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

FCA Consultation on Changes to FSCS Scheme Compensation

The Financial Services Compensation Scheme (FSCS) pays out if you have lost money as a result of an authorised financial services firm going bust or otherwise being unable to pay compensation for various failings – for example a bank or stockbroker. The scheme is funded by a levy on services firms. The Financial Conduct Authority (FCA) is currently undertaking a public consultation on changes to the scheme.

At present there are limits to the protection FSCS provides which vary by financial product. In simple terms, it protects:

  1. Deposits up to £75,000 per person per firm;
  2. Investments up to a limit of £50,000 per person per firm. These include for claims relating to bad investment advice, poor investment management or misrepresentation. That is obviously a very low limit for what many people have invested via a stockbroker, either in a pension (SIPP), ISAs or directly.

It is proposed to increase those limits for certain product types (to as much as £1 million for pension funds such as SIPPs in drawdown which would more closely be aligned with the current lifetime allowance). That certainly seems a more realistic figure when the new pension freedoms are known to be promoting lots of dubious investment propositions.

In addition one of the complaints by services firms that the risky firms are subsidised by the safe ones is being tackled. One of the biggest financial burdens on the scheme has been a few very large failures of companies which many in the industry viewed as likely to fail from their dubious business practices. Why should conservative businesses have to pay high levies as a resul? So the proposal is to introduce levies that match the risk profile of the subscribers.

The consultation document is available from here: https://www.fca.org.uk/publications/consultation-papers/cp16-42-reviewing-funding-financial-services-compensation-scheme

It’s a typical lightweight document from the FCA to give us something to read over Xmas – only 185 pages. We seem to be snowed under with consultations at present – any ShareSoc Members who would care to assist in dealing with them should contact me. Or you can of course put your own individual responses in using their on-line response form.

Roger Lawson

Aero Inventory – Deloittes Fined

There was a brief mention of the latest news on Aero Inventory in the recently issued ShareSoc Informer Newsletter, but here are a few more details.

False accounts are a common problem in AIM companies (Aero Inventory and Globo are just two examples apart from the recent case of Redcentric). Let us hope the auditors of Redcentric (PWC) take note of the recent record fine imposed on Deloittes of £4 million in relation to their audit of Aero Inventory, plus £2.3 million in costs.

These events were back in 2008 and previous years when the reported inventory held by the company, and its valuation, was subsequently shown to be exceedingly dubious. In reality the totals reported were a complete fiction. The company went into administration causing investors massive losses. Aero Inventory was an AIM company but it was one of the largest ones at the time.

There are a number of questions that arise here:

  1. Why has it taken so long for the authorities to bring somebody to account for the audit failings at the company? It’s now 8 years since the company went into administration and it took 4 years for the FRC to even announce a formal complaint was being pursued in respect of the audit. It’s surely a reminder that the Financial Conduct Authority (FCA), the Financial Reporting Council (FRC) and the BEIS Department of the Government are often slow and ineffective in pursuing failings in listed companies.
  2. Why did the Administrators not sue the Auditors? They generally have little interest in doing so, particularly when there is a risk of not winning such a case or where the amount recoverable in proportion to the claim might be low. Also suing auditors is not easy in the UK because of the contracts the auditors have with the company and because they can often simply claim they were misled by the directors.
  3. Why did the shareholders not sue the auditors? Because the Caparo legal judgement makes it impossible to do so – this was a decision that said the shareholders have no contract with the auditors who are only responsible to the company, thus overturning previously acknowledged law. The only way shareholders can do so is via a “derivative” action via the Administrators where any claim won would revert to the company (i.e. the Administrators). Note also that such an action is now probably time barred by the years since the problem arose which shows how delays in investigation thwart such claims.

However if readers suffered from the events at Aero Inventory, you may care to contact David Stredder at ShareSoc as he is keen to raise awareness of these problems more widely. Please use the ShareSoc Contact Page here: http://www.sharesoc.org/contact.html to send a note marked for his attention.

Roger Lawson

AIM Campaign Comments

The launch of our campaign to improve the AIM market (so as to stop the abuses which have led to investor losses) received a lot of media coverage. As expected those who have profited from the cavalier approach to the listing of AIM companies and the “light touch” regulation were unhappy with some of our suggestions. But here is some analysis of the more reasoned comments published in the media:

  1. Removing risk might reduce returns. This argument is based on the financial theory that high risk investments generate higher returns and vice versa. This is based on an academic theory related to high beta stocks (using beta as a measure of risk) but in practice it may be bunk. To quote Dylan Gricce formerly of Societe Generale: “High risk offers high excitement, not high returns, because excitement is overvalued. In other words, the myth entices many more people to invest in higher-risk stocks. The higher demand drives up prices – and, in turn, drives down their profit potential”. That is surely what has been happening on AIM. It is of course true that those companies which are high risk investments may be valued more lowly and hence experienced investors, or those who can accept the higher risk, may profit in comparison with others. But that hardly seems relevant when AIM actually attracts many more private investors, who are often less experienced, than institutional ones and AIM companies are generally not lowly valued on a fundamental analysis. Their average p/e ratio is higher and the yield lower for AIM companies than for the FTSE All-Share which reinforces Mr Gricce’s point.
  2. That AIM does not need more regulation, or it would be expensive. ShareSoc’s proposals did not advocate substantial changes to regulation. Simply that those existing should be enforced and likewise the general laws on such matters as market abuse where the FCA have been very weak. We do not wish to impose higher costs on market participants, but it seems some commentators did not read the details of our document before jumping into words. The details are present in this note: www.sharesoc.org/Improving-the-AIM-Market.pdf and our proposals would of course be subject to detail scrutiny and consultation. Neither did we argue for “a corporate governance structure equivalent to a main market company” as one person alleged. We recognise that smaller companies need a simpler code. The QCA provide such a code for smaller companies and it is used by some, but many do not and hence have no principles to follow.
  3. The failure rate of AIM companies is low and therefore there is no need for change. The former statement is simply not true. The failures and number of withdrawals from the market are much higher than the main market and much higher than most investors expect.
  4. The impact of pre-pack administrations. One commentator on a blog mentioned the abusive use of pre-packs in AIM companies resulting in shareholders being wiped out. Despite being the owners of the business, and where other options might have been pursued, they are not consulted. A classic example of this was Torex Retail some ten years ago in which RBS was involved. See a recent ShareSoc blog here on this case, but there have been numerous other examples: https://sharesoc.wordpress.com/2016/06/12/rbs-and-pre-packs/ . The insolvency laws need changing to stop the abuses generated by pre-packs and AIM companies are particularly susceptible.

We are not suggesting that the AIM market be scrapped, or made unviable. It is possible to make money from investing in AIM companies and there are tax advantages from it being a market for “unlisted” shares (i.e. securities in a non-Government regulated market) but the current structure encourages abusive practices. Nor are we advocating a revolution – just some relatively simple changes that would avoid the unacceptable and unforeseeable risks that investors face. There is no reason why such changes would reduce the returns available to AIM market investors.

If you have not yet done so, please sign our petition to get some change which you can find at the bottom of this web page: http://www.sharesoc.org/aim-campaign.html

Roger Lawson

RBS and Pre-Packs

The FT carried a story on Saturday (11/6/2016) which was a blast from the past. It reported that Neil Mitchell, a former CEO of Torex Retail, had filed a claim in the high court against Royal Bank of Scotland (RBS), Cerberus and KPMG in relation to the sale of the company at the time it went into Administration.

This case goes back to 2007 when Torex Retail got into financial difficulties after some fraudulent accounting came to light (which resulted in subsequent convictions of some of the management). Neil Mitchell was the CEO at the time, reported the matter to the Serious Fraud Office and supplied a wealth of evidence (dumps of the corporate servers I believe) to support his claim. He was then sacked as the CEO.

The main bankers were RBS and effectively the company fell under their control and they proceeded to arrange for sympathetic directors to be appointed. The company continued to trade normally and clearly was a very valuable business – it was one of the largest AIM stocks at the time. But it was then sold via a pre-pack administration to Cerberus at what many considered an unreasonable “knock-down” price – about a third of what it had been valued only recently before by the market.

Now I know quite a lot about this case because I tried to block the fire sale of the business which was clearly taking place after it became apparent that the directors seemed unwilling to consider alternative offers to one they were working on. Indeed I attempted to requisition an EGM to remove the directors and replace them by others for which we got the necessary number of shareholder signatures. However that requisition was pre-empted by the company being put into a pre-pack administration (where the company is put into administration and instantly sold). RBS were and are very keen on pre-packs because it enables creditors to push through what they want – in this case a sale to Cerberus even though others might have offered more. In addition the interests of shareholders could have been protected by a suitable refinancing which is all that was required. In this case RBS retained warrants and hence a future interest in Torex Retail which traded very well subsequently.

Mr Mitchell’s case is that his claim for unfair dismissal under whistle-blowing laws was thwarted by the sale.

I and ShareSoc have complained repeatedly in the past about the abusive use of pre-packs of which this was a typical example. There was no open marketing of the business and a secret deal was done with one buyer and other offers ignored. In the ShareSoc manifesto we suggest pre-packs should be prohibited and the Government has considered changes in this area but never pushed through necessary reforms.

Another aspect of this case is that there have been a number of complaints about RBS’s Global Restructuring Group which took over loans when companies were in difficulties. It is alleged they sometimes forced companies into Administration unnecessarily for their own advantage. Other legal actions on those claims may yet be pursued and the FCA is producing a report on them.

RBS denies the claims of Mr Mitchell and will apparently defend against it, and KPMG also refuted the claims.

All I can say is that the pre-pack certainly thwarted serious approaches from other investors for the business and the sale via a pre-pack meant the ordinary shareholders got nothing as is usual which should not have been so given that there were other viable options that were available to the directors. An altogether disgraceful example of how bankers can operate and how the law on pre-packs help them to do so. So I wish Mr Mitchell has success with his legal action.

Roger Lawson

Globo Administrators Report – There’s No Money Left

The Administrators of Globo Plc have published their initial report into the affairs of the company. It makes for depressing reading. In essence one might sum it up in the phrase “There’s no money left” which was the infamous wording of a note left by one UK Treasury Minister to his successor.

In this case, even the secured creditors (Barclays Bank in the lead), are unlikely to get paid in full and all unsecured creditors and shareholders will get nil. The assets held in subsidiary companies, where most of them were, appear to be of little value. Some of the subsidiaries are already closed down and others are being sold in a fire sale process as the Administrators have no cash to support them. The cash claimed to be held within the Group according to the audited accounts does not seem to be present.

The Administrators have already spent £303,000 and the final cost for the Administration may be double that, which just shows you how quickly the bills can be run up in such cases.

The key question is whether the Administrator is likely to pursue any claims against Grant Thornton or other parties. But the lack of any cash within Globo Plc itself (i.e. within the Administration), may well prejudice against that. Shareholders might therefore have to pursue such claims directly.

The Financial Reporting Council (FRC) has launched an investigation into Grant Thornton’s audits of the financial statements of Globo Plc for the years ended December 2013 and December 2014. This is of course not unexpected but will obviously take a long time to report as is normal in such cases.

Any shareholders in Globo who have not yet registered with the ShareSoc shareholder group should do so on this web page: www.sharesoc.org/globo.html

Roger Lawson

Globo In Administration

There has been a further announcement by the company today which stated that administrators have been appointed “by order of the court”.

The administrators are FTI Consulting LLP and they say “Our focus is to undertake an immediate assessment of the Group in order to evaluate any opportunities to realise value from the various businesses.  We will also be looking to gain control of the books and records in order to be in a position to undertake a full investigation.  These steps will be done in close consultation with the requisite regulatory bodies.” and “No dividends are expected to be available for shareholders.”

The shares are likely to be de-listed as soon as possible and clearly the ordinary shareholders are likely to receive nothing from the administration. Note also that shareholders are not “creditors” under UK insolvency legislation and hence will have no say in the process. The bankers to the company are likely to be able to recover something by having security over certain assets, but it is very usual in administrations to find there is nothing remaining for unsecured creditors and ordinary shareholders.

So if you know of anyone who might be interested in buying the assets of the business they should contact the administrators immediately (it is not clear if this is a pre-pack administration or not but bearing in mind the rapid timescale of these events which is unusual, probably not). If anyone has any doubt that the company does have some valuable intellectual property, they should read this Facebook note written by Globo staff: https://m.facebook.com/story.php?story_fbid=562662883886842&id=562641343888996&soft=notifications . It refutes some of the claims made by Quintessential concerning the Globo products, but that might be poor consolation to shareholders who appear to have been the subject of a major fraud.

ShareSoc did organise a telephone conference call for investors last night (we now have about 150 contacts so apologies if you could not get in). Some specific actions were agreed in that meeting, the first one being to form a small committee to take matters forward.

Now although some actions may have been pre-empted by the administration, it is beginning to look quite likely that shareholders might have legal claims against the former directors, the auditors or other parties. So that is what will now be pursued.

Anyone with an interest in Globo should register on this web page: http://www.sharesoc.org/globo.html

Roger Lawson