Investment risk

www.corporatedirector.co.uk
Investment risk
Dealing with risk

Investment risk
• Due diligence before investing
• Risk within invested companies

Case Studies
Investment risk

Case studies
Look out for:
Poor management
Poor governance
Fraud/corruption

Case Studies
“Recklessness, hubris and greed”

Case studies
The UK’s second largest construction company
collapsed under the weight of £1.5bn debt.
Carillion specialised in construction, as well as
facilities management and ongoing maintenance.
It employed 20,000 people in the UK and had more
staff abroad
Its liquidation will cost UK taxpayers at least £148m

Case studies
“Relentless dash for cash, driven by acquisitions,
rising debt, expansion into new markets and
exploitation of suppliers.”
Work & Pensions Parliamentary Select Committee Report

Case studies
“Carillion was unsustainable. The mystery is that it
lasted so long. Carillion could happen again, and
soon.”

Case studies
2016
Sales £5.2bn
Market capitalisation almost £1bn
2017
£900m debt
£200m pension deficit
Three profit warnings

Case studies
Cost overruns on three public sector construction
contracts
Payment delays in the Middle East
Pension scheme considered a “waste of money”
Suppliers paid in 120 days or discount
Government: “too big to fail”
Retiring FD sold £800,000 of shares

Case studies
“Same old story. Same old greed. A board of
directors too busy stuffing their mouths with gold to
show any concern for the welfare of their workforce
or their pensioners.”
Frank Field – Chair, Work and Pensions Select Committee

Case studies
Europe’s Enron

Case studies
During the 80s and 90s, Parmalat is hailed as the
jewel of Italian commerce, as entrepreneur Calisto
Tanzi converts his father’s Parma-based ham retailer
into a global dairy and food giant with a speciality for
long-life milk.

Case studies
2003 bondholders learn nearly $4.5bn of funds
held in a Bank of America account don’t exist
2004 debts fixed at €16.1bn – eight times the
figure admitted to
BofA former Chief of Corporate Finances in Italy
admits participating in a kick-back scheme

Case studies
Fraud started with an attempt to cover up losses
Disguised losses through fraud and collusion
Created fake transactions through double-billing
Used fake sales as collateral to borrow from banks
Hid legitimate debt from investors
Investment bankers moved debt off balance sheet
Forged letter validating a false account statement

Case studies
300 employees aware of double-billing scheme
Deutsche Bank took on debt disguised as equity
Grant Thornton International conspired with
management to hide a €5bn hole in Parmalat’s
books from the firm’s new auditor
BofA head of credit misappropriated $27 million

Case studies
Questions that should have been asked
• How could this company report margins twice the
industry average without a competitive advantage?
• How could it have gone to debt markets so often
without having built up debt to match?

Case studies
“Whatever Kikukawa said was the course to be followed”

Case studies
• 30-year Olympus executive Michael Woodford
appointed first non-Japanese President and COO,
and later CEO
• Two weeks later he was fired for attempting to
expose a $1.7 billion fraud within the company
• 82% share price collapse
• Resignation of board members
• Arrest of 11 directors and officials for fraud

Case studies
$687 million advisory fee paid to an unknown
Cayman Islands company
Over-valued payments on Altis, News Chef and
Humaloabo
Possible links to organised crime

Case studies
Olympus eventually acknowledged that it had
concealed investment losses since the 1990s by
moving them to an offshore fund in a practice called
“tobashi” – a transfer of assets so as to conceal
losses.

Case studies
President and Chairman Tsuyoshi Kikukawa “was a
very charming man. He talked about my family, and
he knew them all by name. He felt I could do what
was necessary … We didn’t discuss terms or
anything; I just said yes.”

Case studies
However, Michael Woodford soon realised that he
lacked the power to make fundamental decisions.
“He controlled all the levers, and the board were
literally puppets, and he was the puppet master.
There were no ifs or buts … Whatever Kikukawa said
was the course to be followed.”

Case studies
Former Supreme Court judge Tatsuo Kainaka said
the “core part of management was rotten”, having
concealed business and investment losses.
The Olympus case did for Japan what Enron did for
the United States, changing governance policies,
board liabilities and so on.

Echo?

Nissan
No audit committee
No nominating committee
Cross shareholdings
Token independent directors

Carlos Ghosn
• Promotion, demotion and executive remuneration
were entirely decided by Carlos Ghosn.
• “You risk your future if you rebel against Ghosn”

Case studies
America’s Most Innovative Company

Case studies
$63.4 billion in assets made it the largest corporate
bankruptcy in corporate America
Until Worldcom’s bankruptcy the next year!!

Case studies
• 1985 Kenneth Lay merged Houston Natural Gas
and Internorth to form Enron
• 1990s initiated selling of electricity at market prices
• United States Congress deregulated the sale of
natural gas
• 1999 creation of EnronOnline trading website

Case studies
Dubious strategies
Complex financial statements
Merchant model vs. agent model
Mark to market accounting
Special purpose entities
Arthur Andersen conflict of interest
Aggressive use of loopholes in GAAP

Case studies
Governance
Model board of directors
Audit committee unable to challenge auditors
Short-term earnings compensation
Stock options – focus on stock price
Hedging with derivatives and SPVs

Case studies
“You can follow all the rules
and still commit fraud.”
Former Enron CFO, Andrew Fastow

Sarbanes-Oxley
In 2002, the United States Congress passed
the Sarbanes-Oxley Act (SOX) to protect
shareholders and the general public from accounting
errors and fraudulent practices in enterprises, and to
improve the accuracy of corporate disclosures.
Its purpose is to review legislative audit requirements
and to protect investors by improving the accuracy
and reliability of corporate disclosures.

Actions
Investment risk

Investment risk
Analyse the culture
Explore the future
Governance checks

Culture
Investment risk

Analysing the culture

Asking the following questions will help identify the
current culture: -

What is the external environment?
Physical
Market
Regulatory

What is the internal environment of the
organisation?
Physical
Social

What do people in the organisation actually do?
Critical to its success
Differentiates the organisation

What are the corporate skills and competences?
Critical to its success
Differentiate the organisation

What are the beliefs and values of the
organisation?
Beliefs
Values

What is the organisation’s identity?
Metaphorical
army, sports team
family, nurturing
hot house, technology
evangelist, ideas, best practice

How does the organisation interact with and
contribute to society?
What is its purpose?
Why does it exist?

Forecasting
Investment risk

Past investment strategies
Long term blue chip investments
Tobacco?
Coal?
Utilities?
Retail?
Commercial property?

Scenario planning

Environmental Analysis

Environmental analysis
Political
Assess government regulations and legal factors in
terms of their ability to affect the business
environment and trade markets. The main issues
addressed in the section include political stability, tax
guidelines, trade regulations, tariffs, and employment
laws.

Economic
Through this factor, businesses examine the
economic issues that are bound to have an impact
on the company. These would include factors like
inflation, interest rates, economic growth, the
unemployment rate and policies, and the business
cycle followed in the country.

Sociological
With the sociological factor, a business can analyse
the socio-economic environment of its market via
elements like customer demographics, cultural
limitation, lifestyle attitude, and education. With
these, a business can understand how consumer
needs are shaped and what brings them to the
market for a purchase.

Technological
How technology can either positively or negatively
impact the introduction of a product or service into a
marketplace; also its effective life. These factors
include technological advancements, lifecycle of
technologies, the role of the Internet, and the
spending on technology research by the government.

Environment
The environment can affect you directly and, more
likely, through regulations, reputation and best
practice. These factors include changes in weather
and climate, laws regarding pollution and recycling,
waste management and use of green or eco-friendly
products and practices.

Legislative and regulatory
How laws and regulation can impact on business
activities and products. Remember that these could
apply differently in different geographical regions and
states. These factors include discrimination laws,
health and safety laws, consumer protection laws,
copyright and patent laws.

Governance
Investment risk

Roads to Ruin - analysis
Risk professionals’ association Airmic studied twenty
major corporate crises of the last decade, including:
• Coco-Cola, Firestone
• Shell, BP
• Airbus, Societe Generale
• AIG, Railtrack
• Enron, Arther Anderson

Underlying weaknesses arose from seven key risk
areas that the authors recommend should be drawn
into the risk management process:

Board skill and NED control risks
• Limitations on board competence and the ability of
the Non-Executive Directors effectively to monitor
and, if necessary, control the executives.

Board risk blindness
• The failure of boards to engage with important
risks, including risks to reputation and ‘licence to
operate’, to the same degree that they engage with
reward and opportunity.

Poor leadership on ethos and culture

Defective communication
• Risks arising from the defective flow of important
information within the organisation, including to
board-equivalent levels.

Risks arising from excessive complexity

Risks arising from inappropriate incentives
• Whether explicit or implicit.

Risk ‘Glass Ceilings’
• Arising from the inability of risk management and
internal audit teams to report on risks originating
from higher levels of their organisation’s hierarchy.

Roads to Ruin - recommendations
The scope, purpose and practicalities of risk
management will need to be rethought from board
level downwards in order to capture these and other
risks that are not identified by current techniques.

The education of risk management professionals will
need to be extended so that they feel competent to
identify and analyse risks emerging from their
organisation’s ethos, culture and strategy, and from
their leaders’ activities and behaviour.

The role and status of risk professionals will need to
change so that they can confidently report all that
they find on these subjects to board level.

The authors warn that these risks will remain
unmanaged unless boards – and particularly
chairmen and NEDs – recognise the need to deal
with them.

The authors warn that these risks will remain
unmanaged unless boards – and particularly
chairmen and NEDs – recognise the need to deal
with them. Boards will also need risk professionals
with enhanced vision and enhanced competencies to
help them do so.

Review
Do you understand, and are you
happy with, your organization’s
risk appetite and tolerance?
How often is its risk register
reviewed and discussed?
What strategies and policies do
you have to identify, manage and
mitigate risk?
Checking out your risk profile

Richard Winfield
rwinfield@brefigroup.co.uk
www.richardwinfield.com

Investment risk

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