The demise of London Capital & Finance has raised fears over FCA-regulated firms offering unregulated products
The way in which unregulated investments are promoted was thrust into the spotlight again earlier this year after the FCA told mini-bond provider London Capital & Finance to take down its marketing over claims it was misleading.
This led to the firm’s default, leaving 11,500 investors with combined losses of more than £237m.
Experts are warning this could be just the tip of the iceberg, so do the rules regarding investment promotion need an overhaul?
Loophole in the rules
An LCF investor who spoke to Money Marketing was confused about how she could be left without any entitlement to compensation when the company she invested in was regulated by the FCA, and appeared reputable and safe because of this.
The high-profile case not only exposed the FCA’s oversight of LCF, but also shone a light on a “loophole” in the Regulated Activities Order, which lets a regulated business conduct unregulated activities, such as selling mini-bonds, while
describing the firm as a whole as “FCA-approved”. Mini-bonds – loans issued by companies to raise funds – are a high-risk investment and are not regulated.
But the promotion of investments has to be in line with the FCA’s rules, and therefore be “clear, fair and transparent”. The LCF mini-bond promotions did not fit the bill. They falsely referred to high-risk mini-bonds as fixed-rate Isas.
The FCA had another issue with the LCF marketing. In a second warning to the firm, it said LCF gave “undue prominence” to the fact that it was regulated by the watchdog, compared with disclosures that the mini-bonds themselves were not regulated or protected by the Financial Services Compensation Scheme.
LCF is not the only firm to have done this, according to website bondreview.co.uk.
FCA chief executive Andrew Bailey has expressed “great concern” that some FCA-authorised firms use that status to claim credibility for unregulated activities, noting that “people are being misled by this”.
Probing the past
In light of the FCA’s activity, the watchdog is about to be investigated itself over how it handles promotions. The FCA board said it would commission an inquiry into how it dealt with LCF after it faced pressure to do so from MPs.
When Treasury select committee chair Nicky Morgan first called for the investigation, she asked for it to look into whether the FCA acted swiftly enough in its supervisory action against LCF.
While issuing mini-bonds is not regulated, LCF’s business was, and a closer inspection revealed that it lent money to a handful of firms, some of which had links to LCF.
Morgan suggested the FCA examine if retail investors understood the extent to which companies are regulated and the nature of mini-bonds in general.
Calls for compensation
Bond expert Mark Taber, who campaigned for bondholders in the Co-operative Bank crash, has called for the investigation to include a “customer-facing individual”. He was also concerned in the case of Co-op Bank that the FCA would not start its enforcement for four years.
According to the latest estimates from administrators Smith & Williamson, only 20 per cent of lost investments in LCF can be recovered.
The FSCS issued a note on March 6, saying that LCF investors would not be eligible to claim, as it understands transactions were made on a non-advised basis, which is an unregulated activity.
According to the administrators’ report, LCF representatives were trained not to provide advice.
A Smith & Williamson spokesman confirms the FSCS will be listening to calls, however, where advice may have been given.
Two action groups have been formed. The LCF Bondholders Group on Facebook, which is strictly for LCF bondholders, has 1,585 members. LCF – Action Group has 1,025 members and according to its description, is run by an administrator “involved in consumer rights protection, and there is a specialist lawyer in financial services giving advice about this and other similar situations”.
The group is currently coming up with possible ways to claim compensation.
Taber has called for a recovery fund for the victims out of the FCA’s pocket, if it can be proved that the regulator has failed.
Investors pay high price for misplaced trust
It was not the lack of FSCS protection that tripped most LCF investors up. LCF’s website was very clear that the FSCS did not apply. Investors were told by LCF that it didn’t matter there was no FSCS protection, because it lent money to hundreds of small- and medium-sized enterprises, and these loans were asset-backed, which lowered the risk. We now know, of course, that none of this was true.
That in itself just makes LCF your standard failed unregulated investment.
What makes LCF special is that it had been regulated by the FCA since 2016, and this gave investors a false sense of security and allowed the firm to take in more than £230m from over 10,000 investors.
The modern financial system can only function if the ordinary retail investor is generally willing to take on trust what FCA-regulated businesses say. Otherwise, most people would keep their money in jam jars and gold bars rather than banks, funds and insurance companies.
LCF took in £230m because investors assumed that they could trust what the company said as it was regulated by the FCA.
The FCA did nothing to tell them otherwise until December 2018, despite being warned about LCF’s activities from 2015 onwards.
“Brev” is the administrator of website bondreview.co.uk
Has the FCA learned lessons?
The high-profile LCF case prompted a backlash against the regulator. But has it learned from past mistakes?
When the FCA ordered LCF to withdraw its promotions at the beginning of January, it published a Dear CEO letter on its website, in which it warned mini-bond providers to comply with marketing regulations.
Last week, the FCA published another Dear CEO letter, stressing the seriousness of the situation, sending the letter directly to 23 mini-bond providers.
But with the line between regulated and unregulated activities blurred, can UK retail investors be sure their money is safe?
Money Marketing understands that last month, an IFA notified the FCA about a website called AssetBackedInvestment.com, which advertised mini-bonds, after he had found inconsistencies in its register number.
The website claimed it had FCA-authorised credentials, but also had disclosures that mini-bonds were not regulated or FSCS-protected.
One of the mini-bonds that Asset Backed Investment advertised on its website was issued for a company called New Coal Solutions.
New Coal Solutions’ website says: “Our licensed technology converts the toxic waste from coal production into high-performing artificial lump coal, while also upgrading it by removing non-carbon particles and producing a usable high-value product.” New Coal Solutions incorporated in 2017. Its annual report was due on 8 February, but it was late on its accounts by two months at the time of writing.
The missing reports were the first ones due from the company, meaning a potential mini-bond investor would struggle to assess the firm’s financial health or operation.
On Monday, the Asset Backed Investment website was taken down.
The FCA declined to comment on whether Asset Backed Investment was one of the 23 companies sent its Dear CEO letter, saying it does not comment on individual cases.
The administrator of the website bondreview.co.uk, who goes by the nickname of “Brev”, says: “It is possible the FCA had nothing to do with it, unless the FCA confirms otherwise. They may just have gone to ground.
“There have been dozens of these websites since the mini-bond gold rush kicked off.
“The fact that one has disappeared is nothing to celebrate, like the death of one head of the Hydra.”
Director, Red Circle Financial Planning
I first came across LCF in late 2018. I’m always very wary of such promotions offering high rates, but this one in particular because the risk warnings were buried and it highlighted that it was FCA-registered to give an added impression of security in its promotions.
It was that promotion that I, and others, reported it for at that time, and it was that, I understand, the FCA first investigated it for.
What it was doing was, on the face of it, not illegal. There is nothing wrong with selling mini-bonds if it is done correctly and the money raised is used correctly.
The problem here is it was not promoting them correctly and once the FCA looked into it, it found that the money was not being used correctly either.
I suspect other Isas using mini-bonds are doing the same but, as yet, have not been caught out.
I have notified the FCA of other businesses but, again, as it stands, we can only report when they breach promotions regulation, not any suspicions on how they are using the funds raised. Mini-bonds are unregulated so the FCA isn’t responsible or, indeed, interested in that.
As for compensation, there is no claim on the FSCS and that is entirely correct.
Why should anyone pick up the pieces if somebody invests in something like this?
That really would make it risk-free and then people could just invest in anything they saw advertised, safe in the knowledge that if it did all go wrong they would get their money back anyway.
I think we need LCF, and possibly a few more like it, to happen for the public to start to think a bit more before they shove their life savings into any old rubbish they see advertised online on Facebook or other social media sites.
If we pay compensation, it has to come from somewhere, either FSCS funded as now, or the government, hence taxpayers.
If the victims all receive full payouts, there is, I think, less incentive to pursue the crooks and thieves who have scammed and stolen the money, recover as much as possible, and then lock them up.