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Chapter 1. The Right To Be Informed

The UK’s record of preventing insider trading and forcing companies to be frank and upfront with investors has been rightly criticised. In particular, the Serious Fraud Office’s record in prosecuting insider traders has been poor and the conviction rate abysmal.

This is in sharp contrast to the situation in the United States, where admittedly the conviction rate is multiplied by plea bargaining and the very expensive legal process, which encourages guilty pleas and accusations against others rather than fighting a lengthy and ruinous case, however worthy the defence.

Nonetheless, the climate for change has come almost imperceptibly in the City. At one time companies would routinely tell newspapers that they were not prepared to comment on rumours. Now it is accepted practice that rumours of major events (such as a takeover approach or a slump in sales) must be confirmed or denied once they are out in the open.

That is only right and proper. Shareholders are entitled to know what is going on in the company that they own. It is quite outrageous if directors – who are after all merely the managers acting on behalf of the owners – feel they have the right to withhold important information.

While the right of the wider investing public to this information is not so clear-cut, it is in the interests of everyone that information should be freely available. The stock exchanges will generate more trades when investors are empowered to make informed decisions, which in turn increases the liquidity that oils the wheels of the market.

Finding a balance

There does admittedly have to be a balance. The board must be able to get on with the day-to-day running of the business and with making longer term strategic plans without having to turn to the shareholders every five minutes for permission to go to the toilet or to blow their noses.

The London Stock Exchange has over several decades made admirable strides towards finding the right balance. Now the internet, where information can be widely circulated in nanoseconds, has transformed the whole investment scene.

The mood has changed towards erring on the side of openness: if in doubt, make an announcement. That attitude will grow as the regulators tighten their grip.

The Wolfson case

Wolfson Microelectronics, a supplier of parts for the electronics industry, was fined £140,000 by the Financial Services Authority in January 2009 for delaying the disclosure of the loss of a major contract for 16 days.

Wolfson was told the previous March that it would not be required to supply parts in future for two iPods made by major customer Apple. Wolfson estimated that this represented a loss of $20 million, or 8% of its forecast revenue for 2008. However, it also expected to make up the shortfall by selling more than it had previously assumed to other customers, so revenue for the year was likely to meet published expectations.

Wolfson discussed the matter with its investor relations advisor, who wrongly recommended that there was no need to disclose the negative news. It was not for another eight days, after directors started to get cold feet at a board meeting, that the company contacted its corporate brokers and lawyers, who recommended disclosing the news.

Even then it took another seven days for an announcement to be made. When the news did emerge, Wolfson shares dropped 18% in one day.

Sceptics will point out that £140,000 is a comparatively small fine for a company of this size. However, the point is that Wolfson did take advice and felt that sales gains elsewhere offset the effect of the loss of the Apple contracts.

The view from the Financial Services Authority was unequivocal. It regarded the loss of sales to Apple as potential inside information and there was an obligation to disclose it. A spokeswoman commented:

It is unacceptable for a company not to disclose negative news because it believes other matters are likely to offset it. Doing this hampers an investor’s ability to make informed decisions and risks distorting the market.

One may feel it was a pity that it took 10 months for the FSA to make this pronouncement, but better late than never. The move towards greater disclosure is inexorable – why take the risk of a fine?

Honesty is the best policy – Barclays

The value of honesty in company announcements was exemplified by Barclays in the depths of the banking crisis. Its shares had slumped along with the rest of the sector, reaching 51.25p compared with 400p only four months earlier.

Although Barclays had apparently avoided ceding control to the government, a fate that befell Royal Bank of Scotland, Lloyds, HBOS and Bradford & Bingley, it was not out of the mire. Despite an injection of £5.3bn from Middle Eastern investors, plus a further £3bn available, it was feared that Barclays would still not have enough capital to survive in the dire circumstances surrounding the international banking sector.

Matters were made worse when RBS warned that its loss for 2008 would be a record £28bn, dwarfing the previous UK highest annual loss of £22bn reported some years earlier by telecoms group Vodafone.

Perhaps stung by press criticism that the board had lost the confidence of investors, the Barclays board resorted to the highly unusual tactic of issuing an open letter from Chairman Marcus Agius and Chief Executive John Varley ahead of the annual results due a couple of weeks later.

It is hard to think of a similar letter ever being issued by a listed company but, as the Barclays pair admitted with some degree of understatement:

Writing in this way ahead of the release of results is unusual, of course, but the turn of events is also unusual.

The key points of the letter were:

 Barclays has £36bn of committed equity capital and reserves; we are well funded, and we are profitable. However, we know that our stakeholders want to see the detailed figures for 2008 as quickly as possible. To enable that, we will bring forward the release of our 2008 financial results, as agreed by our auditors, to Monday, 9th February.

 We will report a profit before tax for the year well ahead of the consensus estimate of £5.3bn. The profit is struck after all costs, impairment and market valuations. Whilst it includes a number of individually significant items, it mainly reflects strong operating profit generation.

 The profit includes the gains arising from the acquisition of the Lehman Brothers North American business, and also the gain on the sale of our closed life business.

 Also included in the 2008 results are some £8bn of gross write downs. These figures demonstrate that although we have been heavily impacted by the credit crunch, our income generation was at a record level in 2008 and has enabled us to withstand this impact and still produce strong profits.

 As a result of the capital raising announced on 31st October 2008, our capital base has been substantially strengthened in accordance with the capital plan agreed with the UK Financial Services Authority. We calculate that the capital exceeds the regulatory minimum required by the FSA by an amount equivalent to some £17bn in profit before tax. We confirm that we are not seeking subscription for further capital – either from the private sector or from the UK Government.

 Before closing, we should say a word about current trading. Recognising that 2009 is not yet a month old, and that the global economy will remain weak, we can tell you that customer and client activity levels have been high. As a result, we have had a good start to 2009.

This was a kill or cure job. Issuing a highly unusual statement could have spooked the already nervous market; however, if the tactic worked then valuable time had been gained.

Barclays admitted candidly that its Barclays Capital investment arm had run up losses of £8bn, although that would be reduced to £5bn after income and hedging operations were taken into account.

These figures had to be seen in context. They were lower than the equivalent losses admitted by RBS but were higher than Barclays’ own first half figures, so further losses had been incurred in the second half.

The vital ingredient of the open letter was a claim that the bank had £17bn in spare capital over and above the regulatory requirement. It would not therefore be necessary to raise more cash, either from the government or from private investors.

Barclays added that it had made a strong start to 2009 with the performance at the previously struggling Barclays Capital particularly strong.

It was worth watching the Barclays share price on the day of the announcement. It jumped 37.5p to 88.7p by the close, a gain of 73%. However, that was lower than the 98p they traded at before RBS spooked the market and much lower than the 153p at which the Qatari investors had agreed to subscribe for shares.

Figure 1.1: Barclays

Shareholders needed to consider whether they were sufficiently reassured to stay in for long-term recovery or to take the opportunity presented by the share price rise to cut their losses and get out.

Thanks to the frank attitude of the Barclays board, it proved worth staying in as the shares soon powered to 280p, recovering much more quickly than those of its rivals.