The Perfect Fraud? Investing in private companies (Part 1) From the outside looking in…

On 6 July 2021, judgment was handed down sealing victory for our clients in what has been a long and drawn-out legal battle against two individuals who sought to defraud them causing loss of over £1m. The judgment confirms that the Defendants were “…wilfully and deliberately dishonest.” In the first of two articles discussing the case, we assess how the Defendants committed an almost perfect fraud…

Facts

Our clients were all induced to invest in a company registered in the BVI but operating in the UK and globally (the “Company”) by the Defendants who alleged that the Company held assets worth circa £60m. The Defendants were not selling their own shares but acting to sell shares of pre-existing shareholders in the Company or newly issued shares.

In order to succeed in their claim our clients needed to prove that:

  • a misrepresentation had been made (i.e. an untrue statement of fact or law)
  • upon which they relied in being induced to enter a contract; and
  • which thereby caused them loss.

In addition, a claim for fraudulent misrepresentation (as alleged here) also requires the false representation to have been made by the Defendants knowingly, without belief in its truth, or recklessly as to its truth.  Therefore, this was a claim about the Defendants’ personal knowledge which separated it from a claim against the Company in which shares were purchased.

The Defendants were the CEO/Founder and Head of Strategy (later Head of Investor Relations) of the Company in question and consequently had an intimate knowledge of its performance and financial status. They alleged that the Company held assets worth £60m, when in reality the Company’s assets were worth much less (indeed a company 2018 valuation concluded the Company was worth zero).

There was no market for the Company’s shares (it was a private company).  Therefore, their value was entirely dependent on new investors being willing to acquire an outgoing shareholder’s shares, or ‘new’ shares from the Company, at an enhanced valuation.  This case serves as a very powerful reminder of why English company law prohibits companies from giving financial assistance for the acquisition of their own shares.  Regrettably there are no such protections under BVI law for the Company’s shareholders.  The Company via the actions of the Defendants trafficked in its own shares.

When making a decision to invest, our clients all relied upon what they had been told by the Defendants about the Company valuation, the price at which previous new shareholders had purchased shares and assets. As a result of their investments, our clients all lost both the value of their investment, plus the opportunity to have invested the money elsewhere and to have gained a return on those funds.

Background

The case involves a business coaching company which had first emerged in Australia, but which by the time our clients became involved, had a global reach with operations in the UK and the US. The Company enjoyed some early success generating healthy revenues and an almost cult-like following largely due to due to its charismatic founder, Darren Shirlaw, and its training materials which some describe as “revolutionary”.

Shirlaw claims to have had a successful career in fund management and described himself as a “multi-millionaire entrepreneur”. He was a compelling speaker who had a remarkable ability to connect with his audiences. He told many anecdotes of how he managed to significantly increase the valuation of small businesses within a short space of time, and how he had made enough money to retire at 30.

Too good to be true? Well perhaps, however Shirlaw had managed to entice a large group of reputable business associates to join him in the Company journey and also had the backing of a well-recognised, global brand. One of these business associates, Anna Barton (a qualified management accountant who claimed to have previously worked for Virgin Retail Europe and M&S), would become Shirlaw’s co-defendant in the proceedings

The business model was overly complex and difficult to unravel, particularly for an outsider, with holding companies located in the BVIs and Iceland. Revenues were generated by coaches who incorporated their own companies which then paid royalties to the Company for the right to use its intellectual property (i.e. coaching strategies and training materials). By 2006, it was reported that the Company was generating revenues of £6.5m with Shirlaw himself projecting revenues of £60-80m by 2009.

Company valuation

In 2009, Shirlaw sought external investors and conducted a valuation of the Company for this purpose. He claims there were three separate valuations carried out i) by himself, ii) by a colleague, Mr Peter Harford, and iii) by an independent third party (a claim that has never been verified) which all reached a valuation of circa £40m. In fact, a closer look at the detailed valuation carried out by Mr Harford revealed a much lower valuation of £9.75m following the application of a 75% discount due to uncertainties regarding the assumptions underpinning the valuation.

Mr Harford described the valuation pre-discount as a: “…projected valuation of the group if every assumption were to play out over time as accurate based on actual performance in those years (being a period of 10 years) …”. He explained that the discount was high because of the significant uncertainty about the assumptions coming to pass in those future 10 years.

Shirlaw invited investment from those he described as “sophisticated investors”; these were people that knew the business already either through contacts or through being recipients of business coaching themselves. To put it another way, these were people that had already been drawn into Shirlaw’s fold and were unlikely to question him. In 2009, Shirlaw raised £1.2m in investment.

In future years, Shirlaw would tell investors the Company was worth £60m, despite the fact that no one had looked to update the Harford valuation or even check whether the annual revenue assumptions were being matched by actual performance. Shirlaw described the Company valuation as an “asset-based” valuation which took account of ‘off-balance sheet’ assets. Our clients were presented with documents that listed alleged assets against their current valuations, but all were underpinned by the £40m valuation from 2009 which was never reviewed or revised.

The perfect fraud…?

What was it about this fraud that made it so successful?  There are a number of factors that make this such a successful scheme:

  • Firstly, Shirlaw had managed to build a well-recognised, global brand;
  • He had his name above the door which indicates a personal belief in the Company;
  • He surrounded himself with reputable business associates (lawyers, accountants, successful company directors, bankers to name a few) which gave both him and Shirlaws an air of credibility;
  • The Defendants presented the Company’s valuation as having been approved and set by the Board of the Company, thereby distancing the Defendants from responsibility for the valuation;
  • The investments he sought were of relatively low value (usually no more than £300,000) which ordinarily made it cost prohibitive to bring a claim for the loss that would follow;
  • The Defendants would have previous investors who had been duped to purchase at the inflated share value speak to potential new investors, neither knowing they were being misled by the Defendants;
  • The Defendants distanced themselves from the fraud by:
    • choosing not to become registered directors of the Company;
    • seeking board approval of the valuation which critically, had been authored by them i.e., Shirlaw and Barton;
    • choosing elaborate and complex corporate structuring;
    • that as a private company, there was very little in the public domain about its actual financial affairs that could be used to unpick who authored the valuations year on year and if they were true.

But perhaps the shrewdest move was to bring investors into the Company fold as ‘partners’ and participants in the business. This meant that any expression of dissatisfaction or distrust would be seen as a betrayal of colleagues and friends. Furthermore, once you became a shareholder, any cries of “but the company is not worth anything” would have equated to a cry of “but my investment is not worth anything” and consequently an admission that you had lost your money, an acceptance you had been naïve and possibly duped, and bring about infighting against many people who believed in all that Shirlaw would say and preach (as it was in their interest to keep up the façade that the Company was in fact worth £60m).  .

In our next article we will consider how our clients eventually unraveled the fraud and succeeded in their claim…

To read the judgment please download a copy here

Should you suspect that you are a victim of fraud or other wrongdoing, please do not hesitate to get in touch at hello@tenetlaw.co.uk

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