with the USA. The FCA/FRC are both very ineffective, and the recent events regarding the Aviva preference shares and the collapse of Beaufort show how ineffective those bodies are in protecting the interests of investors. It’s a combination of a defective legal system and a culture of inaction and delay that permeates these organisations. Well at least that is my personal view.

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

You can “follow” this blog by clicking on the bottom right.

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

Lack of Transparency at the FRC

The Financial Times ran an interesting article on Friday (13/4/2018) headlined “FRC criticised over transparency”. It reported that the Financial Reporting Council answered only 6 out of 52 Freedom of Information requests since 2013. Atul Shah, Professor of Accounting at the University of Suffolk, was reported as saying: “This shows that there is a real problem within the soul of the FRC. It is a public regulator and not a private members’ club, and it has clear duties of transparency, accountability and reliability which it has been avoiding over many years”. He went on to say they have been fobbing of public queries over a long period and that it was really shocking.

How can they reject so many requests? Because only certain parts of their operations are covered by the Freedom of Information Act and they can claim they cannot comment on on-going investigations.

The Local Authority Pension Funds Forum (LAPFF) sent a long submission to the public consultation on the Corporate Governance Code echoing many of those complaints and adding others and saying that the FRC suffers from “internal cultural problems”. They are clearly very unhappy with the activities of the FRC. The FRC has seen fit to respond with a 5-page rebuttal letter which they have published on their web site.

I have of course covered this issue of the culture and processes of the FRC in two previous blog posts which are here: https://roliscon.blog/2017/12/10/brexit-hbos-globo-and-the-frc/ and here: https://roliscon.blog/2017/11/22/standard-life-uk-smaller-companies-and-frc-meetings/

My view is that although the FRC is under-resourced, the approach that it takes should be reformed. Too many times major accounting and audit issues take years to investigate, and often simply result in no action. For smaller companies, complaints can disappear into a black hole with no response being received at all to complaints. Reform is required.

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

You can “follow” this blog by clicking on the bottom right.

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

Quindell, Carillion and Brexit

The Financial Reporting Council (FRC) have announced that they have fined audit firm Arrandco (formerly RSM Tenon) £750,000 and the Audit Partner Jeremy Filley £56,000 in relation to the audit of the financial statements of Quindell for the 2011 accounts. They also “reprimanded” both parties and Tenon had to pay £90,000 in costs. Both parties admitted liability. Two of their errors were a “failure to obtain sufficient appropriate audit evidence and failure to exercise sufficient professional scepticism”. In other words, quite basic failings. The FRC is still looking into other issues that do not affect those parties.

So after seven years shareholders in Quindell have finally seen some action. But the penalties are hardly sharp enough to cause the targets any great suffering. Quindell which was primarily a claims management company, and a favourite of many private investors, had accounts that were in essence grossly misleading. For example, the FRC reported in 2015 that the restatement of its accounts in 2013 turned a post-tax profit of £83 million into a loss of £68 million. Revenue recognition of future contracted profits was one issue.

Now I never held Quindell despite having looked at it more than once. One thing that put me off was talking to someone about the previous involvement of Rob Terry, CEO of Quindell, in Innovation Group. The FT have a good article on his previous career here: https://www.ft.com/content/62565424-6da3-11e4-bf80-00144feabdc0 . I also did not like the look of the accounts at all and the recognition of revenues. Paul Scott, that well-known commentator on small companies, said yesterday: “…its accounts were fairly obviously highly suspect. Excessive debtors, excessive capitalisation into intangible assets, and a flurry of acquisitions to muddy the waters, are the usual give-aways of fake profits, so these dodgy companies are really terribly easy to spot.”

In essence, just a little background research combined with some understanding of accounting, would have put off most investors. But both private and professional investors (even institutions were fooled by Quindell) do not put in the work, or get carried away by the management and company promoters. Rob Terry has yet to be brought to account for the events at Quindell.

There was an interesting letter in the Financial Times yesterday signed by a number of people including Martin White of UKSA. It said the blame for Carillion’s demise was causing fingers to be pointed in all directions, but most are missing the real culprit – namely that faulty accounts appear to have allowed Carllion to overstate profits and capital. This enabled them to load up on debt while paying cash dividends and big bonuses to the management.

One problem again was recognition of future revenue from signed contracts, but the letter says “anticipated revenues from long-term contracts cannot count as distributable capital, and foreseeable losses and liabilities need to be taken into account”. Carillion effectively reported profit that was “anticipated”. They suggest KMPG’s audit should be investigated as I also said in a previous blog post.

The letter writers suggest that faulty standards mean that today accounts cannot be relied upon and the results for all stakeholders can be devastating. Indeed the fall-out from Carillion is going to be really horrendous with potentially thousands of small to medium size businesses that relied on sub-contract or supply work from Carillion likely to go bust. The letter writers suggest that Carillion is yet another “canary in the coal mine”. Perhaps when MPs get deluged with letters from disgruntled business owners and their out of work employees, they will actually get down and demand some reform of the accountancy and insolvency professions.

Incidentally I never held Carillion either probably because it was mainly in the “construction” sector which I avoid because of low margins, unpredictable and “lumpy” revenue and high risks of projects or contracts going wrong. It also had the Government as a major customer which can be tricky. So from a “business perspective”, such companies are bound to be risky investments.

Another good letter in yesterday’s FT was on the subject of Brexit from Dr Ian Greatorex. It said “For too long, some FT contributors have peddled the line that Brexit is the result of a “populist” backlash that might be reversed”. He restated the “remainers” causes for why they think they lost the vote, but then said “The main reason I voted to leave, often based on FT reports over the years of reported EU mess-ups, was that I believed EU institutions lacked proper democratic control and were complacently trying to create an ever-deeper political union against the instincts of the average voter………”. It’s worth reading and good of the FT to publish a more sober letter on the subject than they have been doing for some months. Perhaps the FT have finally realised that not all their readers are so opposed to Brexit and that the reason a number of educated and intelligent people supported it was for factors other than the possible trade difficulties that will need to be overcome.

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

You can “follow” this blog by clicking on the bottom right.

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