Obtaining Information on Frauds

One of the things that investors find frustrating is the failure of the regulatory authorities (FCA, SFO, the Police, LSE) to obtain information on the progress or results of investigations into the affairs of companies. For example, if a company and its shareholders are the clear victims of a fraud, often involving false accounting such as in Globo not so long ago and at BT only recently, then obtaining information about the matter is exceedingly difficult.

If the company goes into Administration, the Administrators have no obligation to tell shareholders anything (you are not even legally recognised as “creditors”), and although they have a legal obligation to produce a report for the BEIS Department this is not publicly disclosed.

So for example, Torex Retail (one of the largest AIM companies at the time) was a classic case of fraudulent accounting – sales revenue being invented in essence. The company was pushed through a pre-pack administration and shareholders lost everything. Only some years later were some of the executives actually prosecuted and convicted. In the meantime no information was provided and the chance of pursuing a civil action for recovery of losses was lost.

If you ask the FCA for information they will typically say “we never disclose information on the progress of investigations”, and the London Stock Exchange (LSE) take the same approach on AIM companies. Indeed we complained about this attitude in ShareSoc’s recent submission to the FCA on their “Future Mission”.

Now if you are the victim of other crimes the Police take a very different stance and will respond to questions. For example, they will indicate if a prosecution is likely and when, or if, their investigation has been concluded. If they plan no action, they will say so.

Do they simply have a more co-operative frame of mind? No – it’s probably because they know they are subject to a “Code of Practice for Victims of Crime” (you can find it on the internet). This was established by the Ministry of Justice as a result of the Domestic Violence, Crime and Victims Act 2004.

The key point for investors is that this Code actually applies also to anyone who is a victim of financial crime, and it specifically covers the Police and the FCA/SFO/BEIS – the latter being classed as “Other Service Providers” whose obligations are covered in Chapter 5.

So what are their obligations under the Code? They are:

1.27 Where a victim reports a criminal offence to a service provider responsible for investigating offences, the service provider must ensure that the victim receives a written acknowledgement, including the basic details of the offence.

1.35 The service provider responsible for investigating the offence must, without unnecessary delay, ensure that a victim is notified of their right to receive a decision not to proceed with, or to end, an investigation into that crime.

1.36 The service provider responsible for prosecuting an offence must, without unnecessary delay, ensure that a victim is notified of their right to receive the following information:

  1. a decision not to prosecute a suspect;
  2. the time and place of the trial and the nature of the charges against the suspect.

1.37 The service provider responsible for prosecuting an offence must, without unnecessary delay, ensure that a victim who is a witness in the criminal proceedings is notified of their right to receive the following information:

  1. information about the state of the criminal proceedings, unless in exceptional cases the service provider considers the proper handling of the case may be adversely affected by the notification of such information;
  2. the final outcome in any trial.

1.38 If a victim requests information following notification in accordance with paragraphs 1.35-1.37 above, the relevant service provider must ensure it is provided. In providing the information listed in paragraphs 1.35, 1.36(a) and 1.37(b) the service provider must give at least a brief summary of the reasons for the decision concerned (in the case of 1.37(b), only where such reasons are available).

So you can see that they do have an obligation to provide information within reason which they seem to have been ignoring in financial cases. Indeed sometimes they close an investigation and issue a “private warning” which is not made public or even advised to those who have complained.

Now these Code obligations primarily relate to those who are personal victims (business and other organisations are not covered so ShareSoc could not rely on the Code to represent our Members for example in this regard). So if you are the victim of a fraud by a company or its directors, then it is important that you report it personally to the FCA, SFO or another body and then they will have a duty to respond to questions on the matter. You can invoke the above “Code” if they think otherwise.

Roger Lawson

Alliance Trust Shareholder Forum

Alliance Trust Shareholder Forum

Yesterday (25/1/2017) Alliance Trust Plc (ATS) held the first of three meetings for shareholders to explain the outcome of the “strategic review” undertaken by the board of directors and the future investment management arrangements. This first meeting was in London and attended by a couple of hundred shareholders many of whom posed good questions.

More on the questions and answers below, but first let me give you some impression of the mood of the audience and an overview of where Alliance Trust now stands.

One would have thought that the audience would have showered the directors with plaudits for their activity in the last year, but one got the impression of mostly grumpy old men not being happy with the changes being implemented. After all the share price is up 34.5% over the past year at the time of writing. There are not that many stock market portfolios that will have achieved that. This has been helped by the share price discount closing to just over 5% which it is has not been near for years. The wide discount in the past was of major concern and put off new investors – it’s was also something that attracted hedge funds such as Elliott Advisors to stimulate some changes which were sorely needed.

The board has also disposed of Alliance Trust Investments, the subsidiary that managed the investments and not that successfully. It seems to have turned around Alliance Trust Savings (ATS) although there may be more to be done there.

Did shareholders really appreciate the regime of Katherine Garrett-Cox and Karin Forseke (CEO and Chairman)? I do not know many who liked it. The new board have taken some decisive steps to improve the company and make it look more attractive to new investors which is surely one aspect to aim for to enable the company to continue its historic role – namely to provide a low cost, global growth, actively managed stock market portfolio.

How are they going to improve investment management in future? By using Willis Towers Watson (WTW) to select a group of managers who will each manage their portfolios as they see fit. They are expected to improve the Trust’s investment performance further so that it is 2% ahead of their benchmark (WTW have experience of achieving this with other portfolios they advise on). It transpired the individual managers can also be fired at a moments notice if confidence in their abilities is lost. WTW had staff present who explained their investment manager selection process which appeared to be sound.

Will all this cost a lot of money, effectively increasing the charges on the Trust substantially? Well it will increase costs somewhat to say 0.6% p.a. but that will still be very competitive to similar investment trusts – less than two thirds of them they suggested. Note that the geographic/sectoral weightings of the Trust’s portfolio overall won’t necessarily be that different to what it is at present but the individual stock holdings might be very different.

Shareholders will get a vote on the proposed investment management changes at an EGM in Edinburgh on the 28th February. Alliance Trust shareholders should ensure they vote. The Alliance Trust Shareholder Action Group (ATSAG – supported by ShareSoc) is likely to give a voting recommendation at a later date.

Director Karl Sternberg did most of the talking for the board and answered most of the questions. I pick out a few questions and answers below (summarised for brevity).

  1. Who is managing currency risk plus who is controlling gearing? Answer: WTW monitor country and currency risk by weighting allocations to the managers. The future level of gearing will be a decision between the board and the managers.
  2. How are you going to manage the portfolio transfers to the new manager? The questioner also commented that buy-backs don’t work to manage the discount in his experience. Answer: Buy-backs are a short term palliative but they help to mop up loose holders. The transfer transaction will be done using a specialist transition manager who will keep costs down to an absolute minimum.
  3. What if the shareholders vote no? Answer: Then there would probably be another strategic review [and he hinted possibly board changes]
  4. What are the intentions of Elliott? Answer: The board is not aware of Elliott’s plans but they have consulted Elliott.
  5. Will we get an increase in dividends? Other trusts pay more. Answer: Alliance is not an income trusts. They think total return is what matters. [Comment: and rightly so – that’s all that really matters]
  6. What is the board going to do about ATS? Answer: ATS is now profitable. Confident it will be a success. It is now an independent subsidiary with a separate board. The questioner went on at some length on this topic and clearly saw owning ATS placed substantial risks on the shoulders of Alliance Trust shareholders. Another member of the audience spoke against disposal because it provided a low cost investment service to shareholders.

Conclusion and comments: This was a useful meeting and it was obviously focussed on the new investment policy and management approach. But there are some issues such as the Elliott stake that remain to be dealt with. An announcement on the previous day suggested the board would enable Elliott to participate in a buy-back at around the current discount level (i.e. a tender offer to them presumably as they cannot currently participate in buy-backs without prior approval of independent shareholders as they have such a big stake). However, press articles have suggested Elliott are looking for a better deal than that which is surely problematic as it would mean a general tender offer at a nil or very small discount, or some preference to them.

As regards the “multi-manager” approach this certainly seems worth trying and other investment trusts have run similar arrangements successfully. The resulting cost structure does not look unreasonable, if the target performance is achieved, or anywhere near.

One did get the impression from the questions/answers and talking to a few of the attendees that some shareholders would like to revert to the original structure of a self managed, low cost trust based in Dundee. That is probably not a viable structure in the modern investment world, if it ever was if good performance is to be achieved. Hardly any investment trusts follow that model now. And a fully non-executive board as the company now has is much sounder. I suggest shareholders should put more trust in the new board than they demonstrated at this meeting because all they have done to date seems reasonable to me and as good a way forward as any.

Postscript: Soon after the above meeting the company announced that it had agreed to repurchase all the shares held by Elliott (19.75% of the share capital) at a discount of 4.75% to the prevailing NAV. That would be done in five tranches, subject to shareholder approval – resolutions to approve will be put forward at the forthcoming EGM. The repurchase will add about 1% to the company’s net asset value per share to the benefit of other shareholders. In addition the board advises that in future it will buy back shares at or around the same level in the market, so effectively all shareholders are being treated equally.

Roger Lawson

BT Hit By False Accounts

The share price of BT Plc (BT.A) fell by over 20% yesterday after reporting that it would have to write off £530 million in its accounts as a result of “improper accounting practices” in its Italian subsidiary. That included “improper sales, purchase, factoring and leasing transactions” according to the announcement by the company. BT’s CFO Simon Lowth commented that including borrowing against receivables to pay debts, improper sale and leaseback transactions and shifting of operating expenses into capital budgets. The company’s auditors are PWC.

Why is it that so many accounting scandals take place in Southern European countries – Italy, Spain and Greece for example? One of the biggest accounting scandals in recent years was also in Italy where Parmalat became the biggest European bankruptcy as a result (debt was grossly understated). Greece managed to even produce false national accounts so as to get admitted to the EU.

BT also indicated that underlying revenue would also be flat in 2016/17 and 2017/2018 and EBITDA also flat in the latter period. Large public sector and corporate business deals seem to be the problem. But they still expect to grow the dividend by 10% in those years. Prospective p/e is now about 10 with a yield of 5%. But BT was seen to be reviving its business and growing revenue recently which it seems is not the case after all, and it still has a massive pension deficit to fund.

The share price collapse just shows how even megacap companies can be hit by massive swings in sentiment, where institutional investors follow like lemmings and dump the stock regardless. Index tracking funds compound the problem because once the stampede starts moving, it’s difficult to halt.

Could this problem have been foreseen? Ed Croft wrote an interesting article on this on Stockopedia. He pointed out the warning signs were there – an apparent earnings manipulation risk (disproportionate increase in receivables, etc), declining share price momentum (the share price was already down by about 25% from its peak before the latest news), growing debt pile, huge pension deficit and broker estimates being downgraded.

He’s probably right and that the message is clear. Even with FTSE-100 stocks you need to keep an eye on what is happening to a company but nobody can predict where false accounting might appear. It’s just another indication that the audit profession is not doing such a great job as they think they are. There are way too many of these cases where the accounts of public companies turn out not be capable of being relied upon and they seem to becoming more frequent if anything.

Roger Lawson

Brexit Decision by Supreme Court

The Supreme Court has decided to reject the Government’s appeal which means they cannot invoke Article 50 to leave the EU without an Act of Parliament. Will that make much difference? Probably not as the Government is expected to submit a short Bill to give it the required powers to do just that which is likely to be voted through.

The judgement of the Supreme Court, at 43,000 words, was not unanimous with 3 of the 11 judges dissenting. The majority view was that the European Communities Act (ECA) meant that the Government could not simply use its prerogative to proceed without the support of Parliament. But they did reject the “devolution” issues raised by Scotland and Northern Ireland by saying “The devolved legislatures do not have a veto on the UK’s decision to withdraw from the EU” which will make the Government’s subsequent actions easier.

As with most cases that get to the Supreme Court, the issues are both complex and require fine judgement. It does not seem to me that the Court did a bad job of deciding on the issues like many Brexiters have been claiming.

Of course the financial impact of Brexit is still being debated, particularly as it turns out the somewhat cataclysmic forecasts of many economists are to date proving to be quite wrong. It is interesting to read what Tim Martin, founder and Chairman of J.D.Wetherspoon had to say in a recent Trading Statement from the company about economists:

“The underlying reason for their catastrophically poor judgement is a semi-religious belief in a new type of political and economic system, represented by the EU, which lacks both proper democratic institutions and the basic ingredient for a successful currency – a government.

It also lacks any genuine commitment to free trade, other than to countries which are in, or on the borders of, the EU. Unless these lessons are learned and acknowledged by economists, their historic mistakes will be repeated.

As regards the other frequently asked question about the government’s stance on dealing with the EU, the golden rule in any negotiations, ignored by David Cameron, is the willingness to walk away.

Most people now understand that the mutual imposition of World Trade Organisation (WTO) tariffs would create a windfall for the UK, so a sensible basic mantra for the UK is ‘free trade or World Trade Organisation rules – the EU can choose’.”

But there is surely one thing for investors to bear in mind. That is that deciding on investments based on the forecasts of economists or of political commentators is as likely to be wrong as right.

Roger Lawson

Paddy Power Betfair – Same Excuses as William Hill

Bookmaker Paddy Power Betfair (PPB) came up with similar excuses for middling results as did William Hill recently on which I wrote a previous blog post (see https://sharesoc.wordpress.com/2017/01/10/how-bookmakers-lose-money-william-hill/ ).

In this case they complained about results that favoured customers which apparently cost them £40 million, including losing £5m on the US election result alone. As I pointed out previously, this should never happen unless they are betting against their customers or not setting the odds properly. This is particularly amusing if you bear in mind that a big part of this company is the Betfair operation. This is what they say on their web site: “Betfair is a betting exchange – an online marketplace for punters to bet against themselves on sporting and cultural events around the world. Customers bet against each other not against Betfair”.

The fact that two of the major bookmakers are both complaining about this, even though earnings are much as expected and revenue well ahead in the case of PPB, suggests they are yet again trying to fool their customers into thinking that bookmakers can lose money if the punters are lucky.

Roger Lawson 24/01/2017

FCA’s Mission Statement – A Suggestion

The Financial Conduct Authority (FCA) has been consulting on its “Future Mission” and ShareSoc has submitted a detailed response. It can be read here: http://www.sharesoc.org/FCA-Mission-ShareSoc-Response.pdf and there is also a press release which we issued this morning which summarises it: http://www.sharesoc.org/pr86-fca-mission.html

It’s a pretty devastating critique of the activities of the FCA and the muddled thoughts about its mission statement. It has occurred to me that actually writing a mission statement for the FCA should not be that difficult, so here’s my attempt at it. Note: this is my personal view and is not necessarily formal policy of ShareSoc. 

A Mission Statement for the Financial Conduct Authority

  1. We will ensure that financial markets are fair, honest and orderly (that includes not just stock markets but markets for other financial services such as insurance, pensions, banking services, etc).
  2. We will enforce the law and vigorously pursue those who break laws or regulations. Where infringements are proven we will impose penalties and “name and shame” the malefactors.
  3. We will ensure that information is provided to all market participants equally.
  4. We will ensure that investors have the information to make informed decisions on financial investments and other financial services and that such information is unbiased.
  5. That no distinction will be drawn between the wholesale and retail markets (i.e. that individual investors will not be excluded from wholesale markets or prejudiced in any way).
  6. We will not protect retail investors or consumers of financial services from their own ignorance or foolishness, but we will ensure they have access to free or low cost education and free information about any investments or services they are contemplating including the likely risks and returns to be obtained from them. Such information to be provided should be appropriate to the likely readers.
  7. We will generally deter speculation, the excessive use of gearing, trading on margin and other such financial activities where they serve no purpose other than to promote gambling activity rather than serve the underlying needs of businesses or consumers.
  8. We will ensure that the ownership of investments is legally clear and not obscured by artificial structures such as nominee accounts.
  9. We will only approve the sale of new financial products or services where they meet a genuine need that is not adequately covered at present.

So that’s it on the principle that all good mission statements are short and easily comprehended. What more is needed?

If you think there should be more, please contact me.

Or if you think it should be shorter, one could consider the mission statement of the US Securities and Exchange Commission (SEC) which is: “The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation”. An admirable encapsulation, but that only covers stock markets of course.

Roger Lawson


Forward Selling: A Crime Against Shareholders?

Roger has recently written about the censure of Cornhill Capital, in the matter of New World Oil & Gas. The full censure notice, setting out the gory details of the case has been published here: http://www.londonstockexchange.com/traders-and-brokers/rules-regulations/change-and-updates/stock-exchange-notices/2017/n0117.pdf

This case centres around the practice of “forward selling”, a practice which is not unusual at present. So, what is forward selling? Forward selling occurs when a company agrees to issue shares to a third party and that third party sells those shares in the market, prior  to actually receiving them.

What are the motivations behind this practice?

The motivations for the forward sellers are pretty obvious: they can make an almost* guaranteed profit by selling shares at market prices, when they know that they are going to acquire the shares at below market prices. By selling the shares before they receive them, they are taking no risk that the price might decline after the issue process has completed. The practice also benefits brokers and advisers, who generate fees or commissions from the share issuance.

From directors’ point of view, permitting forward sales may make it easier for them to issue shares, thus raising finance which supports the business (and supports the payment of their salaries). This is a particular issue for businesses that are not generating profits, including early stage businesses and pre-production natural resource companies – many of which regularly need to raise fresh capital.

*I say “almost guaranteed”, because the New World case illustrates what can go wrong: it is possible that for some reason the company isn’t able to fulfill its commitment to issue the shares the forward seller is expecting to receive.

Under what circumstances can forward selling occur?

When we start to consider the circumstances under which forward selling can occur, the problems with the practice start to become evident. Firstly, in order for forward selling to be profitable the shares must be issued at below market prices. In the case of New World, the shares had been trading around 0.1p before the massively dilutive placing at 0.055p was announced. They still traded (in volume) at around 0.075p in the days immediately after the placing announcement, meaning an instant & substantial profit for the forward sellers.

Another circumstance where I have learnt forward selling takes place is when companies enter into agreements such as “Equity Financing Facilities” (EFFs). See this example in the case of Nighthawk Energy, another case that I am intimately familiar with. These and similar agreements are even more iniquitous from shareholders’ point of view (and investors should regard the existence of such an agreement to be a “red flag”). They allow the subject company to periodically issue tranches of shares, at prices that are to be determined by reference to market prices, upon issue of a “subscription notice” to the EFF provider by the company.

What happened in practice is that the EFF provider forward sold the shares it was procuring under the subscription notice during the period when the discounted subscription price was being determined, thus guaranteeing a profit, as described above.

What is the problem for shareholders?

There are two evident problems with this practice:

  1. The forward sellers make their profits at the expense of pre-existing (and often long-term) shareholders, who’s stakes are diluted and hence devalued.
  2. The buyers of the forward sellers’ shares may not be aware of what is going on (that was certainly the case in the Nighthawk example) and are purchasing shares that the company is issuing at a price that is inflated relative to the issue price. In the New World case, anyone buying shares from the forward seller at 0.075p was paying 36% more than they could have paid, had the company made the shares directly available to investors.

A less obvious problem is that for this practice to succeed, there needs to be a strong market for the shares that the company is issuing to the forward sellers. In my experience, one often finds very bullish comments about the worth of the company at such times, which can mislead investors and encourage them to overpay. In the case of New World, investors ultimately found themselves with worthless shares, as the company subsequently delisted.

There is obviously a strong incentive for the company or the forward seller to promote such commentary which misleads investors.

In the Nighthawk case, I believed that there was a clear instance of market abuse, which I evidenced and explained to the FCA in this letter – but never received anything other than an acknowledgement of my complaint, and a refusal to discuss it. Watch this space for ShareSoc’s response to the FCA’s recent consultation on their mission!


For these reasons, I believe the practice of forward selling should be banned and companies seeking to raise equity finance should instead be encouraged to do so from existing shareholders, and new investors, on equal terms, with preference being given to the former where demand exceeds supply.

What do you think?

Mark Bentley