It’s Getting More Difficult to Vote

It’s certainly getting more difficult to vote of late, and I am not talking about voting at General Elections but just for resolutions at the General Meetings of companies we own. This seems to be a particular problem with Capita Registrars. Here’s some examples:

  1. Whitbread: As a personal crest member, I am on the register and expect to be sent an annual report and proxy voting form (and at least the latter on paper). But no longer it seems. Whitbread only sent me a single page letter advising me that the Annual Report and AGM Notice were available on-line and I could vote on-line. No paper Annual Report when I had not opted to not receive it. So I phone them up to ask for a paper copy and a proxy voting form. They (twice) sent me the previous year’s annual report by mistake and no voting form until reminded.
  2. National Grid. Similarly I only received a single page letter. So I tried to vote on-line. Even though the instructions were unclear, after speaking to Capita on the phone, they could not advise me how to get it to work. Simply rejected my ID. They seem to have a technical problem and clearly the system has not been adequately tested.

Is it not ridiculous that one should have such difficulties with voting, getting a notice of the meeting or an Annual Report? This is another example of how shareholder democracy is being undermined.

I will be raising these issues at the AGMs of these companies. But it is really annoying to have to waste time on such matters. If everyone on the register (or in a beneficial holding) was sent a paper proxy voting form, that would be one simple solution and should be mandated in law.

Roger Lawson

RBS Potential Settlement: Where’s the Justice?

It seems that the major players in the RBS Action Group have accepted the latest RBS offer. See http://files.constantcontact.com/2fe662f5101/de78446f-b327-4d5e-9eee-5fcd584c7e8c.pdf

This has, in effect, enabled RBS to bully the small individual shareholders into also accepting the settlement. I say “bully” because RBS are threatening anyone who pursues the case to risk having costs awarded against them.

So now the case will be settled. No-one will be found guilty. RBS will pay out £800 million (of shareholders’ money) to a group of its shareholders without admitting any culpability or liability. It all gets swept neatly under the carpet and no one goes to jail. It has taken 9 years for this to happen. It is not just RBS – the HBOS Reading trial took nearly ten years to be investigated and brought to court.

The key players do not come out of this well. Something is wrong with the SFO, CPS, FCA, FRC, BEIS, etc when £12 billion of RBS’ shareholders’ money raised in a rights issue can disappear so quickly.

Very, very few people in the UK have gone to jail as a result of their actions that led to the 2007/08 Financial Crisis, yet millions of people have suffered severe hardship as a result. The SFO, Crown Prosecution Service and/or BEIS should be given more resources and told to pursue problem cases much more speedily. Companies should not be allowed to hide behind expensive lawyers. The whole process of settlements where management admit no blame and shareholders pay the fines/settlement amounts mean management get off scot free and also needs a review. These steps (plus others no doubt) are required to rebuild trust in business and to tackle what Mrs May calls the “anything goes” business culture.

Cliff Weight

Rolls-Royce – Audits Investigated and AGM

Yesterday (4/5/2017) I attended the Rolls-Royce (RR.) Annual General Meeting in Derby. In former years they used to hold the meetings in London but it’s been Nottingham and Derby the last couple of years. As a result, from talking to a few attendees it seemed to be mainly Rolls-Royce employees and retirees attending rather than the normal private investor crowd. The choice of venue may of course be deliberate so as to achieve a more sympathetic audience.

But the story promoted by the company is much the same – orders up, sales down and profits down, but the company says it has a bright future in summary. In the last year we have also had the settlement of past bribery in the company, and the issue of needing to change their revenue recognition on maintenance contracts (these issues have been well covered in past ShareSoc blog posts). In addition there was a massive reported loss arising from foreign exchange hedges being revalued.

The same day it was announced that the audit of the company’s accounts by KPMG in 2010-2013 are to be investigated by the Financial Reporting Council. Which seems very appropriate bearing in mind what was disclosed at the AGM.

Here is a brief summary of what was said by Chairman Ian Davis and CEO Warren East, and what I said in the Q&A session (not verbatim – summarised for brevity) . There is a fuller report on the ShareSoc Members Network:

Ian Davis confirmed the outlook for 2017 was unchanged – a trading statement was issued in the morning which said trading was in line with expectations but that profit and cash flow would be weighted towards the second half of the year. Cost savings were given as being “on-track” and the company priorities includes continuing to “rebuild trust and confidence in our long-term growth prospects” which is a clear admission that investors had lost faith in the company. The share price has improved over the last few months but it’s still considerably lower than it was back in 2013-2015.

Mr Davis said he was impressed by Warren East’s building of his management team, and that the long-term prospects for the company remain outstanding. The order book has grown to £80 billion.

After that short presentation, Warren East spoke at more length. He said that 2016 was a year of stabilisation and was a great foundation for moving forward. Underlying revenue was down slightly but underlying profit was down significantly [49% down in fact]. He explained the large “headline” fall in profits has being due to derivative contract revaluation. But he did say that underlying profit (which excludes derivative charges) fell due to significant headwinds in the civil aviation business. However they have grown the wide-body engine market share from 30% to 50%. There was a once in a generation transition to more efficient engines. The launch costs will decline and the installed base will grow.

They are losing mid-range and corporate jet market share, and defence is still a challenging market. In power systems there was a stable performance and the installed base grew. Marine suffered from extreme weakness due to a dearth of orders for new vessels and servicing. There have been major job losses. In nuclear there had been some investment in the development of small modular reactors.

Mr East continued by saying they had invested a lot in 2016 in R&D, in assets and in operational excellence. But they had not forgotten cost control. He said investors were now more confident in the company now – hence the improvement in the share price. They have restored trust in the company.

Mr East then talked about the new management appointments and said they still need to follow through on strategies set in 2016 while also thinking about the future.

He explained the deferred prosecution agreement over the bribery allegations (£671 million in fines, plus an obligation to change their behaviour). There had been extensive action within the business to change policies in this area.

I covered a number of issues when questions were invited:

1) I questioned whether the former management (e.g. the CEO) should be subject to clawback on bonuses because of the bribery and other issues. The answer given by Ruth Cairnie (Chair of the Rem Comm) was that the management who were involved in the bribery scandal had lost all their bonuses and options and that clawbacks had been introduced. But the Chairman said that the former CEO knew nothing about the matter at the time. Incidentally there was an amusing comment from Matthew Vincent in the FT today which was “All of this prompts the question: which euphemism did Rolls-Royce use for the £100,000 or so it spent on a Silver Spirit car to indulge the automotive appetites of an Indonesian intermediary? Miscellaneous travel?” That question was directed at KPMG but it might just as well be directed at the former CEO surely.

2) I suggested a shareholder committee would perhaps help Rolls-Royce deal with the various problems they faced.

3) As regards the accounting change to future maintenance, which had been explained away as a “technical accounting issue”, I said that it was not just a technical matter but a question of prudence. In my view it was not prudent to recognise future sales and profits in the current year. And it was certainly not clear in the past that this dubious accounting treatment was being used.

4) I also commented negatively on the complexity of the Remuneration Policy. Ruth Cairnie said it had been simplified but I pointed out that the maximum salary multiple in the LTIP had actually been increased. I spoke to Ruth at some length after the meeting on remuneration. I pointed out that such LTIPs result in enormous payouts at companies like Persimmon and Berkeley Group (WPP is another example incidentally) and that a recent Commons Committee said they should all be scrapped. She responded that they had to pay a competitive “package”. I agreed with that but said it would be better to have a higher fixed base salary and do away with LTIPs, or pay bonuses in cash or shares annually. There was no incentive provided by LTIPs as anyone familiar with business management would know – rewards for good performance need to be made soon after achievements. I also said to her that if public companies did not reform their attitude to pay and the levels they considered appropriate that the Government might take a hand. I did say to her that it was her responsibility and she could do something about it. She did not seem happy with my comments but reiterated the usual stance about having consulted all their major investors. Indeed they did achieve 95.6% support on the Remuneration Policy vote and 98.7% support on the Remuneration Report vote.

It was only a moderately useful meeting to attend. As in previous years, treated more like a PR exercise for company pensioners than a serious meeting for investors by the Chairman. Bearing in mind that the Chairman has been Chair of this company for several years, it surprises me that he is still there when the company has had so many problems on his watch. I would certainly prefer a new Chairman. Matters such as remuneration tend to be driven by the Chairman and his response to criticism of any kind is not helpful. But he still got 99.5% of votes to re-elect him. Surely an example of how corporate governance by institutions tends to be brain-dead. The votes on remuneration also demonstrate a pathetic response to the pay issue.

In essence the old problems are still there. Orders going up, but sales falling, i.e. orders not able to be delivered and turned into cash. They need to start using a different measure of likely future business. With such a large and complex business, it is difficult to say yet whether Warren East has really got to grips with reforming the company. We will have to wait and see.

Meanwhile there was a good editorial in the FT on how the defects in auditing at companies such as Rolls-Royce “highlight the failure of the accountancy profession and its regulators to resolve in the intervening 15 years [since Enron and the demise of Arthur Andersen], the fundamental question of how far auditors should be expected to go in their efforts to uncover bad behaviour”. One cannot but agree with that and with their view that 4 major audit firms is not enough to ensure competition and that it tends to encourage cosiness between auditors and their clients. But there are surely more substantial reforms necessary to really improve auditing standards which the profession itself seems to not accept as being required in any way.

Roger Lawson

Banks and Bank Credit Card Accounting

It’s going to be exciting week next week for RBS and Lloyds Bank shareholders with both AGMs on Thursday in Scotland – we expect to issue a report on events. Indeed it’s going to be an exciting period ahead because the law suits by those investors in the RBS rights issue who have not yet settled, and an action over the takeover of HBOS by LloydsTSB, are both getting into court in the next few months. Having Fred Goodwin on the witness stand, as expected, will be particularly interesting.

But the really astonishing recent news to this writer was the revelation on Monday (1/5/2017) by the FT that bankers are recognising future profits on zero-interest credit card customers. Bankers who offer zero interest balance transfers recognise some of the revenue and profits from new such customers based on the expectation that the customer will remain a customer, and not fully pay of the debt, when the interest free period ends.

Now a lot of them might not, but surely it is imprudent to recognise the cost of such promotions as other than a marketing expense which is surely what they are? And recognising future profits in the current accounting period is definitely neither sound accounting nor prudent in my view.

Was this not what Rolls-Royce had been doing which they have had to back-track on? With a major impact on their bottom-line as profits were routinely being overstated (see previous blog post on that).

The level of credit card debt is currently of concern to the Bank of England, and they might bring in tighter regulation on such offers and the level of debt. Or the customers might suddenly realise that not paying off such very expensive debt was nonsensical, particularly as the ability to roll it over to another credit card company might disappear. So all those future bank profits on credit card lending they are recognising now, and paying bonuses to management on them, might vanish.

Virgin Money is one bank where it is suggested they could lose as much as 18% of their earnings if there was a move to “cash accounting” on such arrangements, i.e. profits can only be recognised when the cash arrives.

So there are two questions that investors in banks might wish to ask at this year’s AGMs: 1) Are you doing this and if so why are the directors following this imprudent accounting practice? and to their auditors: Why are you approving this imprudent practice and under what accounting principles?

I fear this may be yet another example where banks will face regulatory action, and have to write off some of their claimed profits. And will investors ever learn to trust the reported accounts of banks when this kind of sharp practice continues?

Roger Lawson

 

Open-Ended Property Funds – Our Views

ShareSoc has now submitted our response to the consultation by the FRC on “Illiquid Assets and Open-Ended Investment Funds”. This follows on from the problems experienced last year where property funds had to close to redemptions but it can affect other types of funds also such as private equity ones.

In summary after listening to a number of our members on this topic, we have chosen to say that although we would not be opposed to the banning of such funds entirely, we suggest the best way to ensure there are no problems in future is to ensure that very strong health warnings are given to investors who chose to invest in such funds. Obviously in the case of commercial property funds, there are a number of closed end funds (e.g. investment trusts) covering that sector so most investors should have very good reasons to choose open-ended ones instead.

You can read our full response here: Open-Ended-Funds which also contains a link to the FRC consultation document.

There were a couple of interesting articles related to this topic in the Financial Times recently. One reported that big UK property funds are hoarding cash – in several cases well over 20% of their assets. Presumably this is because of fears of a repeat of last year’s run on the real estate sector. Holding large amounts of cash obviously provides the liquidity to enable high requests for redemptions to be met and to counter market volatility, but it also reduces the returns from the fund in the longer term as cash typically yields less than property. It would be unusual for a real estate investment trust to hold that much in case, and often they are more than fully invested as they use gearing to improve returns.

Another article reported on the Association of Real Estate Funds (Aref) response to the aforementioned consultation. Their report called for a “comprehensive review” of the rules governing retail property funds as it was unclear what fund managers were allowed to do. A somewhat odd comment and the FRC consultation document clearly covers the matter in some detail already. But another suggestion made is that the problem could be resolved by having a range of different fund structures because most investors are not actually looking to “day trade”. So a range of products reflecting the different liquidity needs of investors might be offered.

Comment: An interesting idea but would it really be practical? It would also add confusing complexity to investors choice. Investors find it difficult to anticipate when they might want to sell, and some sales might be crystalised by the death or major financial/personal crisis of an investor. Would they be considered an exception, or just told it’s bad luck they chose to invest in a fund that requires six months or a year withdrawal notice – because that is how long it might take to dispose of commercial property? For private equity funds, it might take even longer to dispose of assets.

And would investors choose funds with lower returns in preference to others with higher returns? Which might be the result of them offering high liquidity at all times, and holding cash or other low return assets to enable the former to do so?

Behavioural responses to such scenarios could be complex.

Roger Lawson

Why Companies Don’t Get Struck Off, and Maven VCT5

I have had two listed companies in my last 25 years of investing, that delisted and then became worthless. But the directors refused to put them into liquidation or ask for them to be struck off the register of companies at Companies House (which can be done if the company has ceased trading and no debts remain). In both cases the directors claimed they were going to revive the company with a new business but neither seemed very realistic to me and I thought this was a case where the directors did not want to be seen as being former directors of liquidated companies. Requests to Companies House to have them struck off were appealed against, although one of them finally did get removed. But having attended the Maven Income and Growth VCT 5 AGM (MIG5), I now know there may be another reason.

In response to a question, Bill Nixon of Maven explained why they don’t want investee companies to be struck off the Companies House register (they have quite a few “zombies”, the walking dead, still included in the portfolio list in the Annual Report). This is because the cost of the investment in them continues to be part of the “qualifying investments” pool under the VCT rules. Yes it’s all a bit daft is it not but this kind of thing always arises when rules are complex, as they certainly are in VCTs.

Two for the price of one, and my worst investment.

There is a full report on the MIG5 AGM on the ShareSoc Members Network – in fact two, because both I and Tim Grattan have written one. The extra stuff in mine shows how disastrous was my investment in this company some 17 years ago, offset to a large extent by the generous tax breaks. There are some lessons drawn from that debacle. I believe Tim might have been a lot wiser and bought the shares in the “second-hand” market years later which is a tactic to be followed in the VCT market when opportunities arise, although they are not as common as they used to be. It’s worth saying here that the performance problems at this VCT mainly arose in its early days and before the change of name and new management by Maven.

Roger Lawson

Finance Bill and Tax Changes

When a General Election is called, with the imminent prorogation of Parliament when all Bills that are passing through Parliament are effectively abandoned, the Government has to rush through any important Bills that it wants to get passed. That is what happened yesterday (25/4/2017) when only a few hours debate was available on the Finance Bill. That Bill contained many of the recent changes announced by the Chancellor in his Budget but many of them have been removed from the Bill so as to ensure its quick passage. It also avoids any politically embarrassing changes being implemented before the election. They may get revived in new legislation after the election in the new Parliament, reconsidered or quietly forgotten about. The latter being of course likely if there is a change in the political complexion of the Government or changes of Ministers.

These are some of the tax and other changes removed from the Bill:

  1. The reduction of the Dividend Tax Allowance to £2,000 from 2018. ShareSoc raised concerns about this and asked our Members to write to their MPs on the topic – see https://sharesoc.wordpress.com/2017/03/20/double-taxation-and-broken-promises/ . It was certainly a vote loser for anyone who receives substantial dividends and it would definitely be good to get this reconsidered.
  2. The reduction in the annual pension allowance from £10,000 to £4,000 from 2017 to stop “re-cycling” of pension contributions where pensions were already being taken is out. So you may have another year to use the higher amount.
  3. The “Digital Tax” plan to force smaller companies to submit quarterly tax returns electronically is dropped. This was a very unpopular move by HMRC among small businesses as it would have imposed major extra costs on them. This is likely to simply be deferred.
  4. The change to increase Probate Fees very substantially on larger estates has been dropped – see https://sharesoc.wordpress.com/2016/02/20/it-could-get-more-expensive-to-die/. This proposed change provoked a lot of criticism from the public including several ShareSoc Members. Again it would be good if this was reconsidered rather than simply postponed.
  5. Some changes to the rules on EIS and VCT investments and social investment tax relief are out.
  6. Corporation tax relief changes are out.
  7. Disclosure of tax avoidance schemes and penalties for enablers are out.

There are quite a lot of other clauses removed – one could say that a hatchet has been taken to the Bill to get it passed. But if you take the opportunity to ask questions of your prospective MPs in the hustings, you may like to pointedly ask them about their views on some of the above and whether their Party would revive these measures.

Roger Lawson