No sweet treats from Patisserie Valerie

Posted by Liz Rees in Weekly musings category on 18 Oct 18

Patisserie Holdings, parent of Patisserie Valerie, a high street retailer you may be familiar with, made the headlines for all the wrong reasons last week. The company, a purveyor of up-market cakes and other delicacies shocked the stock market with the announcement that it had uncovered ‘significant, and potentially fraudulent, accounting irregularities.’

As a result, the company’s shares, listed on AIM (the Alternative Investment Market) were immediately suspended while an investigation was launched. Investors were floored by the news as Patisserie was considered something of a stock market darling. Since its IPO (Initial Public Offering) 4 years ago, with the rather appropriate ticker designation of CAKE, it had been a stellar performer as it rolled out its café concept nationwide.

How can something like this happen to a public company? Well, the usual explanation is that an employee, in a position of responsibility, has abused the trust placed in them. In the case of Patisserie, it appears that the scandal is down to the actions of one individual; the finance director of the business, Chris Marsh, has since been arrested on suspicion of fraud by false representation. It soon emerged that misrepresentation of the company’s accounts has left it with debts of £10m in unreported loans, instead of the supposed £28m of cash.

News of the cash-flow squeeze facing the company led to some landlords immediately taking back possession of their shops, and suppliers to restrict lines of credit. However, with banks threatening to pull the plug and force the company into administration, the company appears to have been thrown a lifeline. Wealthy entrepreneur Luke Johnson-who was behind Pizza Express, Strada and many other ventures- owns a 37% stake in Patisserie and has agreed to stump up £20m of his own money. Some existing institutional investors are also participating in a rescue package, despite having to make significant write-downs to their holdings.

Could such an occurrence happen to a larger company too? While a determined fraudster is very difficult to detect, there is perhaps a greater chance of it being uncovered in businesses with more audit staff and sophisticated reporting procedures. Generally, the higher up in the organisation the individuals are the harder it may be to pin them down as they are likely to have greater authority. The external auditors come under scrutiny and are likely to get a slap on the wrist and a fine but this is not much consolation for the victims.

You have to go back to the 1990s to find fraudsters who brought down FTSE 100 companies of the time- Robert Maxwell of Maxwell Communication’s and Asil Nadir of Polly Peck were memorable villains that you may recall. Corporate governance was sadly lacking and, fortunately, significant improvements have since been made. For example, most companies now split the role of chairman and chief executives and appoint a number of reputable independent non-executives.

Collusion in criminal activities is even less common; Versailles, a FTSE 250 constituent, was a less well-known trade finance business which collapsed in 1999 in a £100m fraud involving the Chairman, Chief Executive and Finance Director, along with various associates. A more recent case is that of the three senior executives at Tesco who went on trial in 2014 over a £250m accounting fraud-enough to make a substantial dent in profits but not enough to bring the company to its knees. In this instance it does not appear the aim was personal gain- attempts to manipulate disappointing sales figures escalated into something more serious.

Of course, any individual with access to company funds has the potential to misappropriate them. Barings Bank was rendered insolvent by the infamous rogue trader Nick Leeson. There have been a few similar cases since then but, due to stricter compliance and supervision procedures these days, the financial consequences have been less severe.

Even great companies can fall victim to circumstances outside their control, be it criminal activity, natural disasters or the global financial crisis. However, many problems that companies may face, such as an industry sector in decline, excessive debt or poor management, are issues that can be uncovered by diligent analysis. This is an advantage of active fund management.

Perhaps the main lesson to be taken is to stick to the old adage of not having all your eggs in one basket; diversification is the best way to reduce risk so one bad egg doesn’t destroy a whole portfolio. Think of it as the nearest thing to an insurance policy against unexpected events. Fund managers may be licking their wounds over Patisserie but it is likely to be a small part of a broadly based portfolio.

Unpleasant as this experience has been for shareholders, it is important to bear in mind that incidents like this are extremely rare, which is why a relatively small company has received such extensive press coverage. Furthermore, the unravelling saga makes it an interesting subject for journalists to report on. No doubt the full story will be revealed in a future court case.

In fact, this isn’t the first major hurdle that Patisserie, founded by Belgian Madame Valerie in 1926, has faced; its original outlet in Soho was destroyed by wartime bombs. Hopefully, the company can once again get back on its feet and keep on serving those delicious cakes.

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