MTM case was a human tragedy

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The Independent Online
With all of America and half of the rest of the world working itself into a lather over the latest OJ Simpson trial last week, you may well have missed another intriguing case on this side of the Atlantic.

A pity, because the Mysterious Affair at MTM, which reached a climax at the Old Bailey a few days ago, was not only another compelling human drama, but also highlighted some important general lessons for investors.

The victim in this case was corporate, rather than human. It was a quoted company called MTM which made speciality chemicals, and for a while enjoyed a strong following in the City. It came to a nasty end, however, in 1992 when the share price suddenly collapsed, falling in less than two weeks from 286p to 10p. Shareholders eventually lost pounds 250m when it went under.

Last week, the two senior managers at MTM, its chairman and founder, Richard Lines, and the finance director, Thomas Baxter, were jailed after being found guilty of conspiring to account falsely and of making false and misleading statements about the company's financial health. Mr Lines, a former Naval officer, had started the company in 1982 after leaving ICI. It went public in 1986 and then, like so many ambitious companies before it, embarked on an acquisition spree in Britain and the United States, funding each new purchase with a new issue of shares.

The trouble really began, so the Old Bailey heard, when MTM completed the acquisition of two large American companies in 1990.

The deals stretched the company's finances to the limit, leaving little margin for error. When the recession hit, the company, in its desperation to keep its share price motoring, began to falsify the figures in its annual accounts. Mr Lines and his associates, said the prosecution, "cooked the books in order to give the impression that the company was a good deal more profitable than was in fact the case". This they did in a number of ways, the most common of which apparently was persuading its customers and suppliers to buy chemicals or plant on the understanding that the transactions would later be cancelled or reversed.

The aim was obvious: to inflate the turnover and profit figures in the annual figures, so as to reassure the City and investors that the company was still growing at the rate they had come to expect.

The plan eventually fell apart when some of the bogus transactions came to light and the company's auditors started querying transactions and refused to sign off the accounts. Both the company's auditors, BDO Binder Hamlyn, and its merchant bankers, Robert Fleming, were criticised by the trial judge, who told Mr Lines that he had been "less than strenuously guided by your City advisers".

The judge accepted that the MTM chairman's motive in trying to falsify his accounts was not personal greed - there was no question of money being squirrelled away for his own benefit - but simply one of ambition for the company he had created and grown so fast.

At one level, therefore, the MTM case is a simple human tragedy, played out on a corporate scale. Britain has few enough genuine entrepreneurs to be able to afford to be too censorious about Mr Lines' ambition.

He may have fallen into dishonesty at the end, when the pressure of satisfying the City's insatiable appetite for growth proved too great, but his achievement in getting there should not be forgotten. A lot of people made money from his activities on the way up.

But there are cautionary lessons too in this unhappy saga. One is the age-old lesson that accounting earnings are all too easily manipulated. As my chart shows, research has repeatedly demonstrated that there is virtually no correlationbetween a company's reported earnings and its market value. If you plot the earnings of the biggest companies against their price-earnings ratios, all you get is a meaningless scatter diagram. That means that investors who rely solely on published earnings figures are, unless they have the forensic skills of a Terry Smith, or similar seasoned balance sheet analysts, taking more on trust than they realise.

Fortunately, the scope for creative accounting has diminished recently, thanks to tougher accounting standards. But don't assume that it has gone for good. MTM's demise was less than five years ago, and there will be other casualties when the next recession comes round. Companies that grow rapidly by share-financed acquisitions, rather than by organic, internally generated means, require particularly careful scrutiny.

The virtuous circle that enables successful managements to use their share price when the going is good to buy companies they could not otherwise afford can unravel just as quickly as it is created.

Another conclusion is that it is dangerous to rely on advisers and auditors, however prestigious, to protect you against wrongdoing.

No self-respecting auditor is going to sign off on accounts that have been blatantly falsified, but there are many grey areas and scope for negotiations along the way. If and when they do blow the whistle on a client, it is almost invariably, as in MTM's case, too late to save shareholders their money.

A final observation concerns risk in the stock market. The nature of the stock market is that it rarely does things by halves. On the way up, it provides willing and ready partners for companies that are prepared to accept its demanding growth targets.

When the going is good, it can be very good, for managers and investors alike. But the market is also fickle and swayed by fashion. Popular growth stocks, such as MTM in its heyday, often burn out in spectacular fashion, the victims of over-reaching ambition.

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