Two short case studies are offered, both drawn from the United Kingdom over the last 10 years, to illustrate the importance of careful disclosure. The first case shows the consequence of a wrong judgment call on disclosure; the second case recounts a major fraud in which information was deliberately withheld from investors. The first case, while rather historic, is particularly valuable because it shows how easily serious errors in disclosure can be made inadvertently by well qualified and experienced executives.
Case 1—Delayed Disclosure at MyTravel plc (2002 to 2005)1
Between 1993 and 1999, Airtours plc grew at a rapid rate through acquisitions. Over this period turnover grew from £690m to £5.2bn. In November 1999, the chief financial officer (CFO), Tim Byrne, who had helped finance this program of growth, was appointed chief executive officer (CEO).
On Tuesday, September 11, 2001, four U.S. passenger airliners were hijacked by 19 al-Qaeda terrorists in order to be flown into buildings in suicide attacks. The airline industry, which had already been experiencing overcapacity, would be severely affected by the loss of passenger confidence in the months following this terrorist incident. Airtours plc rapid expansion over the previous decade and their complete reliance on holidaymakers left them particularly exposed to this sudden downturn in demand.
On November 27, 2001, Airtours plc announced record results for the 12 months to September, with a profit of £147.4m. Industry insiders, however, knew that Airtours plc was far from immune from the trauma that the airline industry was experiencing because of the challenges of declining demand and increased security regulations. The industry was poorly positioned to deal with falling demand due to fixed capacity, low margins, substantial exit costs, and a surplus of players. Investors became very sensitive to signs of weakness in the industry, as they speculated which airlines would be the first to collapse.
In February 2002, Byrne rebranded the company MyTravel plc, while retaining the Airtours name as a consumer brand. In May 2002, MyTravel plc issued a profit warning. This profit warning was apparently rescinded on July 23, 2002, when MyTravel announced that group trading across all divisions was in line with expectations. About eight days after this announcement, on or about 31st July, the results of a review of the accounting records and balance sheets of certain MyTravel U.K. business units were disclosed to management. The review had identified a number of balances from prior years that totaled £24.3m that would need to be written off as a charge against profits in the financial year to September 30, 2002. These were accounting or reconciliation errors that had occurred in a number of years prior to 2002. The balances represented an inadvertent cumulative overstatement of the profits for FY0l and previous years, and it was agreed that they should be written off immediately and charged to the 2002 accounts.
The CFO (David Jardine) and CEO (Tim Byrne, who was himself a qualified accountant and had formerly been CFO) chose not to inform shareholders of the loss, believing that exceptional gains would offset the one-off cost. Byrne believed that the prior-year balances had been reflected in existing profit forecasts, that the overall profit target would be met and that because of this no announcement was necessary, since the prior-year adjustments merely represented a change in the timing of profits, not the overall level of profit. The board as a whole was not informed of the balances, and no external advice was solicited.
Following disagreements with management, the company’s auditors, Arthur Andersen, were dismissed and Deloitte and Touche appointed. On 30th September the company issued a second profit warning. Following shareholder pressure, Tim Byrne was ousted as CEO on 8th October. The company then issued a third profit warning on 17th October after which shares fell further to 18pence, valuing the company at just £89m. Earlier that year the shares had been worth £2.84.
Peter McHugh (CEO of the Group’s North American operations) was appointed as Chief Executive of MyTravel plc on October 17, 2002.
On 12th November, the Financial Services Authority (FSA) announced that it was proceeding with a preliminary investigation into MyTravel’s disclosures concerning the timing of its September profit warning.
On 28th November, the prior-year exposures were finally announced to the market, as part of the full year results announcement.
The performance of MyTravel continued to worsen, and in December 2004 MyTravel agreed a £800m debt-for-equity swap that saw its debtors take ownership of 94 percent of the company’s shares, while shareholders suffered a 30 for 1 share swap and retained just 4 percent with bondholders receiving the balance of 2 percent.
After a lengthy investigation, the FSA fined MyTravel on November 4, 2004. MyTravel immediately appealed to the Financial Services and Markets Tribunal. Finally on July 14, 2005, the FSA announced that a settlement had been reached and that MyTravel Group plc had accepted the fine of £240,000 and withdrawn its planned appeal. MyTravel had breached the Listing Rules in July 2002 by failing to update the market following a change in its own expectation as to its performance for the financial year ended on September 30, 2002. There had been a breach of Listing Rule 9.2(c) which obliged companies to make an announcement of information concerning a change in the company’s expectations as to its performance which, if made public, would be likely to lead to a substantial movement in its share price. The FSA concluded that there had been a change in the expected source, composition, and timing of the company’s profits, and that where such information, if made public, might lead to a substantial movement in its share price it must be announced. Although the officers of the company had this information around July 31, 2002, the firm did not announce this information until November 28, 2002. By failing to notify a Regulatory Information Service without delay, MyTravel contravened Listing Rule 9.2(c).
No individuals were fined. The FSA regarded the difficult market situation that prevailed at the time of the company’s nondisclosure as an aggravating matter since investors would be particularly keen for performance updates. When the final settlement was announced, the managing director of the authority’s wholesale business division, Hector Sants, said: The need to inform the market was especially relevant in MyTravel’s case, where the prevailing business environment was challenging and any announcement in relation to accounting issues would have come as an unwelcome surprise to investors.
The FSA put particular emphasis on the situation of investor nervousness that existed within the travel sector generally but which applied to MyTravel in particular, given the announcements already made by it earlier in 2002. Underlying the decision in this case is the concept that it is not for the company management to conclude that a loss, in this case a large write off, will be compensated by gains elsewhere and therefore no announcement is necessary. The market must be given the opportunity to assess the information itself. MyTravel’s failure to seek independent advice on the issue was a further aggravating factor which contributed to the calculation of the financial penalty.
A final noteworthy point is the position of the individual directors concerned, the former group finance director, and chief executive. The FSA accepted that their error was accidental and took no personal action against them.
Case 2—Misleading Disclosures at Cattles plc (2007 to 2012)2
Cattles was founded in Hull 1927 and listed on the London Stock Exchange in 1963. Cattles plc was a leading lender to the “subprime” market, lending to customers who had poor credit histories who would not receive credit from high street banks. The loans were unsecured and carried very high levels of interest. In 1994 Cattles plc purchased Welcome Financial Services. By 2007 Welcome Financial Services provided 90 percent of the revenue of Cattles plc.
In 2007, Cattles plc published an Annual Report which subsequently was shown to contain highly misleading statements of arrears, impairment, and profit. The arrears on Welcome Financial Services loan book of £3 billion was stated as £0.9 billion rather than the £1.5 billion, which would have been the figure if accounting standards had been correctly applied. A pretax profit of £165m was declared, when later calculations showed that Cattles actually suffered a pretax loss of £96.5 million for the year.
As the recession in the United Kingdom deepened, the financial position of Cattles plc worsened as more and more of its customers defaulted. Welcome had started to understate the extent of its bad debts by deliberately deferring loans without the knowledge of the customer so that loans would not be regarded as impaired as they should have been when they were 120 days late. Welcome was deliberately understating the proportion of bad debt it held, knowing that the ratio to bad debt to total debt was a key measure of financial performance used by investors.
In April 2008, Cattles plc, desperately short of cash, issued a rights issue prospectus to potential investors which included the misleading figures from the Annual Report. The rights issue was fully subscribed at £1.28 per share and raised £200 million.
In January 2009, the company announced the loss of 1,000 jobs. On March 10, 2009, the company issued its third profits warning in three weeks, and suspended three directors of the Welcome Financial Services subsidiary—James Corr (Finance Director), Ian Cummine (Chief Operating Officer), and Adrian Cummings (Compliance and Risk Director)—pending an investigation by Deloitte into accounting irregularities. By the end of the day the shares were worth 1.8pence, they had been 195 pence 12 months earlier. In April 2009 trading in Cattles shares was suspended pending the publication of its report and accounts for the year ended on December 31, 2008. In July 2009, the above three directors were dismissed without compensation, and the Chairman Norman Broadhurst and CEO David Postings chose to leave the group. In December 2009, Cattles announced that its shares “are likely to have little or no value.”
Cattles was acquired by Bovess Limited in February 2011. On March 2, 2011, Cattles announced a scheme of arrangement under which its shareholders would receive only 1p for each share.
On March 28, 2012, the FSA issued a final notice. James Corr, Cattles’ finance director, was fined £400,000, and Peter Miller, Welcome’s finance director, was fined £200,000, and both had been banned from performing any functions in relation to any FSA-regulated activities. The FSA also banned John Blake, Welcome’s managing director, and fined him £100,000. All three fines were reduced on account of the directors’ current personal financial circumstances. In 2013, Miller was expelled by the Financial Reporting Council from the Institute of Chartered Accountants for England and Wales for his role in the publication of the 2007 Annual Report and 2008 rights issue prospectus, both of which contained materially misleading information designed to create a false market in shares.
Cattles had breached the Listing Principles by failing to act with integrity toward its shareholders and potential shareholders, and failing to communicate information in such a way as to avoid the creation or continuation of a false market. Welcome breached Principle three of the FSA Principles for Businesses by failing to take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems. Both firms engaged in market abuse by disseminating the inaccurate information. Corr and Miller were personally responsible for the breaches by the companies of which they were directors and also committed market abuse.
The FSA publicly censured Cattles and Welcome, and stated that it would have imposed substantial financial penalties had it not been for the weak financial position of the firms. The firms cooperated fully with the FSA’s investigation.
Tracey McDermott, the FSA’s acting director of enforcement and financial crime, made this statement following the outcome of the investigation:
The consequences for shareholders of the misleading statements issued by Cattles and Welcome have been devastating. These directors failed to act with integrity in discharging their responsibilities. They failed in their obligations to shareholders, the wider market and the regulator. In order for markets to function properly, information given to investors must be accurate. Directors of listed companies must act with integrity and exercise appropriate diligence when making disclosures to the market. They should note the personal consequences for those who fail to meet our requirements.
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1 This case study is based on the following sources:
• www.investegate.co.uk/article.aspx?id=200507140700098606O
• www.manchestereveningnews.co.uk/business/business-news/mytravel-fined-240000–1076813
• www.telegraph.co.uk/finance/2829725/Departure-lounge-for-MyTravel-chief.html
• http://news.bbc.co.uk/1/hi/business/4681739.stm
• www.ashurst.com/doc.aspx?id_Content=2028
• www.thisismoney.co.uk/money/news/article-1532624/FSA-confirms-probe-at-MyTravel.html
• www.theguardian.com/technology/2004/nov/27/business.travelnews
2 This case study is based on the following sources:
• www.ccrmagazine.com/index.php?option=com_content&task=view&id=6646&Itemid=99999999
• www.cattles.co.uk/about-us/company-history
• www.theguardian.com/business/2009/mar/10/loans-cattles-directors-covenants
• www.frc.org.uk/Our-Work/Publications/Professional-Discipline/Tribunal-Report-Peter-Miller-File.pdf