Sharks and phoenixes: How the FCA fails to sort the bad advisers from the good

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The FCA has been attacked over its “spineless” approach to dealing with directors of failed advice firms who later reappear in the financial services industry.

Money Marketing research shows nearly half of all firms declared in default by the Financial Services Compensation Scheme in the year to February 2016 had directors who are still listed as active on the FCA’s register.

The regulator recently signalled phoenixing is firmly on its agenda. Last month it blocked the directors of a firm facing insolvency from obtaining authorisation for another business that was to buy the assets, staff and clients of the failing company.

But concerns remain some former directors of failed firms who should never have been reauthorised are getting through the regulator’s approval process.

Regulatory experts are now questioning how well the FCA is monitoring the adviser market.

Directors on the move

The FCA does not prohibit former directors of firms that have entered into default from being authorised to work at another business.

Law firm RPC regulatory counsel Marcus Bonnell says: “Just because you have worked for a failed firm does not mean you cannot be approved to go and work at another firm. The issue is the extent to which you were culpable for that behaviour and the extent to which the FCA investigates why a firm has failed, to be able to establish if you are culpable for that firm’s failure.”

He adds: “The FCA is very concerned about obvious cases of phoenixing. Where somebody sets up a firm that fails and then goes on and sets up a firm that is almost an identikit version of that firm it does start to ring alarm bells for the regulator.”

Money Marketing has pored over regulatory data to establish where the directors from firms that went into default between March 2015 and February 2016 are now. Firms were identified through Financial Services Compensation Scheme statements and were mapped against the FCA register to see if any of the directors, partners or chief executives are now working elsewhere in the market.

During that period, 74 firms from the life and pensions and investment categories went into default. Out of the total, 30 of those businesses currently have directors active on the FCA register.

Of the remaining companies, nine were either still authorised or could not be found on the register while 35 firms had directors, partners or chief executives who are no longer active.

Of the 57 directors that have re-emerged, a number have taken on either adviser or director roles at major advice brands such as St James’s Place, Caerus and Tenet while others have set up their own businesses.

Several directors of businesses that were declared in default are now working together at different companies that were incorporated after their previous firm was deauthorised by the regulator.

What are the rules?

Much of the responsibility for due diligence on new recruits lies with firms themselves.

In its handbook, the FCA sets out its “fit and proper” test which a person wanting to carry out a controlled function at a financial services firm has to meet. The FCA looks at honesty, competence and capability, and financial soundness.

Companies wanting to have an individual approved must carry out their own due diligence before submitting an application.The information the FCA considers “helpful” includes regulatory references, qualification certificates, credit checks, criminal record checks, and directorship checks.

The regulatory reference should include information about any outstanding liabilities from commission payments and any upheld complaints.

The regulator is more hands-on when it comes to cracking down on suspected phoenix firms – those established overnight by the directors of a firm that has gone bankrupt.

Money Marketing understands there is a team at the FCA that monitors phoenixing to try and stop directors absolving themselves of liabilities before they are authorised.

A spokeswoman for the regulator says: “It is unacceptable if directors of regulated firms attempt to shirk their responsibilities by setting up new firms. This calls into question whether someone has the fitness and propriety to operate in the financial services industry. We have a number of tools at our disposal but identifying phoenixing is not easy.

“Where we have taken action against potential phoenixing it is usually through robust challenge at the application stage where about 10 per cent of applications are withdrawn. This figure includes concerns about a variety of issues, not simply those relating to phoenixing.”

Despite this framework, lawyers are urging the regulator to do more to monitor the movements of people who were formally at the helm of a failed company.

Bonnell says there are triggers that would make a firm or individual pop up on the FCA’s radar, such as complaints, but a lot depends on the intelligence the regulator holds.

Bonnell says: “It is right to say there are people who go on to work in another firm that, if the FCA had been aware of the reasons for the firm’s failure and their responsibility for it, they probably wouldn’t have got approved again.

“There are also a number of cases where individuals did not get approval after having been involved with a firm that failed. It is not something the regulator is blind to, it is about managing the intelligence it gets on a huge number of individuals.”

Clarke Willmott financial services litigation solicitor Laura Hazell says the regulator needs better procedures to identify the reasons why a firm becomes insolvent.

She says: “There must be warning signs where one business becomes insolvent and then the director pops up in another one.”

But she admits monitoring where directors from failed firms have gone and the new firms that are popping up in the market is not an easy task.

She says: “It is difficult because the FCA would not necessarily be aware of all of the claims and complaints. The firms do have to include contingent liabilities in their financials but they may not do so. The FCA is not necessarily aware of claims and complaints that go against the company or why it has gone under. It takes someone to bring that to their attention.”

Directors of failed firms seeking to set up their own business are likely to come under greater scrutiny by the regulator at the authorisation stage, which could lead to delays in the application process, according to Threesixty managing director Phil Young.

Young says: “If you were the sole director of a firm and you are trying to set up your own directly authorised firm it will be harder because it will be scrutinised a lot more. If you are going to join an existing authorised firm then [the FCA] will look to that firm to undertake responsibility for fitness and properness.

“It is likely to delay applications and it is something the FCA would consider. More importantly, they would expect a firm taking on a director to do their own checks and put together a case on why it will not be a problem going forward.”

SJP, which hired two former directors from firms that defaulted in the period of the research – one as a director and the other as an adviser – says it works with the regulators on recruitment.

A spokesman says: “In so far as our general recruitment policy, to ensure the fitness and propriety of the individuals invited to join the partnership, we have a robust due diligence process, which includes taking reference from and working closely with the regulators.”

Young agrees monitoring where directors of failed firms move to is challenging for the regulator because it will not always know the reasons for a firm going into default.

He says: “[The FCA] does not have the resources to do a thorough exit interview or an audit of the firms when they are designing their FCA permissions. It would be unreasonable to expect the FCA to do that because they will have to pay someone to do it as well.”

Phoenixing is also hard to identify where there is a fundamental change in the shareholders of a business and those new people have a “blemish-free” track record.

Young points to an intention to do wrong as being an important factor in a phoenixed firm.

He says: “There are a lot of firms accused of phoenixing where is there is no specific strategy to do that. The distinction for me is when people specifically put the company into liquidation with the plan of avoiding some future liabilities and then resurrecting and setting it up afterwards.”

Foot Anstey partner Alan Hughes adds it is common for directors of defaulted firms to go to a national firm as a self-employed adviser. But he argues this does not constitute phoenixing.

He says: “As an individual you buy the clients from the liquidator of your old firm and then own them as an adviser at a national firm. You own your client bank as an adviser. That happens all the time.

“If someone has gone bust you might pop up elsewhere as an adviser, for example if you went to a national firm as an adviser you might use a trading style that is similar to your old firm but that is not really phoenixing. That is different from setting up your own firm again.”

Adviser view

Mark Meldon

Managing director

Meldon & Co

I have never arranged anything to do with unregulated investment schemes and lots of colleagues have not either. Unfortunately the ones that have are the ones causing the problems for the good guys. It is unfair that those people can dump massive liabilities on the FSCS and then continue to practise. One has to question their integrity.

Expert view

Recently, former FCA acting chief executive Tracey McDermott gave evidence to the Public Accounts Committee. She suggested when the senior managers regime for advice firms comes into force in 2018 the FCA would be in a better position to deal with the problem of so-called phoenix firms.

That does not seem good enough.

The FCA, and the FSA before it, seems to have been spineless in dealing with the problem of phoenix firms and, as a consequence, good firms have had to pay for this regulatory failure through the Financial Services Compensation Scheme levy.

The FCA could take effective action now if only it was prepared to take the risk.

It actually lectures regulated firms to be “vigilant for what we call ‘phoenix firms’” seeking to join as appointed representatives, with the unspoken assumption that a firm should refuse to take on such an appointed representative.

Yet when it comes to the FCA itself a more liberal approach seems to be taken. As part of its authorisation process the FCA looks, among other things, at the “threshold conditions”, one of which is suitability.

In essence this means those involved with the firm seeking authorisation must be fit and proper and be expected to run the firm with probity. Surely serious questions must be asked by the FCA when it is dealing with people who have previously had close involvement with a failed firm, and have been content to see that firm’s liabilities dumped on the FSCS?

Stopping individuals who were culpable in a firm’s failure from getting back into the industry is one thing but the FCA could go much further. If it has no option but to let someone back into the industry, the regulator could at least seek to avoid the liabilities of the failed firm from being dumped on the FSCS.

The FCA could seek to do this by making authorisation of any new firm contingent on it taking on the liabilities of the firm which has failed, thus avoiding those liabilities becoming yet another burden on the compensation fund.

David Severn is a regulatory consultant and former FSA head of retail policy

Why do firms go into default?

There are a number of reasons why advice firms go into default – and not all of them are due to bad practice. RPC regulatory counsel Marcus Bonnell says one of the most common causes of failure is firms having a number of Financial Ombudsman Service rulings or Financial Services Compensation Scheme awards against them that will not be covered by professional indemnity insurers. Threesixty managing director Phil Young adds a firm might default due to financial difficulty, perhaps because it was not shut down properly, or because of a complaint against one member of the firm that puts too much pressure on the business’s finances.

What strain does this put on the system?

If a firm has gone into default then compensation will be paid to clients through the FSCS. Clarke Willmott financial services litigation solicitor Laura Hazell gives the example of film industry scams where advisers have sold bad investments and have later become insolvent. She says: “In an enormous majority the IFA [firms] that sold them no longer exist which means the only option is to go to the FSCS but those advisers are practising elsewhere.”