Social media is poison

I’ve been in blissful ignorance for many years. I deleted Facebook over five years ago. My wife and I have an Instagram account (which does have some dark sides). But no other accounts.

I never even had Twitter.

Social media is poison

About 6 months ago I set up Twitter for this website. I’ve learnt quite quickly that Twitter is awful.

Perhaps I was naive, and I’m happy to accept that as a criticism. But I am shocked at how bad social media is for you.

I had a lovely afternoon chat with The Escape Artist last week. For the few of you who don’t know who he is, he is one of the ‘big dogs’ of the UK FIRE community. I strongly recommend you to check out his blog.

I asked him for his view on Twitter. He was pithy: Social media is poison.

Bad diet

Eating fast food is bad for you. Consuming social media is bad for you. Twitter is fucking awful. It’s the equivalent of scoffing an XL Doner Kebab from Dodgy Kebab Shop.

Eat burgers every day you get fat. Get all your ‘news’ from Twitter, Facebook all day you get stupid.

I was probably in a bubble, but I now see why people can hold such idiotic views.

I Think You’ll Find It’s a Bit More Complicated Than That

You can’t sum up life in 200 characters. Or a photo. Or a video.

Life is more complicated than that.

When you think you’re getting the whole story on an issue from social media, you ain’t.

Even writers I hugely respect and read voraciously in long form write utter garbage on twitter. Dangerous garbage. Stuff that is flat out wrong. Stuff that willingly misleads the public.

You are being poisoned

Comprehensive explanations don’t sell. Sex does.

It’s sexy to rant. It’s narcotic to be outraged. It’s rock and roll to rave.

But those people ain’t doing it for your benefit. They are doing it to sell you stuff. Everything is a sale. Sometimes they are selling you a product or service. Sometimes they are selling you an agenda. Sometimes they just want to watch things burn.

You have to ask yourself – are those people’s interested aligned with mine?

Detoxing

I was alive to the insidious nature of the ‘twittering classes’. But reading some of the utter bilge spouted about the NYT piece on FIRE has woken me from my dangerous slumber. Funny, isn’t it, that lots of people who make money from managing others’ money don’t like it when people realise they can do it themselves and not get mugged off? In particular, I saw financial planners lay into some FIRE converts tripping over themselves to get a stab in whilst rule number one of financial planning:

Financial planning is about meeting a client’s financial and lifestyle objectives, not the financial planner’s objectives or the objectives the planner thinks the client should have

I don’t think I’ll delete Twitter, it has been very helpful connecting with people. But this week I’ve started exercising the toxin from my life.

I’ve culled the number of ‘people’ I follow. Any bullshit and I’m done. I don’t mean disagree, I follow many people I disagree with, I mean people who are trying to pollute my mind with poisonous information. It was tough to ‘unfollow’ people I really respect as writers and thinkers, but who cast out rubbish on Twitter.

How can you trust me?

You might be thinking, all sounds great, but how can I trust you Mr YFG?

Good question. You need to ask yourself, are your interests aligned with mine? Will reading this blog help you, or hinder you?

I do this because I want to help people with their finances. I’m not selling anything. I’ve never marketed this website. I’ve never done any promos or any of that SEO stuff (I don’t know how all I’ve got is some plugin that tells me whether I’m doing alright on that stuff).

If you’re here you are here by word of mouth. If you’ve stayed, you’ve stayed maybe because you see some good in this humble blog.

Cut the emissions

My ask of you is this: find the sources of toxic information in your life and purge it. Stop feeding the polluters the oxygen that allows them to burn their rotten garbage and poison our society.

The evidence is unequivocal. You will be happier. You will be better for it.

All the best,

Young FI Guy


Thanks to Barney at The Escape Artist, Ken at The Humble Penny and countless others, the London FI community has regular meet-ups. These are great fun and as it so happens, we’re not all weirdos typing stuff into a computer in our gran’s basement (as The Escape Artist would say).

The next one is from 5.30pm Friday 19 October for drinks, chat and FI related fun.

Come and chat about Financial Independence (or anything really) over Friday evening drinks at The Old Bank Of England pub, Fleet Street, London EC4A 2LT.

I’ll be there. So will Mrs YFG. As will several dozens other people!

You can find more details and updates on the London FI Facebook group (you’ll need to join the London FI Facebook group) link: https://www.facebook.com/events/2178973152318036/

You don’t need to go on Facebook though, I haven’t had Facebook for years!

The directors and auditors of Carillion (Part 3)

This is Part 3 of my Carillion series. In this part, I look at what investigations will be going on and what the aftermath might be for the auditors and Carillion directors. Part 1 on the insolvency process can be found here. Part 2 on the accounting can be found here.

One lawyer with a briefcase can steal more than a hundred men with guns

– Mario Puzo, The Godfather

This post is in two halves. In the first half, I will look at the auditors, KPMG. In the second half, the directors. I’ve written about them together because they interlink in many ways.

Part I: The Auditors

The auditors’ work is governed by the Companies Act 2006 (CA 06) and is regulated by the Financial Reporting Council (FRC). Broadly speaking, the auditors’ job is to assess whether the accounts drawn up by management are ‘True and Fair’. Unfortunately, this is not a defined term. Our politicians and courts have continually refused to offer a definition. Generally speaking, ‘True and Fair’ is interpreted to mean ‘free from material misstatement’, which is jargon-speak for something along the lines of: “free from untrue information that could affect the decisions of somebody who uses the accounts.

The auditors work to a set of standards which set out the principles of the work they should do, these are called International Standards on Auditing (ISAs). These ISAs are used to check the accounts are ‘True and Fair’ according to accounting standards, for a public company like Carillion, these are the International Financial Reporting Standards (IFRS).

Together, these two sets of standards will lead the auditor to undertake particular bits of work. The auditor will look for the areas that are at the biggest risk of being wrong, and spend more time checking them.

The Carillion audit

Carillion’s auditors were KPMG. By law, the auditors have to write about the biggest risks in the accounts. For the last set of accounts in 2016, KPMG said these were: “Recognition of contract revenue, margin, and related receivables and liabilities”; “Other revenue judgements”; and “Carrying value of goodwill” (things I talked in detail about in Part 2… hmm…)

The auditors will, of course, focus on the whole accounts, but by their own judgement, they need to be particularly careful on these self-identified items.

The FRC

When an audit goes ‘wrong’, as with Carillion, the FRC has the power to investigate under what’s called their Audit Enforcement Procedure. The FRC publicly announce these investigations, you can see the list of ongoing ones here: https://www.frc.org.uk/auditors/enforcement-division/current-cases-audit-enforcement-procedure

The FRC will review the accounts and the audit files checking to see if the audit was conducted to the ISAs and in line with the requirements under the CA 06. In particular, they will look at what’s called the Audit Report, a report the auditors give to management (privately) setting out the detailed findings of the audit. There will be a specific focus on whether they found things in their report that are inconsistent with the published accounts.

The FRC will also look at emails, the audit file and accounting records to check the work KPMG was doing and if it was up to scratch. It’s a long process, involving 1,000s of man-hours. Sifting through 1,000s of inconsequential documents looking for important information.

At the same time, the FRC will be sharing information with both the Official Receiver (as representative of the Insolvency Service); the Serious Fraud Office (SFO) and Director of Public Prosecutions (DPP). The former will be looking for potential civil breaches of the Insolvency Act ’86. The latter will be looking to see if there are criminal breaches of the CA ’06 or Fraud. More on all that in a bit.

The process

Overall the process looks like this:

  • FRC decides to investigate
  • Investigates
  • Decides whether to bring proceedings
  • Sets up a tribunal to rule on any wrongdoing
  • Tribunal makes determination

The targets of the investigation have a right of response and are able to challenge any allegations and findings. This means that the process can take a long time. We’re often talking years in the most complex cases.

The investigation

Generally speaking, the FRC will investigate each stage of the audit. Specifically focusing on: “did the auditors miss any big risks?” “did the auditors plan for the right checks given the level of risk?” “did the auditors do the checks properly?” “did the auditors explain any misstatements in the accounts, and if necessary ensure they were corrected?”

Most of the problem comes in the middle two questions: the audit was poorly planned and the audit work was done poorly.

An example from Carillion

In my opinion (and it is of course only my opinion going solely from the facts in the accounts), we can see a potential example in the Carillion accounts.

This is what KPMG said about their response to the biggest risk to the accounts, Revenue Recognition (2015, p77, on the left; 2016, p86, on the right, p.s. you don’t need to read it, only note that they’re different):

What’s important isn’t necessarily what’s said, but what isn’t said. For example, in 2015 KPMG said that they were “challenging these estimates with senior operational, commercial and financial management“, in 2016, this now says they had “conversations with senior… Likewise, “assessing whether or not these estimates showed any evidence of management bias” has been completely deleted. It would appear, from these statements that the auditors went from challenging both senior management and the Group’s estimates to just the Group’s estimates.

Sceptics amongst you might be thinking I’m reading too much into this. But I will say this, auditors *can* be lazy, they would not make more work for themselves by changing ‘standard’ text unless they needed to. For me, this is a potential indication that the auditors did not undertake any analysis to see if forecasts were upwardly biased.

That is a major worry. Firstly, because this is the self-identified biggest risk in the accounts – the auditors should be doing everything to make sure these numbers are robust. Secondly, this is a huge area of judgement (as noted in Part 2). Anybody who has ever worked in business knows that management tends to have ‘rose-tinted spectacles’, they think their business is the best in the world and will make lots of money. It’s the job of the auditors to make sure they aren’t going overboard with their forecasts.

[Tangent: An example of this in action is with BHS – the auditors didn’t sufficiently challenge forecast business estimates that BHS would significantly outgrow the UK retail market. It’s a minefield though, because, even the FRC fell into BHS’ trap. At first, it said these estimates were “unreasonable”. After being challenged by Philip Green in court, the FRC backed down in their report to say these appeared ‘optimistic’ (probably because it hadn’t undertaken the work to prove the estimates were unreasonable). It takes a lot of work to establish whether estimates are optimistic or unreasonable, it’s a grey area.]

Of course, I don’t know for certain what went on in the Carillion audit. So it isn’t right for me to speculate. But it’s safe to say the FRC will be investigating and will report their findings.

BUT! NO AUDITORS EVER GO TO JAIL!

The biggest charge at the FRC is that they are ‘soft-touch’ and that no auditors ever get ‘punished’ for ‘bad’ auditors. I’m sympathetic to these arguments, but there are some important things that the mainstream media don’t say.

The one that bugs me the most is about no auditors going to jail. For an auditor to go to jail, they need to be found guilty of a crime. The FRC cannot prosecute auditors for criminal actions. The government has not given them that power. A ha! you might say, that proves auditors can never go to jail. That is not true, and something I tell people time and time again. Auditors can be sent to jail if they “knowingly or recklessly causes a report … to include any matter that is misleading, false or deceptive in a material particular.” This has been the law for over a decade, and it was widely reported when first brought into legislation. But for an auditor to go to jail, it’s up to the SFO, DPP or the Secretary of State to bring the prosecution. In other words, not the FRC.

The problem is, successive governments have drastically cut funding to the SFO and Crown Prosecution Service (CPS) to enable them to bring such cases to trial. These investigations take a lot of time and a lot of money. You have to prove that the auditor knew beyond a reasonable doubt that the report was misleading, false or deceptive or recklessly so. That is a very high burden of proof. Again, that’s for the SFO and CPS to prove, not the FRC.

The FRC is still soft-touch

That said, it still leaves the civil element, which is in the FRC’s court. The FRC gets its powers from the Companies Act and statutory instrument. In other words, it’s allowed to do only what the government lets them. [Note: some powers are delegated to professional bodies to regulate, for example, the ICAEW to discipline Chartered Accountants, much in the same way as with other professional bodies.]

For as long as I can remember, the FRC has campaigned for more powers, more funding. But this has been refused by politicians. That is reflective of the prevailing political will that governments are reluctant to ‘overpower’ regulators in case they ‘chill business’. Unfortunately, this is nothing new. You can replace FRC with FCA with FSA with the Insolvency Service and the SFO. I’ll avoid delving into politics, but if you want regulators to get tough, you first need to get politicians to allow to them to be so.

Part II: The Directors

As I wrote about in Part 1, the Official Receiver (OR) will be performing an investigation into what went wrong at Carillion. They will produce a report that outlines their findings and recommends future actions. There are roughly five courses of action:

  1. Do nothing (very rare)
  2. Recommend disqualification of the Directors
  3. Recommend bringing a Wrongful Trading claim
  4. Recommend bringing a Fraudulent Trading action
  5. Find no specific breach of Insolvency Law, but potentially recommend further fraud investigation.

At this point, I should mention I’m not a lawyer or barrister. Rather an accountant who worked in the bizarro-world where law, accounting and finance overlap. I’ll try my best to use the right language, but I’ll no doubt get it wrong sometimes.

Each of these actions are covered by different bits of law, each with varying burdens or proof or evidence required. Let’s look at each of them.

1. Director disqualification

This comes from the Company Directors Disqualification Act 1986. In essence, the law here is designed to prevent abuse of the Companies Act and ensure Directors have fulfilled their fiduciary duties.

There are loads of grounds for disqualification ranging from not filing papers at Companies House through to Fraud. These are set out in the CA ’06.

For the lower ranking offences, the burden of proof is low. You either did something you shouldn’t or you didn’t do something you should have. As a civil offence, it runs on the balance of probabilities, was it more likely than not that you broke the rules. Generally speaking, if you were a director of a company that was insolvent, you get disqualified.

The Court will decide how long the directors should be disqualified for. It can be up to 15 years.

Despite sounding a bit wishy-washy, it can be quite severe. If you’re an accountant or a lawyer (or another professional) it almost always means being automatically booted out of your professional body. You’re also banned from being a director, trustee or governor (often the later two ends up being for life). If you try to become a director during disqualification you can be sent to jail.

2. Wrongful Trading

Parallel to disqualification is Wrongful Trading. This is also a civil offence, covered by the Insolvency Act 1986 (IA 86).

Wrongful trading occurs when the directors of a company have continued to trade a company past the point when they:

  • knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation; and
  • they did not take every step with a view to minimising the potential loss to the company’s creditors.

The Directors only need to have probably breached their duties in acting in the creditors’ interests (reflected in the language above). This is more serious than a simple disqualification. The directors can be fined. Most importantly, the directors can be made to be personally liable for the debts of the Company from the point they knew the company was insolvent.

Unlike disqualification, this is less rules-based. The liquidator will try to work out the date at which the company can be shown to be insolvent, and then show why it was unreasonable for directors to keep trading. It’s important to note that it is not an offence to trade while insolvent. In some situations, it can be the correct thing to do.

This is where it can take a lot of time to build the case, and it will often be an evidential and circumstantial case. The directors will get a right of reply. It’s common for such cases to take 2-3 years to reach fruition.

3. Fraudulent Trading

This is much more serious and is the big daddy of the IA 86. Unlike Wrongful Trading, Fraudulent Trading is a criminal act. Therefore, it’s much more serious. The big difference between Wrongful and Fraudulent trading is intent. Fraudulent Trading is when a company carries on business operations with the intent of purposefully deceiving and defrauding its creditors.

The punishments are much more severe:

  • Directors are potentially liable for the Company’s debts (in a greater proportion than under Wrongful Trading)
  • Longer disqualification
  • Fines
  • Prison

Being a crime, it must be proven to beyond a reasonable doubt (near certainty). Therefore a director must both have known and intended to be deceitful.

Proving intent is, therefore, the challenge. You’ve got to prove the directors were actively deceitful. To do so, forensic accountants will trawl emails and accounts to find evidence where the directors took actions to gain at the expense of creditors.

As with disqualification, and Wrongful Trading, it is the OR’s duty to investigate and then bring the matter before the Court. As this is a criminal offence, the SFO, Police and CPS may work with the OR to build the criminal case in the hopes of bringing a criminal trial against the directors.

4. Fraud

The OR may find that the directors did not do any acts the contributed to the insolvency but nevertheless, they may have committed fraudulent acts. Where fraud is suspected, the OR will share information with the SFO, Police and DPP. In these cases, the law shifts to the parallel fraud under the Fraud Act 06. There are three types:

  1. Fraud by false representation
  2. Fraud by failure to disclose information
  3. Fraud by abuse of position.

Each has different circumstances and evidential requirements.

For fraud to have occurred the person must have acted dishonestly and with the intent of making a gain to themselves or others or inflicting a loss on others.

This is a criminal act and the burden of proof is beyond a reasonable doubt. It also runs alongside other potential offences such under the Proceeds of Crime Act or under the Financial Services and Markets Act.

For serious offences, the perpetrator can be sentenced to up to 10 years in prison.

Proving fraud is tough because you have to prove to near certainty the person did something that they knew might be untrue, that they did so to make a gain or inflict a loss and that was their intention.

In practice

Contrary to what you might read, there is a whole pyramid of accountants in any company. For Carillion it’d look something like this (from top to bottom):

  • Chief Financial Officer (CFO)
  • Segment Financial Directors (FD)
  • Regional / Product Line Financial Directors
  • Site Accountants
  • Project Accountants

With potentially some more sub-steps in between these.

So for a hospital building, the chain might look like this:

  • Project accountant responsible for accounting for their sub-part of the building
  • Site accountant responsible for the overall accounting of the whole hospital
  • Product line accountant responsible for all the hospital constructions of the company (or PPP work in say NE England)
  • Segment FD responsible for accounting for all construction projects
  • CFO responsible for all accounts

It’s important to note that responsibility never flows down. It always stays at the top. Bad managers forget that.

The glue that holds this all together are the systems and processes. These are designed to prevent mistakes and ensure the accounts are done properly.

Every single transaction is entered into a General Ledger. It used to be a physical book, as the name implies (and thus where ‘bookkeeping’ also comes from). Nowadays it’s a massive database. For example, paying the salary of a carpenter who worked on Hospital X will be entered like this: -£x cash; £x salary cost. Each transaction will be coded down to minute detail, something like this:

  • Segment code: 123
  • Sub-segment code: 45
  • Site: 67
  • Project: 89

There are billions of transactions and these are compiled together to create the accounts.

Discretion and valour

This is where judgement kicks in. For example, not all transactions are cash (very few are). Let’s look at our carpenter again. They may have worked on several projects during the month, so the accountant will need to allocate their salary cost across those projects. That could be on the basis of the work performed, the time spent, or on contractual terms. Thankfully, there are systems and process in place to make this all run smoothly, down to the timesheets we have all had to fill in at some point.

Each transaction should ideally be reviewed by more than one person, to stop one individual from doing whatever they want (like Barings Bank).

When it goes wrong

The formula for when it goes wrong is almost always the same:

  • Senior management gets external pressure (recession, grumpy investors, cash/financing problems)
  • They push on segment heads to ‘find’ as much money as they can
  • Segment head pushes site managers: are you sure we are that far behind? can’t we find some ‘easy wins’?
  • Project accountant is told by the site manager to find any areas where they can scrape money together.

Multiply this on an industrial scale and you have a recipe for disaster. It sounds silly, but it’s what happened at Enron (Jeffrey Skilling). It’s what happened at RBS (Fred “the shred” Goodwin). Dictatorial management scares the daylights out of staff who desperately scramble to keep their jobs and the lights on.

Proving a fraud

This is why it’s very difficult to prove fraud. Management might reasonably say: “I didn’t know there was wrongdoing. I didn’t tell anyone to cook the books.” “I was only pushing my team hard because the company was on the verge of going bust. I didn’t want people to lose their jobs.”

It comes down to intent, did management intend for their subordinates to make collective decisions that ultimately resulted in misstated accounts?

It is incredibly rare for management to write an email to the hospital site manager saying: “I know the hospital is behind schedule but please book an extra £5m in revenue because otherwise, we are going bust.”

In fact, from my experience, it’s rare to see management send any emails. I once had a case of a CEO of a multi-billion dollar financial services company who sent about a dozen emails over 10 years and signed only half a dozen letters. Apparently, everything was word of mouth or (believe it or not) by sticky notes. It’s hard to prove intent if the person barely exists…

Carillion

So with Carillion, we have lots of the key elements for potential financial crime:

  • A company that was severely struggling
  • Significant grey areas of accounting judgement
  • From insider reports, aggressive and dictatorial management

Right now, the forensic accountants will be sifting through the emails, correspondence and accounting records looking for evidence of wrongdoing. It takes a long time, we are talking years. That CEO I mentioned earlier, they are still investigating them 10 years later.

The OR will be investigating, and ultimately producing his report. Given Carillion went bust earlier this year, I’d expect at the earlier a report late 2018, probably well into 2019. The SFO and Police will also be investigating alongside, sharing information with the OR and vice versa. For a complex fraud, you will be talking about a minimum of 2 years of investigation work, that’s before any trial.

Having been there, nobody wants for the investigation to go wrong or peter out. They’ll be working very hard, trying their best to unravel an unimaginable mess. It requires high levels of patience and attention to detail. Following transactions as they explode through the accounts. This is why I get very frustrated with comments like: “nothing is being done”. It takes time. Rush it, mess it up and your shot at nailing the bad dudes is gone.

But!

You might argue, so few people actually get done for fraud. I agree. There are a few reasons for this:

  • The law itself is very strict, even compared to other countries. We try not to send people to jail unless we are absolutely sure they’ve done the crime. I think that’s a good thing.
  • We don’t give enough time, money and resources to our investigators. The CPS, SFO, IS and the Police are underfunded. They try their best, but massive cuts to their funding mean they are doing the best they can with not enough. I’m sure there are inefficiencies in each of the services, like all organisations. But they don’t have the money and the talent (driven away with pay freezes or redundancies) to work these long, expensive cases.
  • Politically, there’s a focus on ‘quick wins’. We like to nail our bad guys immediately, often before the facts are there. As we live in the UK and not some lawless country, we can’t send people to jail without evidence (even if some politicians wouldn’t mind that…) I think a lot of this is driven by the media and the “Something Must be Done Act“. Is it not rather odd that our parliament creates mountains of new crimes every year but is incredibly reluctant to even discuss the idea of new laws around directors’ criminal wrongdoing?

An ending comment

I’ll end with this, the final paragraph of the select committee report on Carillion:

Carillion was the most spectacular corporate collapse for some time. The price will be high, in jobs, businesses, trust and reputation. Most companies are not run with Carillion’s reckless short-termism, and most company directors are far more concerned by the wider consequences of their actions than the Carillion board. But that should not obscure the fact that Carillion became a giant and unsustainable corporate time bomb in a regulatory and legal environment still in existence today. The individuals who failed in their responsibilities, in running Carillion and in challenging, advising or regulating it, were often acting entirely in line with their personal incentives. Carillion could happen again, and soon. Rather than a source of despair, that can be an opportunity. The Government can grasp the initiative with an ambitious and wide-ranging set of reforms that reset our systems of corporate accountability in the long-term public interest. It would have our support in doing so.

All the best,

Young FI Guy

[p.s. now I really promise to get back to writing about financial independence again…]

Was Carillion like a ponzi scheme? (Part 2)

I’ve decided to create a 3-part series on Carillion and the hidden goings-on in the accounting world. This is part 2, where I look at some of the questionable accounting. You can read Part 1, on the insolvency process here. You can read Part 3, on the ongoing investigations and aftermath here.

I loathe hyperbole. As I explained in the first part of this series on insolvency, a lot of the time that hyperbole is nonsense. So when I started hearing people describe Carillion as like a Ponzi scheme, I was thinking: “here we go again“.

A big difference this time is that one of those saying it is former Auditor General Sir John Bourn. That made me stop and think. When somebody of that calibre says it, you should probably take it seriously.

Having reflected on those comments for a week or so, I think they are right. Carillion had many characteristics of a Ponzi scheme.

What is a Ponzi scheme?

Ponzi schemes are named after Charles Ponzi, who used the technique in the 1920s. A Ponzi scheme is a fraud where a business seeks funds from new investors and pays those funds as profits to earlier investors. The fraudster tricks the old investors into believing that the profits are from sales or trading returns, not disclosing their true origin. Investors are misled as to the true nature of the alleged ‘profits’.

Ponzi schemes can keep running as long as: investors do not demand repayment of their funds, continue to believe that their non-existent assets will continue to generate ‘profits’ and there are new investors willing to contribute new funds.

Revenue accounting

Carillion was primarily a construction and services contractor. As a forensic accountant, a big red flashing light appears. This is because the most notorious financial frauds and scandals are perpetrated by recognising non-existent revenues. Construction and services contracts are the most tricky when it comes to determining when and how to recognise revenue. (So much so, the international accounting standards body is once again updating the standards on revenue recognition).

Profiling

The big problem is this: the contractor pays lots of cash out upfront and gets most of the cash backloaded. It’s easiest to see this graphically:

When the orange line is above the blue line, the contract is making a cash loss. You can see that for most of the project, it is making a cash loss. It’s only at the end that a cash profit is made. This is quite common, where the contractor is paid in increments when it reaches a milestone. [update: for those after a bit more detail have a look at the end of the post]

Recognising revenue

The accounting standard relating to construction contracts is IAS 11 (for general revenues it is IAS 18). Both will be replaced by a new standard, IFRS 15 this year. Basically, it says, if the outcome of the contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion.

If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs should be expensed as incurred.

However, the stage of completion of a contract can be determined in a variety of ways. Such as, including the proportion by costs incurred compared to estimated total contract costs or completion of a physical proportion of the contract work.

Importantly, an expected loss on a construction contract should be recognised as an expense as soon as such loss is probable.

As you can see from the standard, quite a bit of judgement is involved. In the judgement lies the grey areas. In the grey areas lies dodgy accounting.

Carillion’s story

Carillion was a relatively young company. It started in 1999, a spin-off of the old Tarmac Group. From the outset, Carillion’s approach was to take on debt and buy up competitors. Over time, it made increasingly big bets buying out a number of competitors including Mowlem, McAlpine, part of John Liang and even tried and failed to merge with Balfour Beatty.

Despite the rapid acquisitions, following the financial crisis the company struggled to grow profits. Struggling to grow revenues from acquisitions alone, it resorted to taking on more projects to grow profits.

But as we saw above, those projects start off with cash outflows. Generally speaking, the bigger the project (think the big PPP stuff with the government) the bigger the outflow. So Carillion turned it’s hand to getting short projects in to get the cash to fund the big projects. The trouble was, those short projects had wafer-thin margins – making very little profit. So Carillion needed more and more of them.

In other words, Carillion was bringing in projects so it could service the old ones. It became a cycle and somewhat reminiscent of a Ponzi scheme.

How things turned bad

These projects are complicated and often go wrong. Especially when you have little profit margin to play with. So many firms have big cash-buffers to help if this happens. They also retain deep pools of knowledge and expertise that it can use to ride out rough patches and know when to cut their losses.

Unfortunately for Carillion, it had huge debts from its acquisition spree. More concerning, Carillion just wasn’t very good at building things.

At this point, with very little cash in the bank and projects going wrong, a company should cut its losses to stop the bleeding before its too late. Carillion, however, doubled down.

The “Early Repayment Facility”

Its first step was to find cash in more creative ways. Despite being a signatory to the Prompt Payment Code, it used ethically questionable practices to delay payment to suppliers (querying invoices, delaying issuing purchase orders or just flat out not paying for supplies).

It went one further and arguably abused a government scheme called the Supply Chain Finance Scheme.

The scheme, created in 2012, was designed to help SMEs that got burnt during the financial crisis by banks refusing to offer credit. SMEs could use their invoices to get the money from their bank rather than wait for the company to pay them. In turn, the bank would collect the money from the company when it was eventually paid.

Carillion flipped this on its head. It said to its suppliers, if you want your money early then you can use the scheme. They renamed it the “Early Payment Facility”.

However, a few months later it cynically pushed out its credit terms (sometimes up to 120 days). In other words, it wasn’t an early repayment at all. Worse still, many suppliers would have to pay a fee to access that early payment, leaving them with a difficult choice of losing money but getting cash or waiting for longer and longer to get hands on the money it was due.

In effect, Carillion was borrowing from its suppliers to plug its cash and funding gap. Carillion was quite open about this, boasting that the scheme: “Gives Carillion greater flexibility in terms of managing its own working capital.” But in the accounts, there was no mention of the Early Repayment Facility.

A gap in the accounting standards

That’s because, in my opinion, it falls in between a gap in the accounting standards.

Carillion was in effect borrowing cash from its banks secured on supplier invoices. This is, by most people’s reckoning, a debt. But the accounting standards are vague on these transactions (sometimes called Reverse-Factoring). It essentially boils down to a judgement call about whether the link to the original payable has been broken. If it has, it’s a debt liability. If not, then it stays as a payable. It’s a judgement call that depends on the exact wording of the legal agreements.

This is important because if you keep it as a payable your debt levels look much lower. Carillion decided the link to the payables was still there – this wasn’t a debt. This should have been a high-risk area for the auditors because of the large amount of subjectivity.

One of my major projects was where there were bad debts on a factoring facility and the argument was that the accounting by the company was wrong. The answer was, according to the accounting standards: “it depends on the legal documents”.

As far as I can tell from the accounts, KPMG (the auditors) didn’t consider this a high-risk despite the very large sums of money at play (roughly £500m). If Carillion had recognised these amounts as debts, then it may have broken it’s borrowing covenants and the banks could have recalled their loans putting Carillion out of business.

Aggressive Accounting

But the major problem was that Carillion resorted to aggressively recognising revenue on contracts.

If you recall from above, you could either recognise revenue on a percentage basis (only if you could reliably estimate it) or you couldn’t recognise any profit, only the recoverable costs.

As I mentioned before, Carillion was doing a poor job at delivering projects, usually over budget and behind schedule. Where there is doubt that you can deliver the project to contract, you should stop booking profit and only book the money you’ve actually brought in. If it’s probable you might incur some losses, those should be recognised immediately as well.

But Carillion continued to book revenue as if everything was fine and dandy. Trouble is, once you go down this route there is no going back. It’s like Cortez scuttling his ships. The more you book aggressive revenues the bigger the gap becomes between your actual revenue and the forecasts. This is exactly what happened at Carillion when a new finance director came in and said: “hold on this isn’t right!”. In 2017, Carillion wrote off around £800m of revenue (the difference between the stage of completion accounting and the actual money it could bring in).

Insolvency

From my review of the 2015 and 2016 accounts, I would consider that Carillion was potentially insolvent in 2016 (and possibly 2015 as well). This view is shared by, among others, Frances Coppola, a finance and economics journalist. During 2015 and 2016, hedge fund managers smelt something was up and it became the most shorted stock on the London Stock Exchange.

This is because Carillion had a wafer-thin amount of cash, had mountains of debt (excluding even, the payables possibly that were mis-classified), and because its net assets were almost entirely propped up by Goodwill (an intangible asset that is not immediately realisable, unlike cash or hard assets like property, though usually at a discount).

Goodwill hunting

Goodwill is the extra money paid by the acquirer above the asset value of the company being taken over. It can be thought of as representing things such as brands, patents and reputation. In Carillion’s case, it represented the forecast profits from its the subsidiaries, joint ventures and “special purpose companies” that it used to run projects. As those profits evaporated so should have the goodwill.

Put bluntly, the goodwill accounting in Carillion’s accounts made no sense. Carillion was due to pay ‘contingent consideration’, extra money, to the sellers of some of the businesses it acquired. However, because they were missing profit targets it was slashing these amounts. At the same time, it was saying that goodwill would only reduce in value if the discount rate (the time value of money) went up to 20% – i.e. money in 5 years time is worth only 40% of money today. But this would mean almost all of the extra profits from the acquisition had to come within 5 years. This was a big sign that these profits (like Carillion’s own) were overestimated.

Write-offs

In 2017, Carillion tried to undo the damage with enormous write-offs. Including nearly £800m in overstated revenues. But it was too late, the company was already short on cash and had nothing left in the bank. Likewise, because almost all its assets were goodwill, it had nothing to sell either. Carillion quickly went from people thinking it was insolvent to being insolvent (more on that in part 3).

A lesson for all businesses

There is a lesson here for all businesses. It was one of the first I was ever taught as an accountant:

Most businesses go bust, not because they fail, but because they do too much business.

It’s called overtrading (that link made me laugh, Carillion followed the bullet points in that link point-by-point). What happens is that you sell too much stuff, and you run out of cash to complete those sales.

Carillion was the quintessential overtrader following bad projects with more bad projects. Rather than stopping before the damage was permanent, it followed a Ponzi-like business practice that made salvage impossible.

It’s quite inexplicable that experienced directors could act with such incompetence. However, there are questions about whether there was something more insidious going on. I’ll be looking into that in the next and final part.

 

All the best,

Young FI Guy

(p.s. a personal thank you to Frances Coppola, who was an inspiration for me writing this post).

 

This is part 2 of a Carillion three-parter. You can read Part 1, on the insolvency process here.  You can read Part 3, on the ongoing investigations and aftermath here.

[update: some industry bods kindly shared this post on twitter and there were some interesting comments.

This post was designed to be accessible to those with no knowledge of accounting or contracting. So I’ve kept it as simple as possible. That said, for those after a little more detail it’s worth talking a bit more about the contracting subcontracting relationship (something helpfully mentioned by commenters on twitter). Here it goes.

Generally speaking the contracting industry can be broken down into a hierarchy of three (or more) ‘Tiers’. At the top is Tier 1, the contractor engaged by the ultimate customer. For major projects, this will be a national contracting firm like Carillion. Tier 2 is a subcontractor engaged by the contractor to deliver major parts of the work. These are often local contracting firms, specialists and consultants. Tier 3 are the subcontractors engaged by Tier 2 subbys. These will do specific jobs or services in the project ranging from electrical installations through to cleaning toilets.

Even though each tier will have contracts with one another, a lot of the industry still works on trust. That said, there are also specialist ‘supply chain management’ firms that can also act as the ‘grease between the wheels’.

Generally speaking, as you flow down the chain, the subcontractor will rely more on cash to fund works. The Tier 3 contractors will pay for material and labour in cash or short (monthly) credit terms. In turn, the Tier 2 contractors will pay Tier 3 contractors on longer credit terms. And so on, up the chain.

In effect, this means that subcontractors are net lenders of finance to build projects and contractors net borrowers. The contractors ‘borrow’ by having services rendered for them before getting paid, only paying out when work reaches the relevant milestone. In other words, they borrow from their suppliers.

So what happened with Carillion? Well as I noted in the main piece, Carillion aggressively tendered for projects. Taking on projects with very late payment or thin margins. Unfortunately, some major projects became severely delayed or not built up to standard.

You might think that’s the subcontractors’ fault. After all, they are the ones doing the job, right? To some extent, there are bad subbys out there. But it’s important to understand that it’s not just about doing the right job. You have to do the right job at the right time. It is the responsibility of the contractor, like Carillion, to ensure everything is working in order.

As we saw in the main piece, as things started to go pair-shaped, and the cash stopped flowing in, Carillion would delay and delay paying subcontractors. In effect, they had to borrow more and more from suppliers to keep the lights on.

There’s only so far you can push things though. From speaking to people and reading around, Carillion became notorious in the industry (though by no means the only one) for sharp business practices. Over time, a great deal of goodwill was lost between Carillion and its subcontractors.

Eventually, Carillion has tapped out their suppliers as far as they could and only cold hard cash could keep the business afloat. As we saw in the main article, that’s when the business came crashing down.

 

 

 

 

Interesting links:

Frances Coppola on the Early Repayment Facility: https://www.forbes.com/sites/francescoppola/2018/01/30/how-carillion-used-a-u-k-government-scheme-to-rip-off-its-suppliers/#7ab7a7c252dc

FRC letter to the Work and Pensions committee on Reverse Factoring: https://www.parliament.uk/documents/commons-committees/work-and-pensions/Carillion%20report/Letter-from-FRC-to-Chairs-21-March-2018.pdf

Carillion 2016 Accounts: http://www.annualreports.co.uk/Click/12208

  • The references relating to my point on Goodwill are Note 11 (Intangible Assets), p110 and Note 29 (Acquisitions and disposals), p129.

Insolvency and Carillion (Part 1)

I’ve decided to create a 3-part series on Carillion and the hidden goings-on in the accounting world. This is part 1, where I look at the insolvency process. You can read Part 2, on Carillion’s accounting here. You can read Part 3, on the ongoing investigations and aftermath here.

Sex sells. And at the moment, so does laying into accountants. I can’t open the FT or The Times without seeing an article criticising the accountancy profession. Just like banker bashing around 10 years ago, it’s the ‘in’ thing. It’s what the cool kids are doing.

There’s a lot of truth in what’s written. There’s also a lot of hyperbole. There’s also a lot of stuff that is downright wrong.

In particular about insolvency.

In the aftermath of Carillion, I’ve seen people claim there is no insolvency regulation – not true. That secured creditors get paid before the costs of winding up – wrong. Imagined conflicts of interest. And most bizarrely of all, complete ignorance of the involvement of the High Court in insolvency proceedings.

There are problems with insolvency, but these are lost among some of the ‘fake news’ put out there.

How do I know this?

I’m a Chartered Accountant. Not one of those ‘useless’ auditors or ‘thieving’ insolvency practitioners (who don’t have to be accountants by the way). I’m a forensic accountant, the guy you call when the shit has really hit the fan.

I’ve no love for auditors. My heart would sink when my colleague would say: “the X plc audit team needs a hand”. Likewise, when a restructuring came up I’d try to hide lest I get dropped in an alphabet spaghetti of accountancy chaos.

That’s why I’m writing this post. Because I’ve seen first hand what happens in insolvency, and it isn’t like what’s reported in the MSM.

Insolvency and Carillion

Over the past few weeks, I’ve been particularly irked by some of the stuff written on the Carillion insolvency. Whilst lots of writing lays into Insolvency Practitioners, the true ‘bad dudes’, Carillion’s management slide away into obscurity.

So I’m going to run through the Carillion insolvency process.

First off, this is a liquidation (wind-up by the Court). There are four types of insolvency process: CVA, administration, liquidation and receivership. Each is different, each has several different sub-types. But I’m not going to talk about them (at least not today).

What is happening with Carillion

Carillion went bust. It couldn’t pay its debts. At that point, it stopped trading and went to the High Court asking to be liquidated. The High Court heard the petition and said, yes, you should be wound up.

The Court then went off to the Government’s Insolvency Service (IS), asking them to nominate someone to take charge of the liquidation. That person is the Official Receiver (OR). They are a civil servant, salaried by the Government.

The Official Receiver

The OR asks the Court if they are fine with them being in charge. Hopefully, they say yes.

The ORs job is to oversee the liquidation process. They are ultimately responsible. They must ensure an orderly wind up, try to get as much money for the creditors as possible and investigate what went wrong.

The ORs first job is to work out if they need help. That is, whether they need to get an Insolvency Practitioner(s) (IP) to aid them with the liquidation.

The Special Manager

In the case of Carillion, the largest ever UK liquidation, the OR clearly needed a lot of help. So he opened a process to find and select a suitable helper called a ‘Special Manager’ (SM). There are rules about when the OR can do this and he had to ask the Secretary of State for approval.

The OR negotiates with the possible IPs to find the best one for the job. With Carillion, the OR selected PWC (a firm with a very good restructuring team and having managed on the previous largest-ever insolvency). [p.s. I worked for two of PWC’s competitors so I’m by no means a fan.]

Together, the OR and PWC would have sat down to agree to fees and a plan. They would have gone through this plan with the largest creditors, the Pension Protection Fund (PPF) and the Government. When everyone was happy, the OR then asked the Court to approve the appointment of PWC (including their fees and the general action plan).

Work begins

Now the real work begins. PWC’s principal role in the first week is to stabilise the company. Carillion would have been in carnage. They would have taken over operations with three major aims: protect the companies’ assets, save people’s jobs and get the company working again.

Once things have stabilised the OR and PWC will start working through their plan. Generally, this is:

  • Work out what assets can be sold and for how much;
  • Work out what onerous contracts can be escaped from; and
  • Gather evidence to investigate any wrongdoing.

Let’s look at each of these for Carillion.

Assets

PWC will find Carillion’s most valuable assets and try to realise them. It’s a tricky process where good IPs come into their own. On the one hand, the liquidator wants to get as much money as possible. On the other, every day that passes means the costs rack up. It’s about finding the right balance, some of the top IPs are the quintessential wheeler dealers – making money that nobody thought was there.

To make sure the creditors aren’t being screwed, Real Estate experts, asset valuers and business valuers (like me) carry out independent valuations of major assets. The OR will oversee this and check they are happy with what the IP is doing.

Onerous contracts

Carillion was losing money for a reason. It had entered bad deals. PWC and the OR will be looking to get out of the very worst ones. They will negotiate fee reductions, scope reductions or simply get out (sometimes through litigation). In many cases, Carillion worked in partnerships. PWC would look for the partners to take on work as quickly as possible to save costs.

Investigation

The OR will be looking for wrongdoing at Carillion including Fraud, Fraudulent Trading and Wrongful Trading. If they find evidence, they will ask the Insolvency Service to bring action. This is the most difficult part of the job and requires lots of specialist skills (I’m biased as a forensic accountant, little-known fact: forensic accountants are the smartest and best-looking accountants).

The OR will ask forensic accountants to pore over Carillion’s books and IT systems to see if bad things were going on.

Unfortunately, this is a bit like finding a needle in a haystack. There will be trillions of bytes of data. Billions of accounting transactions. You’ll find something that looks odd, start tracing, only to find it was innocuous or a simple error later corrected.

Proving fraud is incredibly difficult. The bar on proof is very high for criminal convictions – mainly because we don’t want to send innocent people to jail. The reality is, most of the time there isn’t enough evidence. That said, the Insolvency Service strikes-off 1,000s of directors each year.

The work

The work is front-loaded, the most costs are borne in the first few months. This was the case with Carillion. PWC and the OR expected most work to be complete after 4 or so months. Most liquidations last around 6 to 12 months. The final months dominated by wrapping up the investigation and tying up loose ends.

The SMs are required by industry standards to update the OR of work progress at least monthly. Most of the time, updates are far more frequent. Given the complexity and size of Carillion, these updates were on a daily basis.

In these appraisals, the OR will be reviewing and agreeing to PWCs work. He’ll be saying if it’s good enough or not. He’ll monitor the direction of work and decide if there are particular areas he wants PWC to focus on. If he ain’t happy he’ll tell PWC. Remember it’s the ORs neck on the line.

If necessary, the OR will petition the Court. Seeking permission to change the process, increase or vary fees or update the plan. If the Court isn’t happy, is says no.

The OR also must produce a report for the creditors. Often, the OR and liquidators will keep creditors up to date on a more regular basis (unless the creditor opts out of such communication).

Denouement

As Carillion is wound down, the OR will get a better idea of the assets left for creditors.

Assets are paid out in a specific order BY LAW:

  1. Expenses of winding up: Liquidator fees and expenses are paid first
  2. Secured creditors with a fixed charge.
  3. Preferential creditors and ‘prescribed part creditors’.
  4. Secured creditors with a floating charge.
  5. Unsecured creditors.
  6. Interest on debts.
  7. Shareholders.

To reiterate it’s by law. You might not like it, I might not like it. Tough.

Order of fees

The OR is paid first. Their fees are paid to the Insolvency Service and are set by law: 11,000 per liquidated company plus 15% of recovered assets. As at the end of March 2018, the OR’s Carillion fees were £297k (£11k x 27 liquidations).

Next in line are the costs of the wind-up. The IP and SM’s fees, the running costs of the company during wind up.

This order is for a specific reason: if you aren’t gonna get paid you won’t do the work. This applies from accountants, to the building staff to the cleaners. If these people aren’t paid, they won’t work. If we didn’t have liquidators and staff doing work the wind up would be disorderly, more jobs are loss and less money recovered.

Next up are secured creditors (aka banks). They lend money but in return get collateral. Just like your mortgage. The deal is, you get a lower interest rate, in return, we get your house. That’s one of the reasons why loan interest rates are higher than mortgage interest rates.

Unfortunately, there’s rarely any money left after paying the secured creditors. That’s not because they gorge themselves on money, it’s because companies go bust because they were rubbish at business (or due to fraud).

Sadly in the case of Carillion, there isn’t even enough money to pay the expenses of wind up. Instead, the Insolvency Service will be picking up the tab. And therefore, ultimately, the taxpayer.

Petitioning the Court

The OR will set out the assets recovered and ask the Court for permission to distribute the money.

If the Court doesn’t like it, they tell the OR to go back to the drawing board. This sometimes happens, especially in administrations if the Court thinks the deal is a ‘bit dodge’ (very technical term there).

Once approved, the OR consults the lists of creditors drawn up during the liquidation process. This is generated as information is found and from creditors petitioning the OR.

In the case of Carillion, the list looks like this:

  • Insolvency Service
  • Nobody else

The report

As mentioned above, the OR has to investigate what went wrong. They will produce a report for the Insolvency Service explaining this and recommending actions against the directors of the company if necessary.

Most of the time, this will be a recommendation to strike off the directors. Where fraud is thought to have occurred the Secretary of State will consider whether to bring any civil action. In the most egregious of cases, the file is passed to the Crown Prosecution Service to consider criminal fraud charges.

A quick work on this. Criminal fraud is very very hard to prove. We only send people to jail if we are sure they committed a crime (beyond reasonable doubt). Unfortunately, proving fraud to certainty is hard. It means very few ‘bad dudes’ get nailed for fraud. I could write mountains on this. If there’s interest I can write a piece on that (this one is long enough already).

An unhappy story

Companies going bust sucks. It is terrible. People lose jobs, businesses go under. Nobody can turn back time to stop it from happening. All we can do is to put a system in place to make the best of it.

I share huge sympathy for the victims of Carillion. It’s upsetting what happened. I can’t bring their money or companies’ back. But I can try to shed some light on what’s going on. That’s why I wanted to write this piece. Free of the bullshit, to explain exactly how the process works.

So let’s turn to our final question.

Is the process up to scratch?

In many respects, yes. In some important respects, no. The process above sounds great, and it works well. But there are some problems.

A long-winded process

Firstly, as you’ve probably realised the process is quite long-winded with lots of back and forth. The idea is to prevent mistakes from happening, but often the process takes too long. A litigation culture has emerged making IPs very reluctant to speed through the process. This means extra costs and a longer wait for money. I don’t have an easy solution for this. But many much smarter people than me have repeatedly asked the government to look into it.

Austerity has hurt services

Secondly, the Insolvency Service and Courts have been savaged by cuts. Things aren’t as dire as in other areas, but they are expected to do more with less. Talent has ebbed away into the private sector and there is a lack of resources available. They are doing the best they can and put on a brave face, but it’s hard. I wasn’t around in the ‘good old days’ when the Insolvency Service was a Goliath, but today only the simplest cases can be managed by the OR alone. That’s all a political choice. I don’t think we should be outsourcing justice and the law to the private sector, but successive governments don’t agree.

Small Creditors aren’t engaged with

Recovery rates and efficiency in the UK is relatively high compared to other countries, but with a concerning downward trend recently. But this hides an uncomfortable truth. Insolvency is dominated by big creditors – typically banks. Engagement with, and by, small creditors is very low. That’s understandable due to basic economics, but we can do better. Other countries have created professionals that represent the collective interests of small creditors in insolvency. I’d like the same here, with an automatically appointed professional to represent SMEs alongside the OR. The job might be like herding cats, but it’s better than nothing.

Lots of regulation doesn’t mean good regulation

Next up is regulation. Insolvency is probably the most highly regulated industry in the UK. The Insolvency Act 86, Insolvency Rules 2016, Insolvency Amendment 2017 are (erm…) ‘comprehensive’. IPs answer to the Insolvency Service, the Courts, the law and their professional bodies (accounting and law bodies).

Trouble is, nobody knows who should be policing what. The Court steps in if things go badly wrong, but most of the time it falls to the professional bodies. They treat discipline seriously (or at least my body, the ICAEW does). But whenever they ask for more powers they get rebuffed. This has been going on for years. I’ve found articles where the accounting bodies asked for more powers a decade ago. If I had to guess why, it’s because the government wants to keep power for themselves. Politicians want it under their control. Unfortunately, they just mainly grandstand rather than actually doing anything. In my opinion, it would be better to have a single regulator given stronger powers to ensure higher standards. [edit: just read now that ministers are considering giving the Insolvency Service some tougher powers! Good news if true.]

Fees are misunderstood

Fees are another issue. Recent changes mean that fee estimates have are published upfront. Trouble is, it’s impossible to accurately gauge fees. Sometimes the liquidation is straight forward, sometimes there’s been wholesale fraud. As such, for fear of not recovering costs, IPs quote the top end of fees, lest they have to go begging to the Court. Likewise, they publish the highest fee rates, just incase they have to seek the specialist expertise of the only world expert on Mongolian Salt mines. These get quoted in the press, everyone gets upset. But the fee rates I’ve seen are the standard City rates for professional services firms. They are dictated by the market. Being upfront with fees has increased transparency but caused confusion and disquiet. The Insolvency Service needs to improve the way it communicates the insolvency process to the public.

Too much in one go?

Finally, there is the investigations. This is an increasingly complex part of the process. Public expectations are for no stone left unturned. Unfortunately, this distracts from recovering assets. It would be much quicker to get the asset recovery done first and get people paid as quickly as possible and leave the bulk of the investigation work for later when it can be given more time and done properly.

To some extent, this is already the case. But the public demands (unrealistically) to know what went wrong almost immediately. It takes time to do a thorough investigation and I really urge more patience. I think its imperative of forensic accountants, like myself, to communicate better what work is required to properly perform the investigations.

TL:DR

With Carillion:

  • The Official Receiver, a civil servant, was appointed by the Court
  • He answers to the Court
  • He chose PWC to help him
  • They set out their fees and liquidation plan at outset and got court approval
  • Carillion is such a mess that the Official Receiver won’t get full fees, the taxpayer will have to foot some of the bill.

Specific problems with UK liquidation process:

  • The process is long-winded.
  • Cuts in services means Court and Insolvency Service deprived of money and resources needed to provide good service.
  • Low engagement with SMEs, we need professional appointed by Court to represent SMEs.
  • Consolidate regulations and bodies that regulate Insolvency Practitioners. Grant them stronger powers to punish bad Insolvency Practitioners.
  • Publishing fees has brought transparency but also confusion. More education required.
  • Splitting asset and recovery will speed up the return of money and improve investigations.

You can find out more about insolvency from the .gov website:

https://www.gov.uk/government/publications/options-when-a-company-is-insolvent/options-when-a-company-is-insolvent

https://www.gov.uk/government/publications/claim-money-back-from-a-bankrupt-person-or-company-in-compulsory-liquidation-guidance-for-creditors/claim-money-back-from-a-bankrupt-person-or-company-in-compulsory-liquidation-guidance-for-creditors

This is Part 1 of a 3-part series on Carillion and the hidden goings-on in the accounting world. You can read Part 2, on Carillion’s accounting here. You can read Part 3, on the ongoing investigations and aftermath here.

All the best,

Young FI Guy

P.S. Don’t worry, I’ll be back to ‘regular programming’ soon, I just had to vent.

P. P. S. As always, I moderate comments. If you post abusive comments like ‘accountants are scum’ I won’t approve them. Constructive comments are always welcome. I’ve tried to get all my facts right, I’m sorry if I got anything wrong. Be nice!

Deciding between drawdown and annuities – 23 years before retirement…

I had planned a completely different post today. But, like a moth to a naked flame, I’m drawn to another post on pensions. This time, on deciding between drawdown and annuities. The catch is, you’ve still got 23 years till retirement.

The question posed comes from a This Is Money post:

I’m only 34 but my pension firm wants me to decide NOW between drawdown and an annuity – can it do this?

http://www.thisismoney.co.uk/money/pensions/article-6023907/How-choose-pension-drawdown-annuity.html

The post is a regular series where readers can send in questions to former Pensions Minister Sir Steve Webb. I found this one particularly interesting because it’s a question I’ve had to answer, and I suspect a large proportion of readers have also had to answer (perhaps without their knowledge!) On the face of it, it seems absurd that a 34-year-old should have to ‘choose’ between drawdown and annuities. Let’s have a little dig in.

The question

I’m 34, make regular contributions into a defined contribution company pension, and until recently have pretty much ignored it.

I logged on to have a look at the provider’s new portal and noticed I had a new range of options which boil down to me choosing now if I think I’ll be wanting to take an annuity or a drawdown pension.

What it doesn’t tell me is how this choice affects what I might get when I hit the magic age. Which is the least ‘risky’? If I say drawdown, but later decide annuity, does that put me in a worse position than if I flipped it around?

Should I be trying to split the pots – I’ve got a couple transferred in from other places? What if drawdown doesn’t exist in the future? What if some magical new pension option appears?!

I’m not looking for the differences between the options at retirement, more about the investments which will be made now. Help?

What brought about this madness?

Steve’s response is, of course, bang on the money – I’ll do my best to paraphrase. This mad situation comes about for two reasons.

First, the ‘choice’ arises because of pension freedoms. Before 2015, almost everyone would have to use their pension pot to buy an annuity. Since the freedoms, savers can opt instead for drawdown.

Second, when you contribute to a pension and haven’t explicitly chosen an investment for it to go into, it will go into a default fund. When everyone had to buy an annuity the fund would use something called lifestyling (or glide pathing). This is where, in the years before retirement, the fund moves out of equities and into bonds. This is to cut the volatility of your pension pot in the run-up to taking an annuity.

Here’s an example from one of my pension schemes:

This is for an ‘annuity’ type retirement:

Lifestyling

This is all very sensible, lifestyling before an annuity is one of the few things most pension experts seem to agree on. But given that you no longer need to buy an annuity, and can opt for drawdown instead, the game changes.

If you’re opting for drawdown, there is strong evidence that you don’t really want lifestyling (or at least, not as much of it). That’s because you will continue to keep investing your pot after retirement, and will want to keep benefiting from growth in your investments.

What happened

Companies will make a decision for all pension scheme members. This is reflected in their choice of default fund.

Most companies now assume that savers will take drawdown. So they changed their default fund from one that used lifestyling into one that did not. Not all companies did this, and the default fund may continue to use lifestyling.

What you do about it

You have the choice as to whether you intend to buy an annuity or opt for drawdown. If you select to go into drawdown, your investments will likely not be lifestyled. You can change this ‘notional’ choice at any time pre-retirement (although you should check your scheme rules).

You can also usually actively dictate what happens to your investments in two ways.

In the first way, you stay in the default fund but you select whether you want lifestyling or not, and the percentage of your pension contributions that go into a lifestyle investment option.

In the second you instead pick which funds you invest into (and not the default fund). Your pension scheme will offer a list of different investment options and you can ‘pick and mix’ between them.

Does it matter?

If you’ve elected to stay in the default fund (the first option above), you won’t see any practical difference in your investments until about 10-15 years before retirement. As shown in the chart above, when I would get within 10 years, the investment proportions changes. It’s around that time when you should really start thinking about whether you want to drawdown or take an annuity with your pension pot (or a mix of the two). Have a look at two previous posts of mine on drawdown and annuities on each option.

A word on default funds

If you haven’t actively selected what funds you want your pension contributions to be invested in then you are likely invested in the default fund.

Unfortunately, this is not always a good thing. The default fund doesn’t mean ‘standard’. In fact, it is a lottery whether your default fund is any good or not (link – FT google result).

It is absolutely worth taking the time to find out more about your default fund and the other fund options available to you. Generally speaking, low-cost, passively managed equity funds are what you are looking for. With these funds, you are invested in higher return assets but with higher risk. However, very few investments are absolutely certain and even government bonds can go up and down in value.

A final question

I want to round off this post with a final question:

Why do I have to make these decisions?

I’m really interested in investing and pensions (I suspect many readers are too). But most people find pensions boring and confusing. Should people have to make these kinds of decisions? As I mentioned before, I think it’s better to make saving and investing as painless as possible than to encourage forced and painful engagement.

The reality is very few people will choose the funds into which their pensions invest. The government and the financial services industry have reluctantly come to the conclusion that it’s better for people to be saving something, anything, even if it’s not perfect than to be saving nothing. Faced with bizarre questions like the one in this post today, most people will (quite sensibly!) run and hide.

Unfortunately, it is rare to find open Defined Benefit schemes. The true beauty of these schemes is not the (usually) higher retirement benefits. Rather, it’s that those savers did not need to make any investment decisions for their pension. They could get on with doing what they are paid to do and leaving the scheme to deal with the complexities of investing.

Then again, that probably means more readers for my blog…

All the best,

Young FI Guy

Pension costs and transparency inquiry

The Work and Pensions committee is launching their pension costs and transparency inquiry (link)[1]. According to the committee, they are seeking your views on whether the pensions industry provides sufficient transparency around charges, investment strategy and performance to consumers:

The Inquiry will examine whether enough is being done to ensure individuals:

  • get value for money for their pension savings;

  • understand what they are being charged and why;

  • understand the short- and long-term impact of costs on retirement outcomes;

  • can see how their money is being invested and how their investments are performing;

  • are engaged enough to use information about costs and investments to make informed choices about their pension savings; and

  • get good-value, impartial service from financial advisers.

Eight Questions

I became aware of this latest inquiry from Henry Tapper, founder of the Pensions PlayPen and a director of First Actuarial. The inquiry has asked for submissions to eight questions, which I copy from Henry’s blog (link) [2] with his highlighting:

  1. Do higher-cost providers deliver higher performance, or simply eat into clients’ savings?
  2. Is the government doing enough to ensure that workplace pension savers get value for money?
  3. What is the relative importance of empowering consumers or regulating providers?
  4. How can savers be encouraged to engage with their savings?
  5. How important is investment transparency to savers?
  6. If customers are unhappy with their providers’ costs and investment performance/strategy, are there barriers to them going elsewhere?
  7. Are independent governance committees effective in driving value for money?
  8. Do pension customers get value for money from financial advisers?

Paul Lewis weighs in

Paul Lewis (of, among others, Radio 4 Moneybox fame) was quick to offer his pithy answers.

For the most part, I agree with Mr Lewis. Here are my responses to those eight questions.

Do higher-cost providers deliver higher performance, or simply eat into clients’ savings?

They do not deliver higher performance – FACT. The evidence from the FCA is unambiguous: “there is no clear relationship between charges and the gross performance of retail active funds in the UK”. The FCA produced a comprehensive, detailed analysis of this (link)[3]. This is the same for not only individual savers but also for institutional pension schemes investing hundreds of millions or pounds.

Is the government doing enough to ensure that workplace pension savers get value for money?

No, the government isn’t doing enough. The FCA has found time and again that people do not have trust in pensions (link)[4]. It’s not possible to think you are getting value for money if you think you are getting mugged off. In fact, the government isn’t doing enough to help people save full stop. 2% contributions for auto-enrollment will not leave anyone with enough in their nest egg to worry about value for money.

What is the relative importance of empowering consumers or regulating providers?

You can’t put it in the consumers’ hands and expect them to correct deficiencies in the market. The providers have the ability and funds to make life easy for consumers. Besides, this isn’t the right question to be asking. I’m sure readers of this blog are very interested in their finances and investing, but most people aren’t. They don’t want to be empowered, they want someone to make it easy for them so they don’t have to worry about something they’re not interested in.

How can savers be encouraged to engage with their savings?

I echo Mr Lewis: Do savers need to be engaged? Do they want to be engaged? I think the answer to both is: No. It’s better to make saving and investing as painless as possible than to encourage forced and painful engagement.

How important is investment transparency to savers?

Very. Lack of transparency leads to lack of trust. Lack of trust leads to lack of saving. It’s important to remember that opacity comes from somewhere. It is a symptom of a market that is too complex and not focused on consumer outcomes.

If customers are unhappy with their providers’ costs and investment performance/strategy, are there barriers to them going elsewhere?

Yes. Both in time and money. But most importantly, in hassle. It can be utterly painful to switch providers and you often have a nerve-wracking wait while your money is being transferred in the ether. These are savers life savings yet time and again providers flout the transfer guidelines. ISA transfers that should take 30 days, can take half a year. This has been a problem for years and the regulators have done little about it. It’s all well and good encouraging savers to shop for the best deals, but if doing so is painful, then savers will not do it. (link)[5] (link)[6]

Are independent governance committees effective in driving value for money?

Somewhat. But IGCs (link)[7] will naturally be focussed on compliance as their number 1 priority. Value for money will always be a distant second. So when there is any ‘doubt’, bureaucracy is followed and improving investors’ outcomes is sidelined.

Do pension customers get value for money from financial advisers?

Rarely. That’s because it’s not cost-effective for most IFAs to offer non-regulated services. It’s these services: planning, asset allocation, behaviours, guidance that are the biggest determinants of financial success or failure. The regulatory regime forces IFAs to focus on products and makes it non-cost effective for the most people to access financial advice (the ‘advice gap’). IFAs need to buy food for their family too (and cover their insurance and compliance costs), we can’t expect them to reduce their prices to a loss or do it for free.

Your thoughts!

You can send your own responses to the committee, and I urge you to do so. (link)[8] The committee opened up responses on its ESA/PIP inquiry and received a flood of submissions that greatly contributed to the committee’s findings.

I would really like to hear your thoughts – please do leave a comment on your responses to some or all the questions.

 

All the best,

Young FI Guy

 

Links:

[1] – https://www.parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/news-parliament-2017/pension-costs-17-19/

[2] – https://henrytapper.com/2018/08/05/thinking-the-unthinkable-franks-at-it-again/

[3] – https://www.fca.org.uk/publication/market-studies/ms15-2-3-annex-4.pdf

[4] – https://www.fca.org.uk/publications/market-studies/retirement-outcomes-review

[5] – http://www.thisismoney.co.uk/money/experts/article-6002491/TONY-HETHERINGTON-leaving-investment-service-Smart-idea.html

[6] – https://www.telegraph.co.uk/finance/personalfinance/savings/11512350/Shambolic-Isa-transfer-errors-continue-to-hit-savers.html

[7] – https://www.fca.org.uk/firms/independent-governance-committees

[8] – https://www.parliament.uk/business/committees/committees-a-z/commons-select/work-and-pensions-committee/inquiries/parliament-2017/inquiry11/commons-written-submission-form/

Last Chance U and Financial Independence

One of my favourite Netflix shows is Last Chance U. It’s about Junior College Football in the US. In the States, College Football is a big thing. Talented kids get scholarships to go to the top colleges to play American Football with the dream of making it to the NFL. In Last Chance U, the show follows a small rural Community College team, made up of kids booted out of top schools or desperately searching for their last shot to land a scholarship and a path to the NFL.

Set in rural Kansas (earlier seasons in Mississippi), the environment is as far away as possible for the mostly black kids. Many have had brutal lives; football being their perceived best shot out of extreme deprivation. The show is bittersweet, in that some of what these kids have gone through is heartbreaking: death, drugs, abuse, broken homes. Then again, watching some of them succeed, despite all adversity, and get closer to their dreams is very inspiring.

I think there are lots of lessons we can take from the show on our journeys toward Financial Independence.

1. No matter your setback you can make it

Most of the kids have had tough lives. Lots have barely had any decent education. Almost all of them have been made to believe they are stupid because they are black/redneck/from a broken family. Getting the grades to get into college is no mean feat for them. Both academically, and psychologically.

In terms of Financial Independence, it’s also about overcoming those limiting beliefs: “I can’t do it.“, “Sounds great but I’d never be able to save that kind of money.” There are no inherent limitations stopping you reaching FI. Society tells us being in control of your financial future is too hard; that you should ‘live for today’. But that’s nonsense, just like those people who tell the kids they’re never gonna be smart, or pass their tests.

2. You need discipline and process

“Ignorance is life f–ing threatening, man, 89% of the NFL and NBA players are broke three years after they f—ing retire. Broke! Bankrupt! Flat broke! And if you think football is gonna pave the way for the rest of your life, you’re f—ing sadly mistaken.”

That’s the coach telling his team that even the guys that make it big often end up bankrupt. It’s shocking how many professional sports persons end up broke. It’s the same in Soccer (Football to us Brits). A lot of it is down to discipline and process. Many of the kids have never had discipline in their lives. They come from chaotic backgrounds. Their pure athletic skill meant they got a pass through lots of life.

That chaos ain’t good for life, and it ain’t good for your financial plans. Just like the kids need discipline and process to get their grades, and improve their football skills; we need discipline and process to keep our finances in order. Sure some people are able to wing it and get to Financial Independence (in many ways, that’s kinda what happened for me). But, even then, you need a process otherwise all that money will slip through your fingers, just like it does for retired athletes.

3. Being the best means nothing

The best player on the team was the star Quarterback. But apparently, at the conclusion of the show, he had yet to get offers from a top school. Throughout the show, it’s the determined kids that come good, even if they are not as good on the field.

It’s the same with Financial Independence. You can earn mega bucks, but without the right attitude you’ll never save enough and fall into a lifestyle trap. Spending every pay rise on increasingly dumb stuff.

4. When you get knocked down – get back up

That Quarterback could really have done with listening to Tubthumping. His big weakness was he didn’t like getting hit – a pretty big flaw in football. But sometimes you’ve got to take the hits and get back up again. Getting knocked down sucks. But, even though it is cliche, those setbacks make you stronger. You learn from them.

As an aside, the Quarterback had a real pushy dad – and it’s clear he’s suffering from some kind of depression or mental illness. His heart wasn’t in playing, and his dad was a total d*ck to him. If your heart isn’t in something, when things go wrong you’re gonna want out. Financial Independence isn’t for everyone, it’s got to be right for you.

5. Quiet determination

This is in stark contrast to the team’s lead Running Back. Throughout the show, he’s calm, cool and not flash. He doesn’t get into fights, he just gets on with it. He has a rough start. It isn’t until halfway through the season he becomes a regular starter. But he was always quietly supporting his teammates, even when they scored at his expense. He actively avoided the camera and a telling moment was that when he asked if he’ll announce his big offer on the radio, he asked if he could not say anything.

Financial Independence can be lonely, and contrary to lots of the big blogs out there, it can be a lonely pursuit. You might lose some friends, a lot of people will be jealous and try to shame you. But it’s important to quietly get on with it and not let other people get on your back.

6. Financial Independence is a backroom pursuit

Perhaps the most telling thing about the show is what you don’t see. Many of the kids love the camera, but many of the top offers went to players that barely featured on film. I presume they just got on with things and sorted out what they needed to behind the scenes.

That’s a lot like Financial Independence. When you make it there ain’t no award or big public celebration. In fact, it might be that nobody even knows it’s happened. A lot of the FI stuff is in the backroom: saving, investing, the discipline. That’s the heavy lifting, not the showy stuff.

7. Football and Financial Independence is a privilege

In one scene, the Coach tells one of his players in a delightfully tasteful way that: “he’s not trying to f*ck [him over]”. He makes the point that the kid has a great deal, with lots of people rooting for him, because out in the real world a lot of people will be trying to screw you over – especially if you’re black. That goes too if you’re a woman, ethnic minority, or just don’t ‘fit in’. If you mope, the Man will wipe the floor with you. The Establishment doesn’t give a damn about you feeling sorry for yourself.

Football and Financial Independence are a privilege. We’re lucky to partake. Sure things go wrong. But, ultimately it’s a great way to stick a finger up at the Establishment. And nobody can stop you from becoming FI but you.

Enough preaching from me

I really enjoy the show, and I’m not really into NFL or football. If you’ve got Netflix I’d recommend watching it. But do be warned, there is a lot of swearing. And I mean a lot (the coach in season 3 would make Tarantino blush). So if you don’t like foul language, this ain’t gonna be for you. Likewise, whilst there are some heroes on the show, the behaviour of the coaches can leave a lot to be desired.

Anyway, thanks for reading.

All the best,

Young FI Guy

Why the Lifetime ISA is not a simple to understand product

I’m gonna be upfront here, this is going to be a bit of a rough and ready post. It’s incredibly one-sided. But hopefully, I’ll be coherent to persuade you of one thing: the Lifetime ISA is a complex and confusing product.

The Lifetime ISA was drawn into the firing line after the Treasury Committee recommended it’s abolition (link). Some far smarter, wiser and more experienced people have made the case that the Lifetime ISA is a complex and confusing product. Most notably, former Pensions Minister Ros Altman (link).

Arguably, the most ‘no-brainer’ case for using a LISA is for those who are funding a house purchase. But even for these people the case is not as clearly made out as you’d think. Here are some reasons why.

Inheritance

Do you have parents? Grandparents? If you inherit a share of a family home sometime in the future that will block you from using the LISA towards your house buy.

Can you plan for that? No way, well except to get yourself written out of the will.

Joint ownership

If more than one Lifetime ISA investor is jointly purchasing a residential property, then each person must satisfy the Lifetime ISA requirements. Lifetime ISA investors can purchase a property as a joint owner with a person who already owns the property, but this is also subject to the conditions of the Lifetime ISA being satisfied.

Occupation

You have to intend to live in the property as your only or main residence. How long that’s for, nobody knows. Living there part-time, no idea. Got an overseas holiday home, no clue.

Helpfully, the government never set it out any more on this in the legislation. So if you’re an NHS worker, or regularly have to move jobs, you might find yourself on the wrong end of this. I’d like to give you some certainty, but nobody appears to know if the government will whack you with a penalty if you do end up leaving the home unoccupied. I’ve searched fruitlessly. If any wise owls out there know the answer please let me know!

Buy to let

Buy to let is therefore excluded. But there is a loophole to that. If you’re a crown employee serving overseas then you don’t have to take immediate occupation. In the meantime, you can buy to let until you return. Although, it’s not precisely clear what happens if you have to live on base on your return. The guidance notes and the legislation don’t seem to quite match.

There’s a cap

The house purchase price must not exceed £450,000. Good luck with that in London or South East England.

Also, there’s no mechanism in the legislation for that limit increasing. So, you’re gonna have to rely on a future government tinkering with the legislation for any increases. Otherwise, you’ve got to there’s a future reverse in house prices.

The cap applies even for share ownership

Want to buy 25% of a £500k flat in London (i.e. £100k purchase price)? You’re not allowed, the cap applies on the whole value, not just your share. So that probably rules out the savvy people co-purchasing their first homes in London.

You have to take a mortgage

Yep, you can’t buy the home outright. You can only use the LISA for a house purchase if you fund the purchase through a loan (mortgage) or under a home purchase plan.

You can only use it against the purchase price

You can’t use it against any solicitors fees, mortgage fees, stamp duty or anything else. Only the purchase price. So you’re gonna have to still save up a fair whack in another account to be able to pay all your purchase costs. That’s still better than the disastrous help to buy ISA which blocked you from using the funds on the exchange deposit!

Got a help to buy ISA?

You can have both a help to buy ISA and a LISA. But you can only use the funds from one. However, you can transfer from a help to buy ISA into a LISA if you want.

In a chain?

Watch out – because you’ve got 90 days from when you’ve withdrawn the funds to complete. Otherwise, you’ve got to put the money back. You can ask for an extension, but there are no guarantees. Hopefully, your chain won’t break. That never happens right?

Got a caravan?

Yeah, you might not qualify. Seriously. (link)

References:

Legislation: https://www.legislation.gov.uk/ukdsi/2017/9780111154618/pdfs/ukdsi_9780111154618_en.pdf

Government’s conveyancer guidance: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/691773/conveyancer__1___5_.pdf

Gov.uk Conveyancers technical guidance: https://www.gov.uk/government/publications/conveyancers-lifetime-isa-technical-guidance/conveyancers-lifetime-isa-technical-guidance

 

p.s. I know I’m being intentionally pernickety, it’s not all as bad as I’ve made out here. But, these rules do exist. And you do need to think about them. I know lots of you readers are very financially savvy, many savvier than me! But, do I think the average 20 year-old will get all this? No chance. But they need to if they want to use a LISA to fund their future first home. And what happens when potential savers or investors are faced with unnecessary complexity – they don’t save, they don’t invest. We need products that encourage people to save. They need to simple and accessible. They need to be easy to understand and usable in financial planning.

That doesn’t mean the LISA is a bad product – in fact, the generosity of the bonus is unbeatable for many people. That’s what makes this all the more frustrating. This is a product that could help so many people. But the implementation is so poor. And we’re not just talking complexity like forecasting life-expectancy for pensions is complex. We’re talking about complicated legislation that even lawyers need guidance to understand. Good luck to the rest of us!

Is private school worth it?

Right now students up and down the country are studying away and taking their final A-Level exams. Mrs YFG and I have carefully observed the mortal panic of colleagues and friends as their kids sit their exams. Good results and the fruits of all the schooling will have paid off. Bad results and it will be back to the drawing board for their future university and career plans.

The stakes are high. Not only because these results will determine what universities and jobs these children will be able to get. But also because Mums & Dads all over the country have spent hundreds of thousands of pounds putting their children through private education. Will it all be worth it?

Giving your children the best possible start

Almost all parents want to give their children the best possible start in life. They want to see their children succeed in the world and enjoy happy lives. For many people, private school is a way of ‘ensuring’ that their children have the best possible chance to succeed.

Both Mrs YFG and I went to pretty dodgy comprehensive schools. Going through state education didn’t hold either of us back. We both got good grades, went to a top Uni and nabbed high paying jobs. Likewise, we know people who went to the best and most expensive private schools only to tumble out with little to show for the huge sums of money spent on their education.

So giving your child an expensive private education is no guarantee of success. Not having a private education is not a guarantee of a life of mediocrity.

It’s all about the money

Unfortunately for Jessie J, when it comes to private schooling it very much comes down to the price-tag.

In doing some research for the article I came across a few estimates for the cost of private schooling your children from nursery through to college.

According to Killik & Co, an investment advisor company, the cost to put a child through private school between 2002 and 2015 was £174,000 to £236,000. They estimate that the cost has ballooned and from 2015-2028 the cost will be £286,000 to £468,000.

I also did some calculations using data from the Independent Schools Council and it could cost between £160,000 and £350,000 to put a child through private schooling from 2004 to 2018 (more on this in a bit).

These are, without being Cpt. Obvious, huge sums of money! Many of Mrs YFG’s colleagues still live pay-check to pay-check despite earning 6-figure salaries. In part, because they are forking out massive sums to keep Tarquin and Octavia in private schooling.

Is it worth it?

One of the biggest factors in me reaching FI was that age 16 my father passed away and I inherited a small 6-figure sum. Rather than blowing it all away, I invested it, with aim of retiring early (having seen how fleeting life is) by saving over 50% of my salary I was able to quickly multiply my stash to the point that working is now optional. In that respect, I was massively lucky (even if that fortune arose through tragic circumstances).

Having money behind me at a young age has given me an enormous advantage in life (along with many other leg ups). This got me thinking. Instead of spending that money on a private education, what if you invested it? Surely a huge stash of money at a young age is as big of an advantage as you could ever hope for in life?

*WARNING MATHS AHEAD*

Without further ado, I am proud to present Young FI Guy’s Super Private Un-education Numerical Kalculator.

I ran some numbers based on the following scenario:

  • Tarquin Jr. was born in 2000.
  • Since 2004 (nursery) he’s been put through private education (through to Sixth Form).
  • Now it’s 2018, he’s about to finish his A-Levels and his schooling.

The questions are:

  • How much would it have cost to put Tarquin through his schooling? and
  • If instead of private schooling you invested that money instead what lump-sum could you have given him today?

Here is the summary:

The cost

I came up with 7 different cost scenarios, these are:

  1. You could fill up your stocks and shares ISA each year from 2000 to 2018. The limit in 2000 was £7,000 up to £20,000 this year. This has a total cost of about £190,000.
  2. If you are a high-roller you could fill up two(!) stocks and shares ISAs, for a total of c.£370,000.
  3. I took the high and low estimates from the Killik & Co research (these refer to an education cycle of 14 years from 2002 to 2015, so pretty close to Tarquin’s 2004 to 2018) and divided them evenly across 14 school years (Reception to Upper Sixth). The cost for these is c.£170,000 to £240,000.
  4. I also went through the annual ISC survey data adding up the costs for each year according to the survey. Tarquin was in Junior school from 2004 to 2011, Senior school from 2012 to 2016 and Sixth Form from 2017 to 2018 for a total of 15 years of schooling. There are three estimates: Boarding School (the highest cost), Day-Fee at a Boarding School (the middle) and Day-only School (the lowest). The costs totalled between £160,000 and £350,000.

In summary, the total cost of the various options ranged from £160,000 to £370,000 with the ISA subscriptions matching the costs pretty nicely. Both in total and by stepping up over time, commensurate with school fees increasing.

Investing

The next thing I did was to say that instead of spending that money on the school fees what if on each January 1st you put that money into an index fund tracking one of three indices: FTSE-All Share Total Return; S&P500 Total Return; or MSCI All Country World Index Gross. I then deducted 0.5% fee lump sum per annum at year-end to roughly simulate investment costs.

The figures are staggering and speak for themselves. In the “lowest-case” scenarios Tarquin Jr. would have over £250,000 to spend on cocaine and strippers his future. With the “best-case” scenarios he’d have over three-quarters of a million!

Investing in the FTSE-All Share, you would have increased your money by only 60-70%. However, investing in the S&P500 or the MSCI ACWI you would have roughly doubled your money.

What’s most impressive

There are two things particularly impressive about these figures:

  1. This was one of the worst times to have invested: you hit both the dot-com bubble and the financial recession, yet your stash still increased enormously.
  2. These returns are back-loaded as the costs of schooling are highest in most recent years (and the ISA limits are highest in the most recent years). You made stacks of cash on your investment despite putting most of your money in relatively late.

If you want to play around with the numbers, you can! I’ve uploaded the spreadsheet which you can access here!

It’s not a fully fledged model (as it’s fixed to cover 2000 to 2018) but I’ve left space to change the cost assumptions, fee assumptions and you can tinker with the market returns.

[p.s. I can’t guarantee it’s fully accurate or doesn’t have any mistakes, if you spot an error let me know!]

Over to you…

I’m pretty against private schooling, but I think that even the most fervent supporters of private schooling might think twice if they could give their child a £780,000 leg-up.

If you had the decision to make, would you rather your child had a private education or a lump of between £260,000 to £780,000 on their 18th birthday?

 

All the best,

Young FI Guy

[p.s. I’ve stuck purely to numbers here without taking in to account the non-numerical aspects. I’m not a crazy numbers-sociopath (or am I?) It’s hard for me to talk about some of the qualitative aspects of parental education choices as I’m not a parent! Many parents will strongly (and perhaps rightly?) argue that private schooling confers many non-educational benefits such as developing discipline, ethos etc. Likewise, none of this takes into account that the most important thing (in my view) is spending time with your children!]

Why We Write

It’s 1942 and Frank Capra is about to embark on his most challenging project to date. By this point Capra, one of the most influential American film directors of all time, had all ready conquered Hollywood. He had already won the Academy award for Best Director three times. And he’d produced, what would become, some of the most influential movies of all time. Amongst them: It Happened One Night, Mr. Deeds Goes to Town and Mr Smith Goes to Washington. But this was his toughest challenge to date. To persuade the American people to fight and die for their country against the growing fascist tide. To explain to them: Why We Fight.

By most reckonings, the Why We Fight films were a success. But hindsight masks what a difficult task this was. Even though the Japanese had just bombed Pearl Harbor, the US had engaged in a decades long non-interventionist policy. That’s not to mention that the country had only just started taking tentative steps out of the Great Depression, would be siding with their antithesis would-be allies the Soviets, and just 20 years ago bloodily tipped the balance in the “War to end all Wars“.

During WWI it was speeches that mainly served to bolster morale. Whilst some speeches would continue to hold such power, it was film, the growing medium at the time, that would spear the fascist propaganda machine. The first of the films, Prelude to War would win the Academy Award for Best Documentary. And the films would have a long-lasting cultural impact on the US. In particular, that the US were the force of good who had a moral duty to fight the forces of evil (the films are available in the public domain, although do bear in mind that, as propaganda films, they contain many untruths and sometimes even outright racism towards other nations).

Why we write

This past week I’ve been reflecting on my experience so far writing this blog. I’ve been following the FI community for a long time, both through many blogs and podcasts. Some of those writers are what encouraged me to reach to FI. When I left my job just over a year ago, I had planned to do some writing. However, I still wasn’t sure whether I would “do the blogging thing”.

For some time, I had reflected on my “word emissions”. Whilst I’ve never been the most talkative of folks, I’d always aimed to say something if it felt important. But I was feeling I was just another emitter of chatter in a world polluted by noise. Over time, I’d been slowly withdrawing away from commenting online and sharing my own thoughts in the Personal Finance community. That’s not to say I didn’t have things to talk about; rather I had felt drowned out in a sea of noise. I questioned what special insight I had over thousands, millions of others.

I’ll confess that it was Mrs YFG who really encouraged me to start blogging. She thought that I should share my thoughts (and rants) with other people. And that those people would find what I had to say both entertaining and enlightening.

Starting the blog

So I started the blog halfheartedly. I wrote a few pieces, but made no attempt to promote them. A turning point came when I felt compelled to leave a comment on the Monevator website. In fact, it was more so the troll response that I got from another commenter. I was frustrated by their (wrong) personal attacks but I was just going to ignore it. But Mrs YFG told me: you’re right, they’re wrong – you know more about this stuff than 99% of people – why don’t you explain. And so I responded.

It was that response that started a trickle to the blog. And that trickle left many positive comments. These comments encouraged me that, opposite to my gut feel, I wasn’t just “adding more noise”. Feeling more confident I wrote some more, and started to go back to my old habit of writing comments on some of the blogs I followed.

The trickle has turned into a daily flow of readers. Now up to 10,000 total visits. And to all those visitors, the commenters and especially the persons who have linked to and shared my posts, I am immensely grateful.

Learning the Internets

An irony in all this is that Mrs YFG and I have another social media account with the best part of 100,000 followers. 10,000 views is a fraction of what each post gets. Not to mention a single post usually gets more comments than this entire blog has to date. But I tell you this, each comment I’ve got on this blog has felt so valuable. Each a small confirmation that I was right to start writing.

Another slice of irony is that, for a millennial, I am incredibly old-fashioned. Most of my posts originate with the simplicity of pen and paper (including this one). I don’t have Facebook, and have no real clue how to promote posts in social media circles (let alone maximising your SEO, whatever that means). I’m on twitter however, mainly due to the insistence of a good friend of mine (I’m still learning how to use it).

That leads me towards the denouement of this piece. The other night, I was reflecting on my blog journey thus far. The thing I’ve found most valuable was being, once again, tapped back into the Personal Finance community.

I’ve enjoyed so much reading the blogs and comments from people I had never seen before. Some of those posts have changed my view on things. But what struck me most was how much excellent content out there and being talked about. In my semi self-imposed absence, the Personal Finance community has grown from being, what used to feel like a couple of strange dudes whispering in the corner of the bar, to being the loud diverse party slap centre in the bar.

The Good Fight

That’s important. Because whilst there’s been a great deal of progress in the Personal Finance space over the past few years there’s still lots of problems. Financial illiteracy is still rife. Much of the Finance industry still engages in opaque practises and deliberate attempts to bamboozle the public, and is being dragged kicking and screaming towards accountability and transparency. And whilst the mainstream media is improving its financial media, much of it falls woefully short and in some cases is downright dangerous to investors.

That’s what conjured up the image of Why We Fight. The fight against fascism replaced by the fight against wage-slavery and poor financial decisions. A collective attempt to unwind the prevailing propaganda in Western society. That spending money will buy you happiness. That a Finance industry that works for its benefit, rather than yours, is fine. That being ignorant of how taxes, pensions and investing works is OK. It’s why we write.

Since starting my blog, I’ve been encouraged, in a way more than ever, that the forces of good in the Personal Finance community will prevail. But I do wonder whether blogs, podcasts and social media is how we will win. What do you think? How can we best bring the fight?

All the best,

Young FI Guy