‘Throw enough mud at a wall, and some of it will stick,’ the proverb says. But since US investor Muddy Waters published a scathing attack on third-party litigation funder Burford Capital on 7 August, the muck-slinging has not stopped.
The charges in the 25-page report were devastating. Having labelled Burford a ‘poor business masquerading as a good one’, and suggesting the company was ‘already insolvent’, more than £1bn was wiped off the listed funder’s value. Five days later, Burford enlisted Freshfields Bruckhaus Deringer, Quinn Emanuel Urquhart & Sullivan and Morrison & Foerster to pursue claims of illegal market manipulation.
Burford has been considered the industry’s leading light. Founded in 2009, it rose to become the most valuable company listed on AIM. But Burford’s share price fell from around 1,600p to 605p in the week following the report.
The scope and velocity of the opprobrium levelled at Burford makes the veracity of each criticism difficult to judge. However, a shake-up announced a week later by Burford – in light of Muddy Waters calling its governance structure ‘laughable’ – suggests some of the allegations have caused ripples. Chief financial officer (CFO) Elizabeth O’Connell made way for Jim Kilman, with O’Connell’s marriage to chief executive Christopher Bogart considered an issue by Muddy Waters. Kilman is the company’s sixth CFO in as many years, while a search began for two independent directors to join the company’s board, replacing David Lowe and chair Sir Peter Middleton.
Though the shake-up will go some way to settling investor nerves, not everyone feels it is necessary. ‘When you look at the board of Burford, they’re not cowboys,’ says one Herbert Smith Freehills litigator. ‘The funders are serious professional outfits. I’d be astonished if they’re doing anything wrong or way off market.’
However, Muddy Waters disagrees. Founder Carson Block says: ‘It’s a cosmetic change. There has clearly been no process to find a CFO, they’ve just found a loyalist who’s not married to the chief executive.’
Numis Securities rubbished insolvency claims as analogous to comments that Earth is ʻarguably flatʼ.
Burford’s chief investment officer, Jon Molot, responds that the moves are not born of necessity, but rather about ‘giving reassurance to those who know us less well.’
More stinging though was Muddy Waters’ criticism of Burford’s accounting practices, which it claims were exasperated by the funder’s weak governance structure. The accusation that Burford was ‘already insolvent’ was the most controversial, and the least convincing for many externally.
‘Burford was reporting unbelievably high margins, but I’m not sure they’re technically insolvent,’ says Fieldfisher disputes partner Tony Lewis, who heads the firm’s litigation fund FeeSolve. ‘Their response that they’re using acceptable accounting standards means it could be a question for accountants.’
Stockbroker Numis Securities – one of Burford’s corporate advisers – has rubbished the insolvency claim as analogous to ‘comments like the Earth is arguably flat’. Many agree that while the criticism of Burford’s governance is fair, attacks on the underlying business go too far.
Burford’s funds-to-expenses ratio – the cost of managing it – was heavily criticised by Muddy Waters, which claims it sits at a lofty 9%. The figure proves invidious, with Muddy Waters calculating the ratio after judging Burford’s capital base to be $880m. However, this capital base figure controversially subtracts both third-party interests and the amount of fair-value gains from the company’s first-half investment figure of $1.768bn.
Burford, unsurprisingly, considers such an adjustment illegitimate, and crucially is not alone. Numis says considering Burford a single fund is inappropriate, arguing it is an operating company that also has third-party funds. According to its own calculations, which more broadly accept the company’s H1 investment sums, the ratio is 4.8%.
Block also concedes that the sums were not compared with the other publicly-owned litigation funders: ‘Compared to other closed-end funds it’s particularly high. That’s what we compared it with, not with Bentham or LCM [Litigation Capital Management] as their accountancy is different, as far as funds go – and I’m a fund’s manager – that ratio is stratospheric.’
But the founder of one rival, a UK litigation funder, contends: ‘I don’t think 9% is high at all, that’s what you’d expect. If you invest in ten cases at £10 each, at a cost of £9, but there’s an 80% success rate on the cases and you get double the returns, that’s £160. It’s a pretty good return.’
The question at the heart of the conflict is how Burford reports its assets. Normally, litigation cases are considered a level three asset: the hardest to value, particularly under fair-value accounting. Burford claims it can accurately and fairly do so.
Meanwhile, LCM and IMF Bentham – the second and third-largest publicly-owned litigation funds – have been quick to distance themselves from Burford, arguing they use conservative cash-based accounting, which does not use current market values to recognise assets. Instead, the pair consider litigation cases intangible assets, which makes for less racy, but safer, balance sheets.
Block lauds LCM and Bentham’s approach, and as a result the attack against Burford seems to be exactly that, an attack on a company rather than an industry. Meanwhile, many litigators interviewed believe the decade of growth litigation funding has enjoyed is unlikely to be stymied in the long term.
But for Burford – long considered the poster child for the funding industry’s dramatic rise – the damage has been considerable. The governance changes are overdue, though far from sweeping. And while it will survive this storm, the clouds are unlikely to clear any time soon.