I invested in a fraudulent company and lost my money...here is what I learned

Things don't always go to plan when you invest in individual stocks.  Some stocks will make you money and others will lose you money.  This post will cover an investment I made two years ago (and which I wrote about on this blog) which went sour and where I lost my whole investment.  I will cover why I made the investment, why it went south and most importantly what I learned from the whole process.

What was the stock and why did I invest in it?

Almost exactly two years ago I invested in a company called Kinghero.  It was a German listed, Chinese manufacturer and fashion retailer aimed at the growing Chinese middle class.  I invested in it for several reasons:

1. The industry was appealing
• Getting exposure to the

Why do companies get away with acting badly? Here is my way to effect change!

Corporate governance is important and can really affect share valuations.  The problem is that as individuals we can make very little difference (even if we do vote at shareholder meetings).  Retail shareholders typically do not have sufficient influence to change the way in which a company acts - as we are dwarfed by institutions.

Why don't most institutions hold companies account for their actions?

Large institutions can definitely make a difference.  However they often don't pull companies up for their bad actions or behaviours for various reasons:

1. The want access to the companies
• Institutional investors are researching these companies day in and day out and one of the ways they do this is by access to the company's board and management teams
• There is always the risk that you lose this access by 'rocking the boat' too often and voting against what the board and management teams want to do
2. They make money when some of these companies do badly
• The performance of a fund manager is often measured on a relative basis versus an index
• Even if a fund manager holds shares in a company which has bad corporate governance practices and can therefore make a difference through their voting, if they are underweight the stock they get rewarded (in performance terms) if that stock does badly
3. They get no positive benefit from holding companies to account
• If you invest in managed funds, ask yourself "when was the last time I made a decision about which fund manager to invest in based on how activist they were in terms of looking after my investments?"
• The fact is that the clients of fund managers do not care enough about corporate governance to make the fund managers care.  As a result fund managers just focus on making more money 
• If the return of a stock is likely to be impacted by corporate governance issues then they will be underweight the stock which creates the issue outlined above

The case for index funds to be corporate governance hawks

Index funds are the one actor in the whole share market who has the best incentives to

Whose priorities matter when corporations donate large amounts of cash?

Yesterday Westpac Banking Corporation (ASX: WBC) announced that it was donating $100 million towards setting up an IT educational scholarship which addresses the lack of females in the IT industry [Edit: The focus of the foundation appears to be much more broad than the news reports originally suggested - I actually support much of what they are doing personally but my comments about the agency problem identified in this article still stand].   As you can see from the attached article, the press loves feel good stories like this and it is almost reputational suicide to publicly stand against a move.

However I am against the very concept of donations such as this.  This is not because I am against donating to charity - indeed I support several charities and micro finance organisations including The Cancer Council, Kiva, Catholic Mission and the Fred Hollows Foundation.  I think charitable donations are a great way to benefit society and save tax at the same time.

The role of corporations is to act in the best interests of their stakeholders

The board and management team of a corporation are charged with acting in the best interests of their stakeholders.  Although some define the stakeholders quite narrowly - i.e. only shareholders - I have a more broad view and believe that corporations should act in the best interests of all of their stakeholders - i.e. shareholders, employees and customers.

Therefore, unless an action is in the best interests of the stakeholders of the company - i.e. the shareholders, employees or customers then it is not their role to donate this cash.

If we use the Westpac example above:

• This is clearly not in the interests of shareholders
• They are giving away a huge amount of money for no tangible benefit to shareholders
• Corporations often argue a fluffy point about goodwill but this is not measurable and is fast forgotten
• It should always be remembered that this is the shareholders money that is being given away
• They are not acting in the interests of employees
• Employees are not the ones getting the scholarships nor does the employee base benefit from these scholarships
• They are not acting in the interest of customers
• It is a really long bow to stretch to suggest that the promotion of education benefits customers
• As a side note I actually found it incredibly difficult to argue against this setting up of this foundation because I admire so much of what it actually stands for and is trying to promote

Some people make the compelling argument that corporations are the only actors which can bring enough clout to an issue to make a difference.  In the modern world they control the largest pools of capital and these pools of capital can be brought to bear in a way that makes a difference.  Whilst this is true there is a massive agency problem that happens - in this world of limited resources and unlimited problems, who determines where the corporations donate their shareholders' cash.

Corporate donations further the interest of management teams...not shareholders

If you look at corporate donations and the charities they donate to - it is invariable the charity that the CEO or Chairman support.  They have a project that they believe is worthwhile and they use their power as the head of a large organisation to further their own

You should NOT pay more to invest in Ethical Funds

Like many people I know, although I am primarily self interested (i.e. I'm trying to improve my life and financial well being), I am also concerned with how my actions impact those around me as well as the environment.  I think there are very few truly selfish or truly selfless people.  I think everyone falls somewhere between those two extremes.

Although we all try and make a difference, sometimes it is hard to see how "doing our little part" makes a difference when there are such big entities and companies out there who swamp any effort we may have to make a difference.  One of the ways that has become more popular in the last few years is the idea that money talks.  That if you (and a significant number of others) are concerned enough about society then you will direct your savings and investments towards those enterprises which are actually doing good and avoid those which are damaging society or our planet.

It is a fairly simple concept which is incredibly hard to implement for one single reason: We all have different ideas and tolerances for what is good and right. Having said that - if we find a company that we like and believe is doing good then this is where we should put our money.

The Ethical Funds management industry has grown around this concept

A whole industry has grown up around the concept that our investments should reflect our desire to make the world a better place.  The good funds generally provide

Board Appointments: A flawed process

Corporate governance is one of those things which shareholders take an occasional interest in but can really make a difference to your investment.  The way in which executives are remunerated is important as are the directors who represent YOUR interests on the board of the company.

However for reasons I have posted about before, people very rarely get involved in the decision making process of their company.  Retail shareholders rarely vote and all too often institutional shareholders rely on proxy advisers to tell them which way to vote.

I have recently come to realise that there is also an inherent flaw in this process.  Even if you ARE interested in the way the company is being run you have little input into WHO gets to run the company.

But...don't I get a vote as a shareholder?

In principle yes.  You get to vote on all resolutions that are brought to an AGM or other EGM.  You get to vote for directors that stand for election and if you want to you can vote for or against directors based on their decision making.

But there is an inherent flaw in the way these resolutions are structured

• It is the directors of the company who effectively determine who and what gets included on the ballot
• When it comes to new directors, the current board will propose ONE name and you get to vote on whether you want that person on the board
• When it comes to existing directors, you are not given any alternative choices if you would like to see a director of the board replaced

Effectively the board has too much power over their own appointment

The board should be there to represent the interests of shareholders, but the way in which the election process is set up means that effectively the board is representing their own interests.  The process is structured so that you are given a false sense of choice.

Further you are given insufficient information

• When an external candidate is proposed the board often recommends shareholders reject their appointment and gives the reasons why they should not be voted for.  You are rarely given the reasons why you should vote for this person
• When the board talks about themselves they talk about you should vote for them not why you would consider note voting for them
• Boards often talking about new potential members as having the skills that the board needs (e.g. financial, operational etc.) however they never give you a choice of multiple people who have the same skills - i.e. give investors a real choice about who they want to represent them

This all makes sense when you think about the fact that directors do not want to lose their very comfortable corporate jobs or reputations.

What is an alternative?

The solutions all have to do with the information available to shareholders.  There are two solutions which I find particularly persuasive

1. Make disclosures around how board members voted on EVERY vote available
• Individual board members can then be held to account for every bad decision that they made as a director in a very real and direct way
• Boards cite confidentiality and business imperatives as the reason that there is not more disclosure about how votes are taken and what options are considered...but as owners of the company we are the ones who have the right to know how are boards are acting
  
2. Make a full list of candidates available for every directors vote
• Companies always talk about screening several candidates for a board before putting one up for election
• I am all for them screening candidates but why don't they put up several candidates instead of just the one that they want - why don't they give the investors the choice about who they want representing them
• Further if I don't like the existing members of the board I want real alternative choices - there should be real, credible alternatives put up for every single current board member

Boards are never going to do this of their own volition.  They are too interested in protecting their own privileged positions but it is something that is a real concern and which people should pay attention to.

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Placements: What are they, why do they exist and what are the downsides for investors?

This post will be all about placements, the ability for companies to issue shares to limited group of investors without offering them to all investors.  The description and the rules below are those on the Australian market as at the date of writing however similar ways of raising equity also exist in other financial markets around the world.

What are placements?

Placements are a way of raising capital.  They allow companies to raise capital quickly and cheaply from a select group of investors without offering these shares to all the investors in the company.

There are limits on how much capital companies can raise through this type of raising.  In Australia, companies cannot issue more than 15% of their issued capital in any 12 month period through a placement without shareholder approval (note that in Australia there is an extra 10% available to companies worth less than $300m which satisfy certain requirements).

Why do they exist?

As outlined above, placements are a quick and easy way for companies to raise capital.  Companies do not have to write and file a prospectus for all investors making it a much cheaper option than doing a pro rata rights issue to all investors.

They are also much quicker.  Placements can take place in an afternoon or over a one or two days rather than the weeks you typically need to give retail investors to make their decision.  It allows companies to access the cash they need much more quickly and this is especially important if the companies needs the cash in a hurry.

They are typically done at less of a discount.  Nearly all issues of secondary shares are done at a discount to the market value to encourage people to participate in the raising.  Companies that have a big shareholder or a shareholder that is looking to acquire a big stake without moving the market price may be able to raise capital at much less of a discount through a placement (thus being able to raise more money for the same amount of shares issued)

What are the downsides for investors?

The biggest downside for retail investors (who are the ones excluded from placements) is that the value of your shares decrease because the placement shares are issued at a discount to the current trading price.  Your parcel which was worth $10,000 may now only be worth $9,500 and you didn't have the chance to acquire shares cheaply even if you wanted to.

To see how the share price is affected by an issue at a discount see my post on how to calculate the theoretical ex-rights price of a share.

Further, your voting rights are also diminished.  Most retail shareholders don't value or exercise their voting rights anyway but it is definitely a problem if you get involved in the corporate governance of your investments or if you are a large shareholder but were not invited to participate.

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Be careful about what you post in investment forums: lawsuits bite!

Most of us who are interested in finance and investing find ourselves in discussions about investing with our friends family and colleagues.  Naturally part of this discussion centres around venting when things do not go our way or when we feel we have been cheated or when corporate executives or directors of companies we have invested in undertake actions that we feel are not in our best interests.

Given the important of the internet in modern communications, more and more of these communications are happening online through investment forums (such as HotCopper) or through people expressing views on their own blogs (such as I do on this one) or by commenting on other people's blogs. As readers of this blog would know I have frequently criticised companies - both listed (such as FKP over their rights issue) and small er companies(though less so the small companies - only when I think they are real scams).

However...keep in mind that speech is not free and that you can be sued for defamation

When you post something on the internet it never goes away - we all know that.  It's the reason we are all so careful about our Facebook and other privacy settings.  However we seem to forget this when we are on investment forums talking to other 'hard done by' investors.  What you always need to keep in mind, however, is that you can be sued for these comments.

Although the story seems to have died down somewhat now, this issue got a fair bit of publicity when Susanne Deveraux, a retired nurse from Queensland, was sued by Empire Oil and Gas for defamation in

GetUp's poker machine proposal for Woolworths fails

Over the last few months I have been following the Woolworths versus GetUp! saga whereby GetUp! was trying to get Woolworth's to introduce legislation through an EGM whereby Woolworths would be seriously curtailed in the way that it was allowed to operate it's poker machines.  After thinking through the implications and issues quite carefully I was against the resolution for various reasons which I have outlined in previous posts.

Last Thursday Woolworth's put the issue to a vote at an Extraordinary General Meeting (which also doubled up with their Annual General Meeting) and the proposal failed.  This is not surprising however if you look at the statistics and breakdowns in the vote there are some interesting features.

The proposal was resoundingly defeated by submitted proxies well before the actual vote

If you look at slide 14 of the Woolworths EGM presentation you can see what the status of the vote was before the open votes on the day were cast.

• 2.47% of the shares voted for the proposal
• 95.41% of the shares voted against the proposal
• 3.14% were open to be voted at the general meeting

If you look at the final results (see the final page of this document) you can see that most of the shares voted at the meeting were actually against the proposal.  The final count of shareholders voting for and against the GetUp! EGM resolution was:

• For: 2.53%
• Against: 97.47%

The resounding defeat means that either retail shareholders didn't turn out OR they were against the proposal

There is often the perception by participants in the market place that institutions are somehow more 'ruthless' than individual shareholders.  GetUp! made a big play about having motivated the retail shareholder base at Woolworths to vote for the proposal.

Retail shareholders make up approximately 30% of WOW's shareholder base (I will tell you how to calculate this in a later post).  As only ~2.5% of shareholders voted for the EGM proposal this means that retail shareholders either voted against the proposal or they simply did not turn up.  I have posted before about the apathy of retail shareholders when it comes to voting.  

Unfortunately it is hard to see which one of these that it is however it is hard to think of a motion that they are more likely to understand or be encouraged to vote for.

It is unclear whether any institutions voted for the proposal

GetUp! tried to get their members to send letters to their superannuation funds to encourage them to vote for the proposal.  Indeed they even had a standard form letter on their website that you could send to them.  However based on the vote count it does not look like there are any institutions that voted for the proposal (though I could be wrong).

I find this actually very comforting - I like to think that my superannuation fund would vote in a way which protected all of their security holders and not just the ones who are particularly vocal.

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AGM season in full swing...and I couldn't care less

Just before the Annual General Meeting season started for Australian companies I did a series of posts on how voting at AGMs was the one time that shareholders had to influence the way in which a company was run.  I also pointed out that retail shareholders do not vote and the companies therefore made decisions which typically favoured institutions.

I decided that one mini-crusade that I would go on would be to inform retail shareholders how important their vote was and how they should vote to protect their shareholding.  For this first AGM season, therefore I committed to doing my small part and actually voting in every AGM in which I was entitled to and I discovered something - I just did not have a good enough understanding of what I was voting on to care.

Voting on remuneration reports

This is the one area that people typically get worked up about - executives get paid too much money and this is a chance to vote that remuneration report down.  However there are several problems

1. The remuneration reports take a fair bit of effort to go through properly
• What you should be interested in is not only the absolute levels of incentives but also how these incentives are structured and how the vesting works for each of these
• Most retail investors do not have the knowledge or know how to go through these reports
• Even if you do have the knowledge and know how they take a fair bit of effort and if you try and do it for any more than about 5 stocks you typically get bored out of your brain
2. Typically remuneration report voting is linked to how well the shares have performed NOT how the remuneration is structured
• You see this all the time - a company that is performing well can pay their senior management almost anything and incentivize them terribly and shareholders will still vote for the report
• Conversely  shareholders will vote against a report which compensates managers in an appropriate way if the shares are performing badly
• This doesn't make sense but it is the only real option that shareholders often have to vent their frustration at the company

Voting for directors

This is the bit I got most stuck on (and I cared the least about).  I simply did not know WHO these directors were, whether they were good or bad, what sort of decisions they voted on and how informed they were. 

The strange thing about investing in companies is that you are constantly exposed to the management team - the CEO, CFO and other senior personnel through conference calls, news reports etc but as a shareholder you get no say over the management team.  You get to pick the guys who pick the management team however you know nothing about these people and how active they are on the board and how much the actually contribute.

I found myself voting for board members if I liked the senior executives and against them if I didn't.  There has to be a better way.  Companies should start providing information on what these board members are actually adding.

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Should you vote for the GetUp! proposal at Woolworth's AGM?

In a previous post I had touched briefly on shareholder activism, how you defined shareholders interests and used the Woolworths battle with activist group GetUp! as an example of when activists work to promote their agenda which may not necessarily be in the broader shareholder interest.  At the time the issue was put off until the Woolworths AGM.

As this AGM gets closer - it is now only a week away (on Thursday 22 November 2012) Woolworths shareholders need to seriously consider how they are going to vote on this issue.  There are several things to consider which I have addressed below.

What are the proposals?

There are three proposals being put forward by shareholders that form the vote that will take place at the Extraordinary General Meeting (which is being held at the same time as the Woolworths Annual General Meeting).  The proposals are summarised below.  It essentially changes the constitution of Woolworths such that from 2016

• The company limits it's Electronic Gaming Machines (Poker Machines) to a maximum bet of $1 per push;
• Limit the profit each machine can make to $120 per hour; and
• The machines are only allowed to operate for 18 hours in any 24 hour period

Is this motion in the best interests of the company and shareholders?

The first thing you need to remember as a shareholder in Woolworths is that this is a real investment for you and this is real money that you stand to gain or lose as a result of this investment. Therefore, while it should not be the only consideration, you need to think about whether voting for this resolution will be good or bad for the company in the long run.

From this framework I would consider the following

• Woolworths is naturally going to lose profitability if you limit the money they can make from these poker machines
• The argument is that they will get some sort of social benefit, or rather avoid a social cost by being seen as a responsible operator
• I do not find it convincing that the benefit (or lack of cost) that they will receive from implementing these measures will outweigh the actual money they will be losing through implementing these measures

I actually find this case analogous to the selling of cigarettes.  Everyone knows that smoking is bad for you and creates real social harm however it is a legal thing to do and therefore stores (including Woolworths through their shopping centres) are allowed to sell them as long as they obey the law.  The idea that people will not want to invest or shop at a store that operates gaming venues seems strange to me because they are more than happy to invest and shop at one which sells cigarettes.

Will the measures work to stop problem gambling?

In this area I think both sides have been a bit disingenuous.  Woolworths has downplayed the Productivity Commission's reports on gambling and in their letter to shareholders was quite misleading on several aspects of this.

However GetUp! is also being a bit sly about it's motives.  It keeps talking about how Woolworths is the largest operator of poker machines in Australia, which may be true however they still only have 6% of the market and GetUp! is obviously targeting Woolworths because they are a soft target (unlike a casino or the actual manufacturer of the gaming machines themselves, Aristocrat, which is also a listed company).

I think the reason that GetUp! is targeting Woolworths is because if they can force Woolworths to operate in a certain way then Woolworths will lobby the government to ensure that everyone operates in the same way.  There is currently very limited political will to implement such measures and GetUp! wants an influential player pushing for rules they want.

Do I think problem gambling is a problem and do I think this is the solution?

I absolutely do think problem gambling is a problem and although it does not affect a large proportion of the population, it is devastating to those who it does affect.

Having said that - I do not believe this is the solution.  I believe that this problem needs to be dealt with by policy makers in this country.  I believe that to really tackle the problem that everyone should be playing by the same rules with the aim of reducing problem gambling.

I think that the Woolworths vote will not do anything to curb problem gambling, will cause Woolworths shareholders to be worse off and therefore do not believe shareholders should vote for this measure.

If you have an opinion on this matter or if you think I am wrong please comment below

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Founders' Voting Rights decreases the value of YOUR shares

In this post I will be writing about founders’ voters rights.  This is not a concept that is present in all markets and so if you are an investor from a jurisdiction that does not have the concept of founder shares or different classes of shares then this is the post for you.  It is something that you need to consider especially if you are investing in markets such as the United States where this is relatively common.

So what are founders’ shares?

Simply put they are a different class of shares.  This necessarily involves the discussion of classes of shares.  In markets such as Australia different classes of ordinary shares do not exist.  One share is exactly the same as another and comes with the same rights, structure and benefits as any other share.

However some markets allow different classes of shares.  At the most basic level you can have, for example, one class of shares which is the equivalent of 10 of another class of shares.  You can see this with companies such as Berkshire Hathaway which has both Class A and Class B shares with the basic difference being that Class A shares are a multiple of Class B shares.  There is actually no real problem with this because it is pretty easy to value the difference in these shares and both classes of shares are tradeable.

Founders’ shares in their current form are a product of the second tech boom and started with Google’s IPO in 2004.  They create a class of shares which are held by the founder, founders or a group of insiders in the business which have super voting powers.  For example with Facebook’s recent IPO Mark Zuckerberg owns 18% of the company’s shares however controls 57% of the voting shares. 

What is the rationale behind them?

Let me say upfront that I do not buy the rationale given for founders’ shares however I will outline both what is the reasons given by the company and what I think the reasons are.

The rationale for founders’ shares or super voting shares controlled by insiders is as follows:

• Share markets are notoriously short term driven with investors focusing on short term gains when if the business took some short term pain, in the long run shareholders and the business would be better off
• The person or insiders that control the company and got it to the stage of being able to list is more likely to be able to take the long term view of the business and knows the best way of taking it forward (Amazon is the most cited example of this)
• If the founder or founders are selling more than 50% of the company, it is in the interests of the whole company for the control of the company to rest with those shareholders who have the long run interests of the business in mind

Maybe I am more cynical by in my view it is more about founders wanting investors to come and board and not say anything.  It is an ego trip where the company needs shareholders but does not want their opinion because the ‘founder knows best’

Why do I have a problem with super voting shares?

There are several reasons I have a problem with them including

1. It is paternalism gone mad.  The assumption that the founder ‘knows best’ and that I should hand over my money and stand back and not get involved is ludicrous to me
2. It assumes that the founder will always do what is in the best interests of the business.  Often CEO’s and founders empire build.  That is they are driven by the power they wield through their corporation and not the returns they generate.  This means that they make decisions and acquisitions not based on what is best for shareholders in a returns sense.  If a founder controls the company and starts to do this there is no way they can get voted out
3. As a shareholder you are the most subordinated interest in the company – the upside of this is that you get a say in the company.  You can vote your shares in a takeover or you can vote out the people that control the company if you do not think what they are doing is in the best interests of the company.  Super voting shares ruins this.

IF you were able to buy super voting shares on market (and thus they became a truly distinct class of shares with a different value) then you could probably value it and adjust your valuation of your own shares accordingly. 

If you are planning on buying shares in a company which has a dual class of shareholding like this make sure that you put a discount for the damage that a founder can do the company where you have no control.  The risks are high and you have limited recourse.  I would value your shares like a non voting share because effectively that is what it becomes. 

Note that there are many jurisdictions in the world where one share equals one vote.  If someone wants to control a company they need to put their money where their mouth is and have a big enough stake to be able to do so.  This aligns their interests better with that of other shareholders.

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FKP's Terrible Corporate Governance Screws Retail Shareholders

This post will cover FKP Property Group's equity raising and their blatant disregard for retail shareholders in relation to their oversubscription facility in their recent equity raising.

As background you may remember that last week I participated in FKP's property raising and it had an oversubscription facility which allowed shareholders to apply for up to $100,000 in over allocations.  At the time I had said that this was a great deal however which came with the significant risk of scale back.  I had experienced a scale back before in QBE's SPP and so I was very wary of this risk.

What FKP announced on Friday was that there was a 76% takeup of the retail entitlement offer however those that applied for overallocations were being limited to 50% of their entitlement offer.

Isn't this one of the risks of oversubscription facilities - why do you have such a problem with it?

It is true that scale backs and caps are a risk associated with equity raisings however if you continue to read the press release you will see the following statement:

The resulting shortfall after the allocation of Additional New Securities is approximately 35 million New Stapled Securities which will be issued to (or as directed by) the Underwriter, Goldman Sachs Australia Pty Ltd, under the terms of the Underwriting Agreement

If you follow the math you will see why I am so outraged at what FKP has done.  Earlier in the release it had the following statement

FKP recieved valid applications....for approx. 165 million New Stapled Securities in respect of their pro rata entitlements, representing a take up rate of approximately 76%

You can see how much of the oversubscription was allocated to shareholders and how much was allocated to the underwriter in the following way

1. Gross up the number of shares available to be take up: 165m / 76% = 217m shares
2. Work out the shares available for the oversubscription facility: 217m - 165m = 52m shares
3. Work out how much retail shareholders got = (52m - 35m) / 52m = 32.8%
4. Work out how much the underwriter got = 35m / 52m = 67.2%

The reason that this was such a great deal was the steep discount to TERP that these shares were issued at.  The people that got allocated the shares were always going to make a big profit off the shares.  I would have no problem if the shares were way overallocated and I missed out.  I have a massive with the fact that Goldman Sachs made the money even though they already being paid a fee for the undwriting.

It means that retail shareholders could have been allocated up to 150% of their entitlement instead of just 50%.  Benefits like this should flow to shareholders and not to investment banks.

The fault lies with the FKP Board and management

The FKP board and management are to blame for this debacle because one of several things has happened, none of which are acceptable in my view

1. Goldman Sachs was promised a minimum share of the equity raise provided the share price was above the raising price after all oversubscription allocations had been recieved 
• This would provide Goldman Sachs with a free option in the shares.  If the share price is above they can make a quick profit.  If it is below then the retail shareholders who subscribed to the oversubscription get allocated the shares
2. A certain percentage of the equity raising was promised to sub-underwriters who are typically instituional shareholders
• Sub underwriters are typically instituional shareholders in the company that is doing the raising
• While this way the value still flows to shareholders the company is making a distinction about which class of shareholder gets the benefit
• As usual it is the retail shareholder who has no voice and suffers

What should FKP have done?

There are a lot of options that FKP could have undertaken to make this acceptable including:

1. Not allocated any shares to the underwriter
• The benefit that is therefore meant to flow to retail shareholders does flow to them
2. If the provision of a certain proportion of shares (or cap on overallocation) did exist it should have been disclosed to shareholders
• If I as a retail shareholder was never going to get more than 50% overallocation, I would not have submitted more money than I needed to. 
• However the company got the benefit of this money for a month so if this is the way in which it was done I think this is particularly deceitful
3. Not treated classes of shareholders differently
• I can guarantee you that institutional shareholders and the institutional component of the equity raising would never have been treated in this way.
• Institutional shareholders have a voice with companies whereas retail shareholders do not

What can be done?

Unfortunately not a lot can be done at this point.  However as a retail shareholder you can voice your displeasure by:

• Writing to management and the board and asking them for an explanation
• Voting against board members at the AGM
• Keeping track of all board members and voting against them for all future boards they may wish to sit on

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ESG considerations really do affect share values

In a recent post on corporate governance I outlined what ESG is and how it is different from ethical investing.  This post will deal with why, even if you do not think of yourself as a particularly 'activitist' or ethically driven investor (i.e. your decision is first about the return that you get) you should build some sort of ESG framework into your decision making process because it really does affect valuations.

A recap of what ESG considerations are

Investing with ESG considerations in mind can be thought of as a 'positive screen' for those firms and investments which operate in ways which

• Minimise damage to the Environment
• Promote Social well being
• Are proactive about good Governance

How do ESG considerations affect valuations

It is much easier to see how bad performance in ESG considerations affects valuations negatively than how good performance affects it positively.  This is because bad performance often results in valuation impacts that you can point at whereas proponents of ESG investment argue that good performance creates or enhances a business over the business life.

For this reason I will be focusing below on how bad performance with respect to ESG negatively impacts valuations.

Environment

• There are several ways in which companies which do not look after the environment are penalised.  Most of these have to do with legal ramifications or government regulations
• For example the tragic oil spill in the Gulf of Mexico was expected to cost BP US$7.7 (see link) and this amount comes straight off the valuation of the company. 
• Another example is the introduction of the carbon tax in Australia which taxes the largest polluters in the country, reduces profitability and thus the value of your investment
• Although we do not think of environmental concerns as having an impact on our valuations - in a world which is concerned with global warming and the sustainability of resources you should evaluate the environmental performance of your investment and it's impact on your valuation
• On the positive front, with the current focus on clean energy, companies which actively reduce pollution or deal with environmental issues are seeing a premium attached to their valuations.  You need to decide how much you want to pay for this premium but the fact is that this is also impacting valuations

Social

• Generally speaking it is hardest to see the impact of social considerations on valuations.  However you can see it very clearly in some situations including
• When workers strike due to poor working conditions, the business is often brought to a standstill or affected significantly which affects profitability and thus valuations
• Poor PR can kill a business and in an age where news spreads amazingly fast over twitter and other social media, acting in a way which is seen as socially irresponsible (including something as simple as selling inappropriate children's clothing) can be detrimental to business valuations
• It is often the hardest to pick the companies which will be affected by social issues such as these.  If you are trying to avoid poor performers perhaps avoid companies which typically have issues with their workforces or companies which offer goods which are considered dubious or questionable by the broader community

Governance

Dirty Letter from Hancock Prospectin​g should have you questionin​g Gina Rinehart's motivations

The increasingly bitter war for Fairfax media took another turn when Gina Rinehart's Hancock Prospecting sent a letter to ALL shareholders of Fairfax which outlined their case for change and what they wanted to achieve.  Normally it is clear why the person agitating for change is doing so

• Often it is a large activist fund manager who has taken a position and who wants the board to change direction so that their bet pays off
• Other times it is a shareholder who is trying to push a particular agenda - I did a post on these types of people later

With Gina Rinehart (Australia's richest person and the richest woman in the world) it is hard to say.  There has been much speculation including

• Wanting to influence journalistic content so she appears more favourably in the news (this is widely speculated in the media and investment community)
• An activist shareholder trying to enhance the value of their shareholding (what Rinehart is trying to portray herself as)

So here is a brief outline of what she wants for her 15% shareholding in the company

• 3 board seats (2 for her and an 'experienced independent director') out of a board of 12
• KPI's for the chairman personally including increasing the share price from the current value of ~$0.52 to $0.87 prior to the AGM which is only a few months away.  If these are not met they ask that the Chairman resign
• The ability of directors to comment publicly on the state of the company.  Currently only the Chairman and the Managing Director are allowed to make public statements about the company
• Want to be able to share board minutes and materials with outside parties

Why I think her requests are ridiculous

If Gina Rinehart wants control of Fairfax she should make a bid

• Although the letter says that she does not want control of Fairfax, having 25% of directors in her pocket before any contentious issues arise puts her in a very powerful negotiating position
• If Gina Rinehart wants to control Fairfax she should make a public market bid.  That would be one way of making sure the share price reaches $0.87 before the AGM.  She however is trying to gain effective control of the company without doing this

Asking for a Chairman of a company to resign if the share price does not reach a certain level is ridiculous

• While the Chairman has a fair amount of influence over the company, it really is the management team which determines how well the company is doing
• Final responsibility should and does lie with the Managing Director and the Chairman however they can no more control the share price than they can people's opinon of the company.  Even if they turn operating performance around there is no guarantee that the share price will move at all
• This is purely playing on small shareholders' dissatisfaction with the share price performance. 

Wants directors to be able to publicly comment on the state of the company

• I think requiring all media communications to go through the Chairman is a perfectly acceptable way of operating - it helps the company keep it's message on track.  If there are disagreements the relevant directors should resign and then they are free to speak publicly
• Gina Rinehart does not want this because in the event she does get her directors nominated to the board, she is probably going to try and make a public case for all the people who do not agree with her to be kicked off the Fairfax board (thus getting back to the effective control point)

Want to be able to share board conversations and minutes with external parties

• This is just ridiculous.  The way they phrase their argument is that it allows directors to get independent advice.  HOWEVER what it would allow is for directors to share the information with the public, with the media or with anyone else which would destroy the company's ability to keep their business dealings private

Why I think Gina Rinehart should NOT get a seat on the Fairfax board

She will not sign the editorial charter of independence

• In the letter the shareholders she says that the disagreements with the current board were never about the charter of Independence.  If this is the case surely it would be much better for her to sign the charter once and for all
• HOWEVER she has refused to do this indicating that her intentions are to control the news and influence public opinion to her point of view

Gina Rinehart has no experience running a publishing company nor of turning ailing companies (like Fairfax) around

What is the difference between ESG and Ethical Investing?

This post will deal with the difference between ESG (which stands for Environmental, Social and Governance) and ethical investing.  They are actually very separate ideas although people tend to use them interchangeably.

At a high level the difference comes down to the following

• ESG is a positive screen for companies which consider the environment, their social obligations and promote good governance
• Ethical Investing is a negative screen which eliminates investments based on certain criteria (common examples include no gambling, tobacco, mining etc)

What is ESG?

When you invest using ESG you are investing in firms which operate in the 'best possible way'.  It can therefore be though of as a 'positive screen' for those firms and investments which operate in ways which

• Minimise damage to the Environment
• Promote Social well being
• Are proactive about good Governance

Note that every investor that considers ESG will place a different emphasis on ESG considerations.  Further when considering ESG factors one can either look for firms that avoid the bad outcome or promote the good outcome.  For example:

• Some investors will look for firms which minimise damage to the environment while others will look for firms which actively promote environmental well being
• Some investors will look for firms that do not cause social harm while others will look for firms which promote social values
• Some investors will look for companies which do not have any glaring governance issues while others are particularly concerned about good governance

If you are particularly concerned about ESG and are looking for a fund that invests using ESG principles have a look at the language in their documentation to see where on the scale they are.  Some funds are primarily value funds who see the downside for firms not investing in ESG principles while others truly believe that investing in ESG conscious firms will result in higher long run returns. 

What is Ethical Investing?

Ethical investing, quite simply is investing only in those companies which meet a strict criteria for investment.  It is often considered a 'negative screen' because there is a very definite idea of what sort of companies should not be included. 

The type of investments chosen will depend on the criteria used.  There are several common types of ethical funds / approaches including

• Christian funds which only invest on a biblical basis and excludes investments in things like weapons manufacturers among others
• Islamic funds which do not invest in companies involved in usury or alcohol among others
• Environmental funds which do not invest in mining operations etc

There is no real limit to the number of ways that ethical funds can be cut.  In fact most of us probably have some things we would never invest in because we do not feel comfortable doing so and so in our own way we have an ethical criteria for investment

What is the difference between ESG Investing and Ethical Investing?
 

Externally managed listed vehicles: a corporate governance nightmare

Prior to the GFC the number of externally managed listed vehicles was truly amazing.  There were infrastructure funds, real estate funds, various listed investment funds, assets that were partially sold off by bigger corporate entities as well as many other variations on this theme.

Everyone acknowledged at the time that these structures came with questionable corporate governance structures but no one was really thinking about this in a world where practically everybody was making money.

After the GFC hit though this all changed and these structures went out of fashion.  There are still several companies out there with these kind of structures in place so I thought I would use this post to explain what these structures are and why they have fallen so fa from grace.

What are externally managed vehicles?

Quite simply these are listed companies which have no real management of their own.  They are managed by another company that gets a fee for the services they provide.  They get paid fees for:

• A base fee for managing the company
• A performance fee for outperforming their listed competitors
• Fees for the use of logos and other corporate materials
• Fees associated with corporate activity

What is the problem with their structure?

There are several problems with the structure.

• As you can probably tell the first relates to the amount if fees the investors have to pay even when the entity is not performing well.  Generally these fees are much higher than they would be under an internally managed system
• The second big problem is around alignment of interests. 
• Oftentimes the managing entity sold have no stake in the company they were managing so they were incentivised to maximise their fee income through things like corporate transactions where these were not necessarily in the interest of shareholders
• Further a common practise was for the managing entity to sell the managed vehicle badly performing asses for premium prices so they come get them off their own balance sheet

What has happened to externally managed stocks since the GFC?

When investors woke up to the inherent issues within these vehicles they abandoned them in droves and most still trade at a discount to their net asset value because of the inherent risks associated with the vehicles.

What has ended up happening is that these assets have had their management's internalised so they then operate the way a normal company would. This normally involves a payment to the external manager to give up their rights. This payment is often a very contentious amount as there have been some payments made in the hundreds of millions of dollars. Typically after the stock is internalised the shares significantly outperform the market in the following months.

If the process is all over why am I writing this?

The fact is that the process is not over and there are still a fair few of these dinosaurs left out there.

• You can make a fair it if money if you pick when the company is going to announce their internalisation but there is significant risk around the internalisation payment.

If you are thinking of investing in these vehicles make sure you keep the alignment of interests issue front of mind as you can lose significant value if the manager s making decisions for self serving reasons.

Electronic voting for AGMs becoming a reality

In previous posts I have done on corporate governance I have lamented the fact that voting was so difficult and archaic.  In fact I believe that it is  one of the primary reasons that retail shareholders do not vote at company meetings and AGMs. 

I always found it strange that the option was not available to vote online.  After all, you could trade online, change the way you receive your dividends online so why not vote.  It was only going to be a matter of time before the shareholder registries caught on.

Then for the first time last week I noticed that computershare, the largest shareholder registry had the option to vote my Macquarie shares online.  I was absolutely ecstatic to see that.

However the system has a fair way to go

• There are only a few companies that have adopted the online voting concept so far and while I applaud these early movers I suspect that it will be a fair while before it is commonplace.
• The biggest issue so far though is that you can only appoint your proxies through the electronic voting process. 
• Remember proxies vote on your behalf and how they see fit. From what I could see there was no way for shareholders to vote on each resolution.  This is the next step.

The next step is convincing retail shareholders to vote

• Now that the ability to vote is there, the next step is convincing retail shareholders that it is in their best interests to care about what happens at these meetings and that voting is an essential part of maintaining their investment.
• This is the truly hard part and involves a combination of both education and empowerment. 

I'm not sure if there is a golden bullet or solution but I DO know that the person that solves this problem will leave an indelible mark on the finance and corporate world as we know it

Shareholde​r activism: Defining shareholde​rs' interests and the way in which companies respond to shareholde​r complaints

In my last few posts on corporate governance, in which I covered the topics of who votes at shareholder meetings and why retail shareholders never really bother I was bemoaning the apathy shown by retail shareholders to issues which directly affect their financial well being.  I personally would like to see shareholders take a much more active role in questioning management and voting their shares in order to protect their interests.

I was discussing this issue with a friend who raised the very pertinent point of 'how exactly would you define these interests you want them to protect?'.  This was in the context of the recent fight between anti-gambling activist group GetUp! and Woolworths (ASX:WOW), a major groceries retailer in Australia which owns a large hotel chain which has a significant number of pokies / slot machines. 

• The issue arose because under the Corporations Act in Australia a group of 100 shareholders can ask a company to hold an Extraordinary General Meeting (EGM) which the company has to do and it needs to be held at the expense of the company. 
• GetUp! claimed in court that they managed to convince 257 shareholders to sign the required documentation to request a meeting so that shareholders could vote on whether to reduce the maximum bet size to $1
• WOW argued that they could roll this EGM into their Annual General Meeting which would save the cost of an EGM and would have the same function.  GetUp! obviously wanted more publicity for their cause which a separate EGM would cause so took the matter to court arguing that WOW was failing to honour their obligations to their shareholders under the law
• The end result (you can see a full description here) was that WOW was allowed to roll the meeting into their AGM.  This probably turned on the fact that GetUp!'s motion was to limit the size of gambling stakes by 2016 so delaying the vote would not make a difference to anyone

There are several interesting questions that come out of this case with respect to corporate governance

1. Should shareholders working for a 'social cause' be allowed to influence the way in which a company is run? 
• Traditionally companies are profit making entities which are run for the financial benefit of shareholders and a real question needs to be asked about whether a small group of shareholders agitating for socially better outcomes are really acting in the interests of all shareholders - i.e. is activism in this case a good thing?
• Note that there are arguments that can be made (and this is very true in extreme cases) that particularly bad social outcomes harms a company's reputation, therefore earning ability and share price (the James Hardy asbestos case is a case in point) however when things are not as clear cut has adverse health outcomes / breaching social norms (such as gambling caps) then the issue becomes more confusing
2. It worries me that a large corporation was so easily able to dismiss the rights of it's shareholders
• The ease with which WOW was able to dismiss the small shareholders and roll an issue they found important into an AGM which presumably covers other significant issues is slightly worrying - it shows the almost disdain that small shareholders are treated with
• This comes back to my point in the last post that small shareholders often do not vote because they are not large enough to bear any pressure - even when they organise in a matter like this the evidence of them getting anywhere is futile
3. Sets a bad precedent with respect to the balance of power between management and shareholders
• When it comes down to it the shareholders own the company and should have a say over what is important and what isn't and management should not be able to dodge these issues
• While I don't think it is a problem in this particular example the real problem arises if a shareholder has a particularly valid grievance against management and seeks to make a change for the benefit of all shareholders but they are unable to because management do not respect their rights and the courts do not uphold them

What I find particularly interesting in the above case was that it was retail shareholders who were agitating for change, not the institutions.  I like the fact that retail shareholders take an interest in the actions of their companies.  Although I think the decisions by the courts was probably the right one, I am worried about the precedent it sets for shareholders rights

Why Don't Retail Shareholders Vote at AGM's?

In my last post on corporate governance I covered the fact that retail shareholders generally don't vote at AGM's which puts significant power in the hands of institutions (who often hand this over to proxy advisers) and large controlling shareholders (who operate purely in their own interest).  This post will look at why retail shareholders don't vote.

Retail shareholders do not vote at AGM's and shareholder meetings for several reasons:

1. Lack of time to really consider the issues
2. Believe that because they have such a small shareholding their vote isn't going to count anyway (i.e. the institutions and large shareholders will control the vote)
3. The process is clumsy

Lack of time to consider and understand the issues

As any of you who have shares would know, voting is the least of your concerns.  If you are doing something other than investing full time, investing is just part of your life.  Your 'investment time' is taken up with

• Evaluation of new opportunities
• Monitoring current investments
• Weighing your sector allocations 

It is little wonder therefore that so little time gets devoted to.

Also there are limited resources available for retail shareholders to make an informed decisions.  Proxy companies do not provide reports to retail shareholders which outline the major issues and retail shareholders are unlikely to want to pay for them even if they could (because they don't believe they can make a difference the vote). 

Further although the decision to elect a director is likely to impact value it is a lot of effort to research directors, find out which ones are good and bad when the benefit of doing so is so uncertain.  Things like remuneration reports and special meetings regarding takeovers etc have much more tangible outcomes and are easier to research and assess but still quite difficult.

Lack of influence

I think this is one of the main reasons shareholders do not vote.  They believe that as the institutions and controlling shareholders have such a large part of the company their vote isn't going to make a difference.  I thought about this in terms of a political election - almost the same premise holds - your vote is so insignificant in the scheme of things as to be unlikely to make a difference but people still turn out and vote anyway (the difference being in a political election my vote carries the same weight as yours and this is not the case in a shareholder vote).

What retail shareholders often don't appreciate is that retail shareholders typically control 20 - 40% of a company which is a massive voting block.  Individually they may not have much influence but collectively they could be the most influential block. 

Who votes at AGMs and other shareholder meetings?

The underlying hope when you invest in shares is that the company will be run well and that it will realise it's full potential. That is often why we look at prior performance of management and how the company has been managed in the past. This is also why the share price tends to react so strongly when there is a management change (especially of a key figure like the CEO or CFO).

Given the level of importance that this implies it seems a logical link therefore that shareholders would take a significant degree of interests in shareholder meetings, annual general meetings and any other chance they have to vote their shares for the option that would yield the best outcome for them. Given the control that the board has over management (especially in choosing the right management and monitoring them) it seems logical therefore that shareholders would spend time finding out about the board members and who is right for the company.

All of us who invest in shares on a personal (i.e. retail) level know that this is never the case. In fact the point was driven home to me yesterday when I received the AGM voting forms for Macquarie Bank (MQG), an investment that has lost me significant amounts of money over the years and theoretically one which I should be the most passionate about agitating for change in. What I did though was look at the voting forms and then throw them straight in the bin!. As I did this I found myself wondering if I was the only one. I called several of my friends who are active investors and work for financial services firms (and who presumably has a better understanding of the companies they invest in than the 'common punter') and they all said they did exactly the same thing as I did.

The question then really is: who actually does vote at shareholder meetings? And on a related note why don't retail shareholders vote? For the rest of this post I'll cover the first point and the second I will leave for a later post.

The simple answer is that it is the institutions that vote at shareholder meetings.

• They are forced to by a combination of laws that require them to (in the US) and the need to explain to their investors why they are not taking a greater interest in the companies they are investing in if they don't.
• Institutions often vote through firms which are known as proxy advisers. These advisers (such as ISS and Glass Lewis) provide advice to institutions (for a rather hefty fee) on what they think the institution should vote for on every resolution.
• I have heard from several sources (though have no real proof) that many institutions just go along with the advice of their nominated proxy advisor and never question and probe the issues surrounding remuneration and the choice of directors.