On the rare occasions a discretionary fund manager collapses, advisers are in for an nervy time. Are their clients’ assets safe? Will the failure trigger misselling accusations? There may also start doubting their own process. Did they do enough due diligence? Do they need to question their recommendation?
Smith & Williamson insolvency specialist Adam Stephens notes that while insolvency cases specif-ically relating to fund managers may be rare, they are not unheard of. There have been about 16 in history.
Stephens is one of the key specialists in the field and he has worked on two recent cases: Sipp specialists European Pensions Management and Strand Capital, the £100m DFM that entered the Special Administration Regime (SAR) insolvency proceedings on 17 May.
In many cases, investors will get back much of their capital. Yes, money may be needed to cover the insolvency process and it may be problematic managing the capital to everyone’s satisfaction in the interim, but the custodian responsibilities carry on regardless and in many cases, client assets will be protected.
Another reassurance, he says, is that not all companies are undone by mismanagement, so it is not necessarily something that advisers could have spotted.
Stephens says: “It could be something as simple as a large insurance claim, or an IT project gone wrong, or a fire, or something where the business didn’t have the operational capacity to cope.”
Stephens says DFMs may fail for a number of reasons: “First, the enterprise simply runs out of money. This is no different from an ordinary administration – the company is unable to pay its debts. The second is where the management is at risk of not being able to manage the funds under management adequately. Sipps and Isas have a lot of regulations around the way they are managed. Poor or inadequate management will likely trigger the involvement of the FCA. The regulator will seek to work to safeguard people’s assets as part of its responsibility, so it takes it very seriously when it sees an enterprise that can’t do it.”
Businesses are usually referred to him from a professional services firm such as an accountant or a lawyer. They will have an existing relationship with the DFM and will have advised the management team that they need to seek insolvency advice. Stephens must then do what he can to restore it to a financially healthy life.
This is considerably easier if a company has not left it to the last possible moment to seek advice. He says: “In many cases, if we got in earlier, we could sort it out in a more effective, and cheaper way. Shareholders and creditors would lose less.”
However, he admits it is a hard conversation to have with business owners and directors who may not want to accept their holdings are value-less.
Digging the managers out of trouble
So what happens first to rescue a DFM? “We sympathetically and empathetically engage with management who often don’t feel very comfortable talking with someone who appears to them as a company undertaker. We look at the cashflow and balance sheet – how bad is it? Can they pay their wages next week? How long have we got?” He says in some cases, it could be days.
Then, Stephens says, he needs to look at the current situation with the FCA, and whether there is pending litigation. “In financial services, the numbers can be very big,” he says.
“We’re aiming to look through all this to the cashflow. We discuss with management what their options are. That might include the transfer of an enterprise to another enterprise.”
This is usually the best option in terms of safeguarding client assets and client money. If this cannot be achieved within the timeframe, the enterprise will likely go into special administration.
The legal framework for this process was formalised around 2011 as policymakers recognised that the 1986 Insolvency Act was inadequate for some financial services groups.
It ensures responsibility for safeguarding client assets and client money, and proper liaison with market infrastructure bodies.
“There was a belief that the normal Insolvency Act wasn’t best placed to deal with client assets and client money, where assets were held on trust for someone else,” Stephens says.
Even when it goes into special administration, the option of a sale remains open and will, in many cases, still be the best course of action. This is what happened with European Pensions Management – which was bought by Curtis Banks last year – but has not been possible for Strand Capital.
Often, there is not an open-ended period of time to secure a buyer and FCA extensions have been exhausted. Then, Stephens will need to look at a wind-down of the business. He says: “We need to pool people’s assets together and distribute according to the rules. It is very prescribed.”
The insolvency specialist may recommend an appropriate transferee company. Stephens adds: “This is very a very time-consuming, and expensive process. There will be a client and creditors committee.
“The Financial Services Compensation Scheme will also be heavily involved – some people will be owed money under the rules.”
There will generally be three pots of money at the disposal of the administrator: the pot from any
indemnity or other insurance; the assets of the business; and the FSCS.
A hierarchy of needs
The rules over how these three pots interact are complicated, but are clearly laid down.
Stephens says: “In general, people lose money for a number of reasons such as misselling and the costs of the process. There may also be problems because assets haven’t been properly reconciled.”
If there is a client portal, for example, where clients can see their assets, this may not have reflected the right prices, so there may be an expectation gap. That said, he points out that for derivatives broker MF Global, the largest of case of this kind, some people got a full return.
Where there is potential mis-selling, continuing legal action can freeze it, allowing the administrators to focus on safeguarding client assets, rather than being tied up with litigation. It doesn’t stop people making a claim, it just won’t go to court in the short-term.
As part of the process, Stephens also has a duty to investigate the conduct of the management. He says: “I need to present a report to the Insolvency Service and it may result in management being disqualified from being a director. The FCA is rightly concerned about inappropriate people having responsibility for client assets and monies. We are looking for evidence of misfeasance, misappropriation of assets, preferential claims to creditors, or wrongful trading amongst other things.”
When is the process complete? For clients, it will end when money and asset have been transferred to someone else. The length of the process can vary enormously, but at the very least it will take months and could take a year or longer. For Strand Capital and its 3,000 clients and their advisers, they are still working through the process.