The revelation that Patisserie Holdings, one of the darlings of the Aim-index, was not as profitable as it seemed and had a £40m hole in its books caught markets and shareholders completely by surprise.
Cavendish portfolio manager Paul Mumford who has been an investor in Patisserie Valerie for years was taken aback by the scandal that rocked the British cake chain which up until that point hadn’t caused him “any sleepless nights”.
“If I had to list the 70-odd companies I own in order of risk, I probably would have put Patisserie Valerie right at the bottom,” he says. “It didn’t seem to be a high-risk situation.”
The person who was most gobsmacked by the news was Patisserie executive chairman and majority owner in the business Luke Johnson.
Veteran entrepreneur Johnson, who owns 37% of the firm, described in excruciating detail how the revelation of Patisserie’s accounting scandal culminated in the “most harrowing week” of his life to the Sunday Times, the same paper he writes a weekly column for sharing tips on how to be a savvy investor.
As the events of the week unravelled and senior management uncovered £10m in two “secret” overdraft accounts in addition to the accounting discrepancies, Johnson said his world was turned upside down. “It was as if I was in a nightmare that I’d wake up from,” he told the paper.
Who is to blame?
With a Serious Fraud Office investigation into suspended Patisserie finance director Chris March ongoing shareholders have been left scratching their heads, wondering how such a serious account deficit could go unnoticed.
Many have placed blame squarely at the feet of Patisserie Valerie’s auditor Grant Thornton, who only months before had given the café chain a clean bill of health and verified that it had £28.8m of cash in the bank.
Patisserie Valerie has jumped on this bandwagon, with reports suggesting it could sue its auditor of over a decade. Grant Thornton, the UK’s fifth largest accounting firm by revenue, may also potentially face the wrath of the Financial Reporting Council, which regulates the audit profession.
While Mumford says that people are right to criticise the management team, he believes the auditors principally should have picked up on the multi-million pound accounting hole, particularly given their history with the café chain.
A forensic team from PwC that was brought in to investigate the matter by Johnson and the company’s CEO Paul May spotted that Patisserie’s accounts didn’t add up almost immediately.
“Grant Thornton aren’t renowned for being exactly great in this area of practice,” says Mumford, noting that the accounting firm was fined £2.3m by the FRC last year for “not doing their job properly” while auditing another company he holds, Assetco.
The accountancy firm was fined £3m again this August over its audits of Vimto-maker Nichols and the University of Salford.
In response to Portfolio Adviser‘s request for comment Grant Thornton said: “We are aware of the news released by Patisserie Valerie. Given our duty of client confidentiality it would be inappropriate for us to comment.”
Peter Sleep senior portfolio manager at 7IM says Patisserie’s auditors should have been able to spot basic fraudulent manoeuvres like ‘layering’, where a person moves an amount of money through several bank accounts very quickly to give the impression of having a lot of cash, or ‘teeming and lading’, where a person takes cash from a transaction for their personal use and records it later.
Sleep, a chartered accountant himself, notes that junior auditors are typically assigned to look over company cash levels because this is usually the easiest thing to check. But this work should be checked thoroughly by senior auditors at the firm, he adds.
Deficient system
Peter Parry policy director of the UK Shareholders Association thinks Patisserie’s problems are also the result of “the fundamental failings of the auditors”.
But he says this problem is not unique to Patisserie or even Aim-listed companies, which have looser regulatory controls in place than their larger FTSE 100 and 250 counterparts.
The corporate blow-ups of 2018 like Carillion, Conviviality and now Patisserie have revealed a “deficiency in the whole audit procurement process,” says Parry.
He suspects external auditors are chosen because of the “cosy relationships” they have with members of the internal audit committee and senior management instead of whether they will deliver the best results for shareholders and other interested parties like employees and suppliers.
“There’s no transparency and no evidence of real robustness the way in which audit contracts are tendered and the bids are evaluated to ensure they do get the best one that provides the most appropriate service the stakeholders want.”
This is reflected in company annual reports, which feel more like a box ticking exercise and “easy words on the page” as opposed to a comprehensive audit that highlights concerns that would impact stakeholders.
“When you read the annual report all you get is vague, superficial comments which state the external audit people looked at this and that. But you don’t see why they were asked to look at certain things like revenue recognition or the valuation of intangible assets.”
Sophisticated fraud
Sleep’s hunch is that the accounting blow-up was likely a “fairly sophisticated” fraud that evaded Grant Thornton’s detection.
He says the matter ultimately boils down to an internal control issue and thus falls under the purview of Patisserie’s internal audit committee.
Johnson is one of the members on the committee. He sits alongside non-executive director James Horler, another big name in the hospitality industry, who is the current CEO of 3Sixty Restaurants and previously oversaw the rapid expansion of restaurant chain Frankie & Benny’s. The audit committee is chaired by Lee Dale Ginsberg who is also a non-executive deputy chairman at the firm.
“I am not sure what the internal auditors were doing,” says Sleep, “but one hopes they were doing a bit more than counting office stationary and cakes.”
‘Secret’ accounts
Sleep also questions the secrecy of the two overdraft accounts the firm had set up with HSBC and Barclays which were drawn down by £9.7m.
He says one of his contacts at HSBC told him that in order for Patisserie to open an account the bank would have required a board resolution and minutes approving the account.
“If they were secret, my guess this was all forged if it was “secret” as suggested in the press and then hidden from the auditors”.
Pattiserie Valerie declined to comment.
