Patisserie Valerie Scandal

Patisserie Valerie, founded in 1926, is a food processing company which owned and operated a chain of cafes specializing in handmade cakes. The company’s headquarters are situated in Birmingham UK, and as of March 2019 had a revenue of $86.8M and 2,500 employees. Patisserie Valerie is owned by Luke Oliver and Steve Francis was the CEO after Paul May stepped down.

The Collapse of Patisserie Valerie

According to the Guardian, Patisserie Valerie has fallen into administration when the company was refused funding by debtors which would have been a potential lifeline since they were aware the company was under critical financial stress since October 2018 (Butler and Wood 2019).

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In October 2018, the company had come to realization that there was a major cash shortfall and accounting irregularities, due to possible fraudulent activities. Patisserie Valerie also had a number of issues with paying suppliers. They had a deal in place with the suppliers to pay any credit outstanding within 60 days, however this failed to be met and often stretched to double the timeline resulting in some suppliers resorting to pursuing legal actions. Patisserie Valerie was later rescued by Luke Johnson by investing cash to pull the company out of trouble (Eley 2019).

In May, the company had declared its net cash position at £28.8 million and Johnson had claimed the company had a strong balance sheet. However, when the company directors had come to realization of the accounting irregularities, the firm had suspended Mr. Marsh the finance director. The company had also suspended trading of shares and launched an investigation (Herbert 2019).

October 2018, Luke Johnson was informed by the CEO, Paul May, that their understanding of £28.8m of cash was incorrect and this in fact consisted of a debt of £10m and £9.7m deposited into two bank overdrafts which was unknown to the management and as a result, all accounts was put on hold (Irvine 2019).

Accountancy age had interviewed Simon Bonney, partners and insolvency expert at Quantuma. Bonney had commented on the fraud, quoting: “Was it a fraud of a successful business where money was removed from the accounts of the company or was it a fraud which caused an unsuccessful business to appear successful. I don’t think that question has yet been answered” (Practice et al. 2019). The statement Bonney had made clearly states that the fraud which had taken place was a well -organized plan, it also states (Practice et al. 2019) the directors was asked to inject more funds to keep the firm running. If they had failed to do so the company could’ve collapsed. This course of events took place two months prior to going into administration. This shows a clear indication that company management was not aware of the fraud taking place (Practice et al. 2019).

According to a recent journal, KPMG had made it public that there has been a total of £94m accounting black hole, this is more than what was originally anticipated. The journal also states a further five arrests have been made (Wood 2019).

The accounting irregularities were only uncovered by HMRC when they had created a petition for an unpaid tax bill of £1.14m, and this resulted in an immediate investigation and it was later discovered that instead of a £28m profit, the company was in fact in debt of £10m. (Halstead 2019). The recent collapse of Patisserie Valerie has created a substantial impact by the closure of 70 out of 200 stores being closed down and over 900 jobs lost (Partington 2019).

The Extent of Patisserie Valerie’s Compliance with the UK Code

There are five main code compliances with corporate governance: leadership, effectiveness, accountability, remuneration and relations with shareholders.

Leadership

Leadership within a corporation or any organization is vital, this ensures the operation to run smoothly and efficiently. Responsibilities should be clearly divided between the chairman and chief executive, and neither individuals should carry out the same job role nor should they be given any power to do so individually. Patisserie Valerie was known to have followed this compliantly however they were not as effective as expected. The role of the board is to manage risk and identify any possible fraudulent activities earlier to prevent possible bankruptcy. Patisserie Valerie made a delayed discovery of the ‘black hole’, and this is a clear indication of poor and possibly a corrupt leadership. Given the fact that the chief executive had stepped down when the accounting irregularities was discovered also concludes the possible involvement (Rach 2019).

Non-executive members of the board are expected to criticize the managements performance, this allows a non-biased view on the firm and controls that the goals of the company are met. Non-executive members have the power to appoint and if necessary, remove executives to allow smooth operation. Patisserie Valarie had a well-structured board however they had failed to monitor any risks (The UK Corporate Governance Code 2016).

Effectiveness

Patisserie Valerie had an effective team of board members and each member consisted of different specialties in order to aid the businesses success, as they had a strong portfolio of previous successes. The company has a mixture of executive and non-executive members on the board. However, although each member had their own specialty and previous experiences, they had failed to comply with risk management (Disclaimer – Patisserie Valerie 2019).

The chairman and head of finance had previously worked together on a business venture which was a great success, and this could be a possible reason why the financial reports were not being questioned in depth (Irvine 2019). The compliant procedure of hiring members of a board should be done via a nomination committee, this enables a fair evaluation of the individuals background and ability to assess any skills sets. However, the board members believed that due to the size of the board, there will be no need for a nomination committee and any decisions that takes place will be made through the board itself.

Accountability

Accountability is a crucial part of governance within any company, it enables directors to monitor one another and ensure all board members are compliant and have the same interest for the company (The UK Corporate Governance Code 2016).

Patisserie Valerie has clearly failed to have any fraud prevention/detection methods in place and a as result the board failed to identify accounting irregularities and rectify them accordingly. If the directors within the firm had a strategy to monitor any risks, this would have possibly enabled the identification of two overdraft accounts being authorized by a single member of the board which also indicates a clear lack of communication (Parrish 2019). Directors are expected to monitor yearly reports and assess any potential risks that may occur to the company, this could affect any future performances or may have risks of liquidity.

Patisserie Valerie had a basic risk management strategy where they had only concentrated on risk of liquidation. The board should have implemented a fraud detection process and serious consequences policy. The initial fraud taken place was by signing off an overdraft, Patisserie Valarie should have had made sure that any borrowing or lending needs to be foreseen by two or more members of the board, if this strategy was in place for risk management the company could have prevented numerous accounting irregularities (Christopher 2019).

Due to the lack of communication and information provided between each other within Patisserie Valerie, the shareholders were not aware of the crisis they were in when the fraud was uncovered. There has also been a period off statement missing which could have put the shareholders at ease but the whereabouts of this is unknown. If the directors had communicated all issues with the shareholders from the start, there could have been a possible chance in saving the company from going to administration. (Butler 2019)

Another example of failure within accountability is where the CFO of the company had overstated the accounts to make the company’s performance look positive which provides false information to investors and influences the stock market incorrectly where the accounts were overstated by £94M (Croft 2019). Tesco had a similar incident. Overstating accounts for companies are a common fraudulent activity which occurs within companies whether or not it is intentional for example, Tesco had overstated their accounts by approximately £250M (Oakley and Felsted 2019).

Remuneration

Remuneration committee should consist of two non-executive separate to the board members. Patisserie Valerie has their own remuneration committee with two non-executive members, Lee Ginsberg and James Horler, however, the committee is chaired by the company chairman (Disclaimer – Patisserie Valerie 2019). Directors should not be involved in the decision making of their own remuneration, having the company chairman being the chair of the committee could possibly affect any decisions made for himself or may even affect any decisions made on other directors of the board. The chair of the committee should be an independent non-executive director and they are required to attend yearly meetings with shareholders to answer any concerns they may have. Having the chairman play the same role as the chair of committee may cause conflict of interest which may affect the decisions made along with any remuneration to other directors (Nomination and Remuneration Committee – Terms of Reference 2019).

The directors of Patisserie Valerie were paid through short term employment benefits and share based payments. Paying directors through shares make them more involved within the company; the more shares they have the more they’ll be getting paid.

Relations with Shareholders

The mutual understanding is between board members and the shareholders is creating long term value for shareholders and putting in place tactical methods to efficiently manage and achieve objectives. This has been successfully achieved as the 191 premises has been open within 11 years with an increased revenue of £109m (Disclaimer – Patisserie Valerie 2019). Although the directors and shareholders have mutual understanding, shareholders were not informed or even consulted to when the CFO and CEO were awarded million pounds of share bonuses and this goes against other principles of governance such as accountability, remuneration and leadership (Cocco and Mooney 2019).

Although Patisserie Valerie had complied with most of the code of governance, they had failed to meet all relevant provisions. If the company had a strategic leadership in place, they would have been able to identify all illegal activities being performed. It is the director’s responsibility to identify any fraudulent activities at an early stage and deal with it. There have been two directors in particular who have been working together and violating the code of governance, the CFO and CEO. The CFO manipulated the accounts to show more profitability as well as signing off two ‘secret’ bank overdrafts and they have both been paid share bonuses without other shareholders having any knowledge of this. This is clear evidence that other shareholders and board members were not managing one another, and no questions were being raised. If Patisserie Valerie had complied with all the provisions, they would have been able to monitor all activities carried out within the company and ensure everyone’s interest is the same, which is to maximize shareholders value and company value.

External Auditors

An external auditors’ duty is to analyze reports being conducted by the company accountants and ensure no officer of the company has manipulated the accounts in any way. They are required to promote accountability to the firm and suggest possible consequences to any person who does commit fraud (Keith 2019). However, Grant Thornton, the external auditors for Patisserie Valerie, claims that is not within their duties to identify any fraudulent activities (Kollewe and Butler 2019).

The core responsibility of the external auditors is to ensure the company has relevant strategies in place to identify risks and eliminate those risks. They are also responsible for reporting any irregular activities to the relevant person (Financial Reporting Council 2019). Grant Thornton has failed to compliantly audit company financial reports. They had been the worst performer in the Financial Reporting Councils (FRC) annual review for the last 5 years (Farrell 2019). It may not be grant Thornton’s duty to identify fraud within the company or predict the future, but they have a duty to identify manipulated accounts. HMRC reports indicate that the auditors have simply completed the reports without properly analyzing the company and as a result has overlooked the existence of two ‘secret’ overdraft accounts, overstating accounts and outstanding balances with creditors.

Lessons Learned from the Collapse of Patisserie Valerie

There are a number of lessons to be learnt from the collapse of Patisserie Valerie. The initial lesson is to be cautious in a rapidly growing business and before investing into any such companies, to do substantial research into previous financial reports and assess whether or not the current reports are trustworthy. If there are huge rises in its revenue, always ensure to investigate in how the company has been able to accomplish this. Management within a small business differs vastly in comparison to a large business and this consists of employment of new management or more training for existing management. Although there may be a well-known successful investor, this does not necessarily imply security for the firm. All members of the board are required to have the same best interests of the firm. Risk management is a key control for any business - small or a large. Having knowledge of all activities taking place within the business is crucial as this enables you to monitor these activities and ensure they are being performed compliantly. In order to accomplish this, regular checks and spot checks should be carried out to ensure all procedures are done correctly and any person who is not compliantly performing given tasks should face penalties and possible dismissal depending on the extent. This would create a deterrent and encourage everyone to ensure they are following the correct procedures.

By prosecuting someone who commits fraud rather than just dismissing them or letting them resign prevent the person to from committing the similar actions.

If someone who commits fraudulent activities is simply dismissed or given the option to resign then they have the chance to carry out the same activity within another company

Companies should have to carry out an internal controlling strategy as a compulsory action and this is regulated by the FRC to ensure they are following their given duties. Internal control is vital for the company to be able to run smoothly with no downfalls. Having a nomination committee for the hiring process within a company will allow thorough checks to be conducted and to ensure the interests of the individual is aligned to the company’s interest.

Patisserie Valerie collapsed as a result of internal fraud committed by two officers of the board who have carried out these fraudulent activities for their benefit, and if the company had the correct measures of internal control in place, they may have identified this misconduct. However, the company directors and non-executive directors did not question other members intensely, this could be due to the fact the CFO was a well-known acquaintance to the chairman Luke Johnson. This is also another lesson to be learnt from Patisserie Valerie - to avoid any private relationship within the board as it could affect the judgement or influence decisions made. Prior to hiring any member of the board, intense background and knowledge checks should be performed and this would be a healthier option for the firms. The key lesson learnt from the collapse of Patisserie Valerie and other similar cases is to follow the code of governance to its full capacity which will ensures a level of security for the company and enhances the experiences for shareholders and directors, possibly even future investors as they have a reassurance the company is running compliantly and efficiently It is also important that any non-compliances are picked up immediately and risk management strategies are implemented to overcome critical consequences. All board members of a company have a responsible for the effective running of the business and therefore are held responsible for any downfall.