The government should take responsibility after helping the firm create an air of official approval
When I lived in Kent, there was a ritual every spring called “beating the bounds”. The local vicar and some councillors would walk around the border of the parish to mark its extent. Some people would carry sticks and symbolically strike a hedge or a tree in a ritual that dated back to before the Norman Conquest. Beyond the parish boundary, there were dragons, and dreadful things might befall anyone who strayed over it.
Today, it is called the “perimeter” and the FCA has been asked to get out its sticks and check exactly where it lies. This year, it has left 11,625 people outside and the dragons have breathed fire over £237m of their money. For those inside, the parish alms box would make up at least some of their losses. Yet anyone outside is left unprotected, apart from a share of a few singed notes blown into the boundary hedges.
On May Day, the FCA issued a paper which opens the door for it to consider this perimeter. It is to begin the process of assessing “whether advice and guidance services meet current consumer needs and will do so in the future”. I prefer to call this paper “what customers of financial services want”. The answer is perimeter clarity.
Readers will be familiar with the egregious case of the dragon called London Capital & Finance, which took £237m off 11,625 investors and went into administration in January.
The administrator says they might get back 25 per cent of the money.
LCF sold investments which it called mini-bonds, saying the money would be lent to small businesses and their repayments would fund the promised returns to investors of up to 8 per cent. Some did indeed get their quarterly payments and were no doubt behind the 98 per cent Feefo satisfaction that LCF reported.
Unlike most peer-to-peer lenders, investors had no relationship with the firms LCF passed their money on to. So it would have been a collective investment, except that mini-bonds are excluded from that category.
However, a partner in the London office of US law firm Shearman & Sterling – who has an interest in the matter – has written a 10-page letter, explaining the products were never bonds at all because LCF had no intention of investing most of the money. A quarter of it – £58m – was paid to a PR firm, Surge, and Shearman says most of the rest was “dissipated” into items producing negligible returns, such as a helicopter and horses. LCF broke its contract so these products were not bonds and became regulated collective investments.
To solve this problem in the future, regulated firms should not be allowed to sell unregulated products, or the perimeter should be flexed so any product sold by a regulated firm is regulated.
Being regulated would bring these products into the scope of the Financial Services Compensation Scheme and allow redress for victims up to £85,000. However, it would not help the victims who invested in LCF. The solution to that lies elsewhere.
One reason people trusted their money to LCF was the claim, in big type at the top of webpages, that it was regulated by the FCA.
Investors were not told that this only covered financial promotion and advice, and naturally thought it gave them protection when the LCF call centre advised them – whether or not in a regulated sense – of how marvellous these mini-bonds were.
LCF continued taking money until the FCA stopped it on 19 December. That was more than three years after the FCA had been warned by IFA Neil Liversidge, and subsequently by others, that LCF’s figures did not add up. On 1 April, the FCA announced the government had ordered it to investigate its own behaviour.
The regulator was not alone in giving investors confidence in LCF. The firm got approval as an Isa manager from HM Revenue & Customs on 1 November 2017 and subsequently sold the mini-bonds as tax-free Isas. It was not until seven weeks after LCF went into administration that HMRC announced the mini-bonds were not suitable for an Isa. It added, unbelievably, that it would be going after investors for the tax due on any payments already received.
Guided by the twin lights of FCA regulation and HMRC approval, thousands of investors entrusted LCF with their money.
Three days after it received the letter from Shearman, the FSCS announced it was reconsidering whether it could compensate investors. If it does, who will pay?
Normally, it would be the good and honest financial advisers – including 4,500 independent advice firms – who are levied to pay for the misdemeanours of others.
Their levy from the FSCS is already high and if it does approve compensation, they could be levied again to cover the balance of the £237m. That would be wrong. Given the regulator and HMRC’s part in making these mini-bonds seem officially approved, the government itself – but not taxpayers in general – should fund the compensation.
Eight years ago, the Treasury started snaffling FSA/FCA fines for its own. Total fines since then exceed £3.5bn. In the first four months of this year, fines totalled £273m. The FCA deducts the cost of enforcement and collection before passing the money on, but there is plenty in the Treasury coffers from fines on the bad guys to pay compensation to investors who trusted LCF. If anyone should be levied to pay the cost, it is not the good, honest IFAs (OK, or restricted sales advisers) but the government and its agencies, which helped LCF create an air of official approval when it sold these products.
Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s Money Box programme. You can follow him on Twitter @paullewismoney