In many ways, Neil Woodford became a victim of his own success. At Invesco Perpetual, his judgement had been questioned on several occasions, such as for avoiding technology stocks during the late 1990’s boom, or later, in selling out of bank stocks before the financial crash. Both times, he was proved right, which cemented his aura of being an astute investor with the strength of character to maintain his convictions in the face of strong criticism. His record had also helped to generate a fierce loyalty in the growing band of investors who had made money through him and his team.
Within Invesco, its US senior executives became increasingly concerned about the dependency of its UK subsidiary on the £30bn of funds under his management. They began trying to rein him in, and their view was strengthened when they discovered that he was investing in private companies which, being unquoted, were hard to value. This led to a Financial Conduct Authority (FCA) investigation and a fine in 2014, but the FCA found no evidence to suggest that action was warranted against any individual.
Red flags
Not long after this, Mr Woodford and others left to set up the Woodford Equity Income Fund (WEIF), which soon had £5bn funds under management. Given what happened later, that FCA fine might have been a red flag. But in its early days, the new fund published its complete list of holdings, so any stakes in unquoted companies would have been easily seen.
Unlike investment trusts, open-ended funds must settle clients’ sales out of cash reserves and then reimburse themselves by selling investments on the market. But unquoted companies can’t be sold easily, so regulations limit unquoted companies to no more than a tenth of their total assets. This might have seemed academic during those first couple of years when WEIF’s concentration on UK stocks delivered a barnstorming performance, but two of its four founder members became concerned that if its performance faltered, the fund could become unbalanced. They pressed for the internal limit to be lower than 10 per cent. But Mr Woodford had left Invesco to allow himself more freedom, and he was convinced he had a flair for spotting potential in private companies. In vain it was pointed out that the risk in these companies is higher, and that different skills are needed than those for spotting pricing anomalies in quoted ones. The two founders lost the argument and resigned.
The fall
By 2017, the fund had grown to £10bn, but then its performance began to decline. Mr Woodford tried to offer reassurance by suggesting that overseas investors would return to the UK once the uncertainty of Brexit was out of the way. Several of his main investments turned sour. Burford (BUR) suffered a shorting attack; Provident Financial (PFG) and Kier (KIE) were torpedoed by profit warnings; Capita (CPR) and Allied Minds (ALM) also slumped in value. Short-term market fluctuations were to be expected, but at WEIF, they seemed to have become stuck in a groove. The exodus of sales gathered pace, and by March 2019, the fund had shrunk to £4.5bn.
In 2018, some observers, such as Tom Winnifrith of Shareprophets, began warning that Mr Woodford was offloading WEIF private companies by selling them to Woodford Patient Capital Trust plc. Mr Winnifrith’s calculations suggested that the prices paid by the investment trust were too high. He alleged that Mr Woodford was employing desperate measures to prevent his fund from breaching the 10 per cent limit. WEIF said the valuations had been made independently and the prices had been determined by its authorised corporate director, Link Fund Solutions.
Later it was found that since late 2017, four of Mr Woodford’s private companies had listed on the Guernsey stock exchange. This technically re-categorised them as quoted securities, and in March 2019 Citywire reported that this stratagem had reduced the proportion of unquoted stocks in the fund from 16 per cent to below 10 per cent.
The crunch came in June 2019, when Kent County Council pension fund tried to offload its £263m holding. Institutions normally phase large sales over weeks, but Kent had been alarmed by a report in the Financial Times that the fund was shrinking at an average rate of £10m a day. Its push for an immediate redemption left little choice. WEIF had to be “temporarily” suspended, trapping over 300,000 investors in a fund that by now had shrunk to £3.7bn. For four months, Mr Woodford sold what he could to reposition his investments into liquid assets. That critical ratio became more elusive when, in July, the Guernsey authorities, evidently concerned about reputational risk, de-listed some of his private companies. By October 2019, Link saw no choice but to wind up the fund. Mr Woodford was sacked.
The suspension of Woodford Equity Income Fund (WEIF) in June 2019 trapped over 300,000 investors. But while investors would suffer losses, had they been misled? And if they had, by whom? For investors seeking to recover some of their losses through legal action, who they should the claim against is a pivotal question.
Neil Woodford
Lack of strong compliance within WEIF allowed Mr Woodford to invest heavily in unquoted companies. There have been allegations that some of these were sold by the fund to Woodford Patient Capital Trust plc at inflated prices, and that at a time when WEIF was making monthly reports to the Financial Conduct Authority (FCA), the proportion of unquoted assets was flattered because some had listed on the Guernsey stock market. There is resentment that between 2014 and 2018, Mr Woodford received about £65m in fees (via dividends to his personal company) and that during the fund’s suspension, between June and October 2019, when investors were locked into the fund and locked out of having influence over it, Mr Woodford received a further £8m.
The defence to these allegations would most likely be that his actions were intended to be in the best interests of investors. The valuation of the unquoted companies was conducted independently and the price was agreed by WEIF’s authorised corporate director, Link Fund Solutions. The Guernsey listings were made to enable the fund to continue working with the companies to realise their potential value. Mr Woodford has said that he believes that Link’s decision to sell the fund’s assets was premature, since the proceeds were less than would have been obtained had the assets been held for longer. Subsequent price rises add weight to this view.
Platforms
WEIF was on Hargreaves Lansdown’s Wealth 50 best buy list until the day it was suspended. According to the Financial Times, “the deal with Hargreaves was that the fund manager would receive a discount on its products to the fund supermarket, in return for heavy promotion”. For clients who were left exposed, a legal claim might look at the close link between Hargreaves and the fund, but would probably focus on proving that Hargreaves, or indeed any other fund supermarket, had given bad investment advice to those who had invested directly (excluding those who held a stake through a managed vehicle). Could the marketing of the Wealth 50 list be construed as advice? And might the investment risks have been appropriate for some clients? Clients’ varying circumstances could undermine a blanket claim.
The regulator
Several former staff and clients had warned the FCA about compliance within Woodford businesses. It took no action until 2018, when it asked for monthly updates on the proportion of unquoted shares in the fund. In 2019, it launched an investigation, but the outcome is likely to take several years. Regulatory changes might follow.
The corporate adviser
Link Fund Solutions had day-to-day responsibility for policing compliance within the firm. Should it have stepped in earlier, or given the fund more time before forcing closure? Might it have placed the better assets into a “good fund” that could have continued trading? Investors are likely to end up recovering about 70 per cent of their trapped investments, but the winding up costs so far have topped £15m. How could a legal case against Link be framed?
The mechanics
Five law firms have considered the viability of taking legal action, but which is the best one to turn to? ShareSoc, ever the champion of the private shareholder, has endorsed Leigh Day, who decided that Link was most at fault. The firm says that the case stems from Link breaching the rules of the FCA Handbook and failing to “properly carry out the management function of the [fund]” due to allowing WEIF “to hold excessive levels of illiquid or difficult-to-sell investments, and that this caused investors significant loss”.
Legal remedies can be expensive, so Cliff Weight, a director of ShareSoc, says it was important to find lawyers who would charge no fees unless the claim was successful. Leigh Day would then keep 30 per cent of the settlement, and 70 per cent would be distributed among those who had instructed the firm to act for them. To avoid claimants becoming liable for defendants’ costs if the case is lost, after-the-event insurance has been taken out.
Mr Weight points to another advantage in this sort of arrangement. If they lose, the claimant’s lawyers will have worked for no reward. Lawyers will never take on a case on a no-win-no-fee basis unless they think that the odds of winning are in their favour.
