Clamp Down on CFDs – ShareSoc’s Comments

The Financial Conduct Authority (FCA) is proposing to clamp down on CFDs (contracts for difference) and similar financial products such as binary bets. CFDs are complex financial products that have historically been used by sophisticated traders. But they have been growing rapidly in usage by small retail “investors” and the FCA reports that 82% of them lose money based on a review of such accounts.

ShareSoc has now published it’s formal response to the FCA’s consultation on their proposals to tackle this problem. You can read it here: http://www.sharesoc.org/CFDs-Conduct-of-Business-Rules-Response-2017-03-03.pdf

In summary we support the FCA’s proposals with only minor reservations.

Roger Lawson

Alliance Trust Vote – A Victory for Private Investors and ShareSoc

Today Alliance Trust shareholders voted to support the Board’s proposals to change the investment management arrangements and to buy out Elliot. This is surely a major win for private investors and for the stance taken by ShareSoc and the Alliance Trust Shareholder Action Group (ATSAG) which ShareSoc has supported over the last 3 years. ShareSoc wholeheartedly backed the Board’s proposals. Alliance Trust can now move forward.

But it was a close run thing as proxy advisory services who advise institutions were not happy with the buy-back. As a result only some 77% and 83% of votes were cast for the relevant resolutions and the second one required a 75% vote as it was a special resolution.

See the ShareSoc Alliance Trust campaign page for more information and a report on the Meeting: http://www.sharesoc.org/alliance.html

Roger Lawson

NCC Group – All Credibility Gone?

NCC Group is a FTSE-250 company operating in the “cyber security”and “risk mitigation” areas primarily, and the former is surely one of the “hottest” sectors of the market at present. But it’s hotter in other ways for NCC at present it seems.

Yesterday at 4.16pm (always a bad time to make announcements) they issued the latest of a series of profit warnings. In addition they announced a “strategic review” and that the capital markets event scheduled for today was cancelled. The share price fell 30% before the market closed yesterday and was down another 30% this morning. The share price was about 365p last October. It’s now about 90p at the time of writing.

Looking back over the recent history of the company, the long-standing Chairman Paul Mitchell announced he was stepping down in January, and in the same month a new CFO was appointed. In that month the company also announced the sale of the “open registry” group of companies that was trying to establish the use of trusted web sites in which the company had invested a lot of money without success.

The company has made a number of acquisitions in the cyber security area including Accumuli for £55m and Fox-IT for £126m in 2015. These were expected to generate rapid growth in sales and profits and the forecasts have turned out to be optimistic while the cost base has grown and hence damaged margins. Indeed the latest announcements says that sales levels are “unlikely to utilise fully the cost base deployed across the Assurance Division in the current financial year”.

In October last year the company announced the loss of three large contracts and problems with retention of others. Clearly the company has acquired businesses that have lumpy revenues with large projects that are subject to cancellation or implementation issues.

Meanwhile the Escrow Division “continues to perform in line with expectations” according to the latest announcement. This side of the business is very attractive in that the customers are very “sticky” and a very large percentage will renew each year, so there is very high and reliable repeat revenue.

So in essence the company has appeared to make dubious acquisitions which have turned out badly. This is undoubtedly a massive management failure for which the long-standing and previously successful CEO Rob Cotton must surely take part of the blame. Is he the right person to sort out this mess? We shall no doubt see in due course but any shareholders who have an opinion on that might like to comment.

Note: I have to admit to holding this stock, but I sold most of my holding in January. Simply did not like the emphasis on EBITDA in the reporting and the large number of reported “adjustments”. It was also clear that the nature of the business had been changed substantially by the acquisitions, and the previous trading update in October gave a way too optimistic view of the future with comments such as the rate of growth of profitability “remains in line with the Board’s expectations” and that “we remain on course to sustain our double digit organic revenue growth”. This was surely pure hogwash in essence.

As Mr Cotton was presumably responsible for these announcements, I doubt many investors will continue to believe that he should lead the company.

Roger Lawson

Foresight VCT Incentive Fee

In addition to my recent comments on Foresight 4, it’s worth covering the latest news from the original Foresight VCT (FTV). They have announced a General Meeting on the 8th March to consider two matters:

  1. An offer to investors to raise up to £20 million by an issue of new shares (an offer document was enclosed with the notice to existing investors).
  2. The introduction of a new performance fee for the Manager (Foresight Group) and co-investment scheme.

As regards the former, the covering letter from the Chairman suggests that the VCT is “regarded as one of the best performing VCTs” and has “20 years of market leading performance”. That’s not my experience having held this VCT for almost 20 years. Just looking at the latest AIC figures for the company it shows an NAV Total Return of minus 4.9% over 5 years and minus 7.1% over 10 years. That compares with a comparative sector performance of generalist VCTs of plus 50% over 5 years and plus 73.6% over 10 years at the time of writing.

Foresight VCT did achieve one very good realisation in its early years which had a major influence on their reported performance subsequently. This was Yoomedia – it later transpired that they floated on AIM on the basis of fraudulent accounts.

In respect of the new performance fee arrangements (there is no existing one following the merger in 2015), this looks a particularly egregious one. I am not in favour of management performance fees (on top of the normal fixed percentage base fee), for any investment trust. But this one looks both easy to achieve and can result in perverse payments.

The proposed performance fee has two hurdles that both have to be achieved for a payout to be made. The first (Hurdle A) requires an NAV Total Return of 100p over 3 years, from a base of 88p. In other words a total return (capital plus dividends paid) of 13.6% over 3 years which is roughly equivalent to 4.5% per year. Hardly a great return is it?

In addition as it is partly based on dividends paid out it is open to manipulation as we have seen with other VCTs who paid performance fees based on dividends in the past.

The second hurdle (Hurdle B) pays out on individual investments which achieve a return of 4% plus RPI per annum (say 6% at present). Any companies exceeding that on a full or partial realisation cause a payment to be made of 20% of profits to the Manager.

Now the returns on individual investments within VCTs vary widely. Some will show losses, while others can produce returns of 5 times, ten times or even more from the initial cost. But this formula ignores the losses (so long as Hurdle A is met) so in practice large fees can be paid out on a few successful investments when the overall return on all investments is very pedestrian. It also means losses in one year can be ignored, while large profits are paid out in good years if there are just a few successful investments.

Paying out based on individual investments is not right – it encourages a search for lottery tickets. Shareholders only get a return based on the whole portfolio, so the manager shouldn’t be able to cherry pick returns out of that.

This is not a wise performance incentive arrangement even if the principle of even having one was accepted.

Shareholders are recommended to vote against the proposed performance fee arrangement.

Roger Lawson

RBS Rejects Democracy

ShareSoc has today issued the following press release:

The Royal Bank of Scotland (RBS) has rejected a requisition to implement a Shareholder Committee.

ShareSoc will not permit this unreasonable obstruction of shareholder democracy to stand. It is a basic principle of Company Law that shareholders can requisition resolutions which must be put to a vote of shareholders. If the directors do not like a requisition, then they can advise shareholders to vote against it. But they should not be using tenuous technical excuses to avoid putting it to shareholders.

Their grounds for rejection have yet to be clarified (see note 1), but ShareSoc took great care to ensure that the requisition was valid and would not create practical problems with implementation. The requisition provided RBS with wide discretion on how they implement the proposal. (see note 2)

RBS is not intending to propose an alternative resolution addressing their drafting concerns. Hence it is clear that the board do not want a Shareholder Committee, and the objection is not really to the specific drafting of the requisition.

ShareSoc is consulting legal advisors on this matter.

ShareSoc Chairman Mark Northway had this to say: “It is disappointing that, instead of leading from the front on corporate governance, RBS have instead chosen to try to thwart this initiative. This behaviour by the directors of a company that is majority owned by the UK Government underlines the broad reticence of UK boards to address the breakdown of the agency model and the rights of shareholders. There is more work to do at RBS before the government places its 73% holding back into the market.”

The resolution, from 168 shareholders, was jointly coordinated by ShareSoc and the UK Shareholders Association (UKSA).

Note 1

RBS accepts that the resolution was properly delivered under CA 2006 S153 with the requisite number of member signatures, but is refusing to distribute and / or to present the resolution to the AGM on the basis that it is “inconsistent with the law and with the company’s constitution”.

In a meeting, representatives of RBS suggested that the proposed resolution breaches CA 2006 S172, and that this is the basis for claiming inconsistency with the law. They further claimed that the resolution is inconsistent with the company’s articles, by dint of being too broadly drafted. This notwithstanding the fact that it is a special resolution.

ShareSoc have asked RBS to provide their reasons in writing, but so far RBS has not done so.

Note 2

The RBS AGM resolution is quite simple. It reads as follows

That the Directors establish a Shareholder Committee, the members of which will include representatives of large shareholders willing to serve and a representative of retail shareholders, and that the Directors be instructed to use any and all means to implement this resolution, subject to appropriate conditions to ensure that the CA 2006 S172 duty to act fairly between members is not breached.

More Information

The purpose of the introduction of a Shareholder Committee is to improve corporate governance in a company. We suggest that this initiative will significantly benefit corporate governance at RBS, and represents a valuable opportunity for RBS to lead the way in exploring a concept which works well in other countries, which is under consideration by the UK Government, and which could have broad application in addressing the current breakdown in the agency model in UK public companies.

Note that more information about Shareholder Committees and their applicability to RBS can be obtained from this page of the ShareSoc web site: http://www.sharesoc.org/rbs.html

Investors in RBS can register their interest in the campaign on that web page.

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