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Distributor diligence

Questions are being asked about the due diligence required of distributors in the structured product chain after the Serious Fraud Office launched an investigation into £103m of missing assets invested via Keydata Investment Services plans.

It follows the discovery by administrator PricewaterhouseCoopers that income from £103m invested in Keydata plans with Luxembourg investment vehicle SLS Capital had not been paid since October 2008.

The income shortfall had gone unnoticed by investors as it had been topped up by Keydata’s own corporate funds.

After the CF Arch cru debacle which saw cru, as primary distributor, bear the brunt of concerns and questions from investors and advisers following the suspension of the fund range. Now it is Keydata’s turn to face some uncomfort- able questions.

In a statement issued on Tuesday, Keydata distanced itself from SLS, saying: “Like a number of other UK distributors of structured products, Keydata was only a distributor of the SLS bonds and is not and never has been connected in any way with SLS or its owners or managers.

“Nor is Keydata in any way connected with the various other counterparties involved in the SLS bond issue, such as investment managers, custodians, listing agents and bond registrars.”

Keydata positions itself as an “innocent victim”.

But according to Baronworth Investment Services director Colin Dickson, as distributors, Keydata directors had a duty to oversee clients’ investments. He says: “They have said they are an innocent victim but they were directors of Keydata and it is their duty to do their best to make sure things like this do not happen.”

Keydata directors emphasised they have co-operated fully with the regulators and the joint administrators on the matter.

According to the FSA’s treating customers fairly outcome three, regulated firms must ensure: “Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale.”

Whether or not Keydata had the interests of its clients at heart when it covered the income shortfall, should investors have been informed?

When questioned by Money Marketing as to why it did not disclose issues about income to the authorities or to investors, Keydata says a clause in its contract with SLS Capital put in place by David Elias, the former head of SLS, legally allowed SLS to delay making quarterly income payments by up to 90 days.

Keydata says it covered an income shortfall to investors after payments were delayed from SLS Capital to prevent them “losing out” during the gap.

It says it was receiving quarterly payments from SLS Capital, albeit late, and was not aware that money had disappeared from the products.

Keydata says that upon questioning SLS Capital over the delays, it was “thrown back legal answers, saying ‘We can do this’ because it was contractual.

A Keydata spokesman says: “Keydata had an obligation to pay the income within five days of the due date for investors. MeesPierson (the custodians of the bond and the registered payment agents) were given 20 days to pay and so there could be a lag.

“This is a moot point in that October 2008 income and the next payment was paid, but very late. The March payment from SLS was likewise very late but events have spun out since then to make it sort of obsolete.

“In January 2006, Keydata had to make a payment when MeesPierson was late, so it was not just a David Elias issue.”

A leading product development consultant, who did not want to be named, says: “While the legal mechanics might be technically interesting, I am sure it is scant comfort to investors. It sounds highly unusual to set up the contracts behind a retail offer in this way.”

Chelsea Financial Services managing director Darius McDermott says: “I would certainly expect a distributor to do the appropriate due diligence on any form of product they are taking to market, otherwise, their own reputation is at risk.”

Keydata says when the bonds were presented to the firm, David Elias was the global distributor through BWT Capital, which owned the special purpose vehicle SLS Capital.

It says: “At the time the SLS capital bond was created and presented to Keydata, the then investment manager CRT Capital had a controlling 55 per cent shareholding.

“David Elias was the distributor, not the controller, and so due diligence concentrated on the structure of the bond, the trustees, the custodians and on CRT as the majority share-holder of BWT and the investment manager.”

If Keydata dug into its own pockets to put money into a solution for investors, can it now avoid blame for lack of oversight in the failure of these plans?

Lowes Financial Management managing director Ian Lowes says: “You can buy all the insurance in the world and put all the best locks on your house but if someone wants to break into it they will.”

Lowes says the risks to capital posed by the secure income bonds were unquantifiable and he discouraged clients from the plan.

He says: “The due diligence sounds reasonable but this just underlines the need for financial advisers to be cautious. Remember, if it seems too good to be true, then it very possibly is.”

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