Shares in Slater and Gordon (SGH) continued to slide today after the firm issued an update to the Australian Stock Exchange (ASX) stating that two errors had been uncovered in the reporting of historical cashflow by its UK business.
The stock has crashed by over 40% in five days of trading on the Australian Stock Exchange, meaning that the paper value of the world's largest publicly listed law firm has more than halved in two months.
SGH's travails are also attracting a volley of negative analyst comment, with one hedge fund declaring that there are likely to be more 'cockroaches in Slater & Gordon's kitchen'.
Last Friday evening, SGH was notified that Australian market watchdogs intend to raise queries directly with the law firm following a 'routine’ review of Pitcher Partners’ audit process of SGH.
The law firm has engaged Big Four accountant EY to independently assess its responses to the queries, which are being lodged by the Australian Securities and Investments Commission (ASIC).
Last Thursday SGH shares dipped 17%, after it released a statement to the ASX in a bid to reassure investors following news that UK City watchdog the Financial Conduct Authority would investigate accounting practices at insurance business Quindell, which once claimed to be the world’s largest stock exchange-listed legal services firm.
Quindell disposed of its professional services division - including its legal section - to SGH in a £637m deal completed last month.
In a market update on Monday, SGH stated: '[SGH] and Pitcher Partners have commenced a detailed analysis of the financial information to be provided to ASIC. In the course of that initial analysis, a consolidation error in the reporting of the historical UK cashflows has been identified.
'The company has been advised by its auditors that the usual way of dealing with such an error is a note affixed to the FY15 Financial Statements.’
The errors relate to the method used to report receipts from customers and payments to suppliers and employees dating from Slater’s acquisition of Russell Jones & Walker in 2012. A second error concerned the recording of VAT in receipts from customers, the update said.
A draft of the disclosure is included in the statement, but SGH stresses that net operating cash flows as reported remain unchanged, as do the consolidated statements of comprehensive income and financial position.
SGH said it intends to provide an update to the market on EY’s assessment in July. The law firm also stressed that, because it did not acquire Quindell plc or Quindell’s common stock, it is ‘satisfied’ that any findings made by the FCA against Quindell will 'not expose [SGH] to any material financial risk’.
SGH shares, which were trading close to A$8 as recently as April, closed down 25% on Monday at A$3.78. They fell a further 6% by the close of trading on Tuesday to A$3.56.
Sydney hedge fund manager VGI has alleged that 'there is more than one cockroach in the kitchen' at SGH.
VGI partner Douglas Tynan told the Australian Financial Review that there is likely to 'be more to come' from SGH, describing the company's revelations of an error in the consolidation of the accounts of the UK operation as 'a highly unusual accounting error'.
'It's highly unusual to see an accidental mis-statement in the cash receipts from customers that coincidentally is the exact same number as the mis-statement in the cash payments,' Tynan said.
He said the errors went to the heart of the questions over the way SGH recognised revenue and had aggressively grown its amount of work in progress (WIP) in recent years.
'The company now acknowledges that cash receipts from customers have been overstated, which means they haven't been as successful at converting WIP into cash as the market previously believed. That naturally brings all of the WIP accounting into question,' he added.
The global fund manager said in a presentation that it was shorting the company's shares after uncovering what it alleged were at least 10 key red flags relating to the company's accounts.
The report alleged that these include aggressive revenue recognition; growing balances in work in progress, receivables and payables without growing cash; aggressive valuation of goodwill; poor cashflow; and long-standing auditors and management.
A Slater & Gordon spokeswoman said the company would not comment further due to the process under way with ASIC.
UBS analysts, meanwhile, said that until the findings of ASIC's investigation are provided, forming a view on SGH's 'underlying earnings and valuation is challenging'.
Deutsche Bank's analysts were relatively positive, maintaining their 'buy' rating on the stock 'notwithstanding the near-term risks associated with the ASIC queries and the disappointing accounting errors'.
* This story was updated at 10.15am on Tuesday