When you see a red flag, pay attention

This article is part of
Autumn Investment Monitor - September 2015

Every now and then the market sends a reminder of why corporate governance matters, and why investors need to pay attention.

Ask any governance expert, and many of them will tell you that the writing was on the wall for Afren many years ago. The Nigerian-focused oil company was listed on the London Stock Exchange, but has now gone into administration.

A glance at its board in 2011 said it all; as far as many investors were concerned, there was not a single independent director on it. One director received a monthly retainer for consulting services while serving on the audit and remuneration committees. Two directors had unexercised share options, a hangover from its days as an Aim-listed company and a governance no-no for main market companies. One previously worked at the company’s stockbroking firm, which also acted as its nominated adviser or Nomad for listing on Aim; and another director provided consulting services to Afren before he was appointed an ‘independent’ director.

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Yet in true ‘comply or explain’ fashion, the company asserted that “the relationships do not interfere with the directors’ exercise of objective, unfettered or independent judgment or their ability to act in the best interests of our business”. Directors consistently received a high number of votes against their re-election, some as much as 41 per cent, but they continued to serve on the board. The company also regularly reported high non-audit fees paid to its external auditors – which in theory, can point to a problem with the independence of the auditor.

The remuneration report failed to receive majority support from shareholders in 2011 and 2013, with 40 per cent and 20 per cent support respectively. According to figures from Manifest, the proxy voting agency, Afren’s executive directors were granted £47m in options and shares from the time it was listed on Aim in 2005 until August this year when it went into administration. Many lapsed, but just under £20m was exercised. Directors received £29m in salaries, bonuses and fees in the 10 years since listing; executives made regular, unauthorised use of the company’s private jet; and Afren also notified the UK’s Serious Fraud Office over concerns relating to expenses payments earlier this year.

However, the directors were slick and well spoken. They had a good story to tell; they were a start-up oil company successfully operating in difficult countries where Shell and Chevron were struggling. Their approach was based on mutual respect and supporting local communities through resource development and corporate responsibility programmes. Investors wanted it to succeed.

But there was always something that just did not stack up. One red flag emerged in 2013 when Afren announced it had failed to disclose that the chairman, chief executive and finance director held personal shares in First Hydrocarbon Nigeria (FHN). Afren later purchased 18 million shares in FHN, providing them with a windfall paper profit of nearly $23m (£15m). It was a glaring omission but the directors shrugged it off as a case of bad advice and everyone moved on.