A rogue adviser that opened up a firm to more than £1m in compensation claims has reignited the debate about who should pick up the tab for bad advice.
Central Investment Services (Aberdeen) was declared in default by the Financial Services Compensation Scheme in 2015.
A recent insolvency report for the firm, seen by Money Marketing, details the myriad difficulties in repairing the company’s finances after an adviser missold unregulated investments. It also suggests the adviser has avoided any personal liability.
As a case study, it shows how the combination of the Financial Services Compensation Scheme, the professional indemnity insurance market and FCA rules have failed to return total losses back to investors and creditors, and serves as a microcosm of the wider problems the advice sector faces in handling liabilities for poor advice.
Central Investment Services did not respond to repeated requests to comment.
Tracing back a firm’s collapse
Central Investment Services was set up in 1973. After it was declared in default by the FSCS, a new company was created called Central Investment Services (Scotland). This firm reported a £256,148 profit in 2016, with nearly £600,000 in capital and reserves. Its website lists seven advisers and four directors.
The insolvency report says former director John Moore caused client losses through misselling unregulated investments. Central Investment Services entered an insolvency process known as a company voluntary arrangement with its creditors in 2014.
The report states: “Creditors may recall…the unauthorised misselling activities of a former director of the company, John Moore, in respect of the sale of unregulated investments resulted in a comparatively small number of the company’s clients suffering significant financial loss.”
The report says the company would have failed if all these clients decided to make claims against it on or around the same time.
Moore’s position as a director was terminated in August 2013, according to Companies House records. However, the problems he created are far from over.
A total of 60 claims to the FSCS have resulted in more than £1m in payouts to investors, despite 21 being rejected. Nine were still under assessment at the time of the report.
That means the average payout is just over £33,000. The FSCS limit for investment claims is £50,000.
Apfa council member and Richmond House Group managing director Paul Beasley has long campaigned for unregulated investment sales to be taken out of the FSCS’ scope.
He argues this is the “latest in a long line” of similar cases in the wake of the Keydata and Arch cru sagas.
He says: “The FCA continually rejects our proposal for unregulated to mean exactly that. Such products could carry prominent financial health warnings that make it clear to the investor that the status of the adviser is not relevant as there is no protection if it goes wrong.”
National advice firms such as LEBC have also called for unregulated investments to be taken out of FSCS protection entirely.
As part of its consultation on the future of FSCS funding last year, the FCA estimated a third of all FSCS claims stemmed from what it terms “non-mainstream pooled investments”, including unregulated collective investment schemes.
The regulator has also issued an alert to advisers about how to deal with unauthorised introducers.
The FSCS says removing unregulated investments from the scheme or how to reform the PI market are matters for the FCA.
The FCA says it is continuing to investigate links between unregulated investments and the FSCS as part of its work on reforming the compensation scheme’s funding.
Total claims from Central Investment Services set out at a creditors meeting in 2014 amount to more than £40m. Under the company voluntary arrangement, the firm proposed setting aside some of its assets to pay back the creditors.
It would do this in five ways:
- Through a minimum contribution from its own profits of £400,000 over three years
- Through selling the company’s shares in Nucleus Financial Group and holding company Nucleus IFA Company
- By issuing £500,000 in new share capital
- By seizing Moore’s assets
- By claiming on its professional indemnity insurance policy
But according to the insolvency report, few of these avenues look to be a successful prospect for creditors.
The firm is on track to pay out the minimum profit contribution, having paid at least £175,000 to date in £25,000 quarterly contributions. Yet the other revenue streams look to be either delayed or unlikely to materialise.
First, the Nucleus shares. Central Investment Services holds 10,000 ordinary shares in Nucleus Financial Group, with an estimated value of £443,500. Its holding company shares are estimated to be worth around £333,000.
Restrictions mean the Nucleus Financial Group shares could not have been disposed of until June 2016 at the earliest – 22 months after the firm entered its company voluntary arrangement.
The insolvency report says: “As the Nucleus Financial Group shares are not listed, the market for this shares [sic] is extremely limited.”
The bigger problem is with the holding company shares. The report notes that, unless Nucleus undertakes an “exit” event, for example, an initial public offering or being bought out by another company, the value of the shares cannot be transferred to a third party.
The report says: “We understand from Nucleus that, at present, there are no current proposals for an exit.
“As the value of the holding company shares could be restricted and Nucleus has no plans for an exit, valuing of the holding company shares at nil would seem prudent.”
Nucleus business development director Barry Neilson argues while shares in the platform are illiquid, this is not a significant problem for advice firm finances. He suggests firms will have taken stakes in Nucleus and other platforms such as Novia and Transact to impact on the strategic direction of the platform and not mainly to make profit from them.
He says: “We have all the restrictions and difficulties of transacting shares any private company would have. There clearly isn’t a market there. But we haven’t seen any great demand from our adviser investors for us to create liquidity.
“Shareholders understand we are focused on growing the business organically. All the advisers will be well aware the shares aren’t liquid. Most of the firms we deal with are successful in their own right and will have a number of shares that are likely to be immaterial in the context of the value of their business.”
On issuing new share capital, this was meant to have taken place within six months of the company voluntary arrangement. However, while “some preparatory steps” have been taken, this is now likely to be happen ing towards the end of 2017 as opposed to early 2015 as originally intended.
Seizing Moore’s assets to pay back debts has not gone to plan either. Despite having obtained a court decree for £225,000 from the former adviser, EY, which is managing the company voluntary arrangement, has been told by Moore’s trustee that “it is unlikely any funds will be available for distribution to ordinary creditors”.
EY says: “Regrettably…the supervisors are of the view that no funds will be received.”
The professional indemnity puzzle
Finally, the PI insurance will not be paying out either.
The insolvency report reads: “The extent of the company’s PII for the client losses arising from the misselling activities is likely to be extremely limited.
“The supervisors discussed the position with the company’s legal advisers and it was concluded there is very little likelihood of a successful outcome in pursuing a claim under the company’s PII.”
PI broker 03 Insurance Solutions managing director Jamie Newell says exclusions in PI policies frequently hurt advisers facing financial difficulty.
Newell says: “There’s no minimum standards set in place by the FCA, so the insurer is free to put in certain exclusions. What a lot of advisers do is get their PI quote, look at the premium that’s the lowest and go for that one. But there’s a huge amount of difference.
“The majority of the insurance market has become commoditised, but you may have an agreed policy per individual risk as they see fit.”
The FCA is reviewing the PI market as part of the FSCS funding review, and has also flagged issues with policy exemptions, affordability and excess payments.
In its FSCS funding consultation, the regulator said: “Our analysis so far shows there is justification for strengthening PII, particularly for personal investment firms, for example through the use of mandatory terms.”
EY has incurred time costs of £153,386 for managing the company voluntary arrangement. It says it continues to believe this route is a better option for creditors than either full administration of liquidation.
Central Investment Services continues to give advice through the same brand, but with an official entity change to Central Investment Services (Scotland).
The directors of Central Investment Services also appear to have set up a new advice firm called Pacific Shelf 1788.
Pacific Shelf was incorporated in 2014, a year before the FSCS declared Central Investment Services in default. The firm has four of the same directors: Derek Robertson, Michael McAnulty, Grant Ronald and William Ellis.
Former Central Investment Services directors Graham Cobban and John Bremner also own shares in the new firm but are not listed as directors.
Money Marketing research last year found nearly half of all FSCS defaults in the year to February 2016 involved firm’s whose directors are still listed as active on the FCA’s register.
The FCA has previously said the incoming senior managers regime will enforce greater accountability for individual liabilities.
Moore does not hold a regulated position in any other company, according to the FCA register.
Moore tells Money Marketing that the allegation of mis-selling in the CVA report was provided by Central Investment Services to EY “to divert blame”, and that he had never been accused of mis-selling or had a chance to respond to any allegation previously.
The EY administrator listed on the report could not be reached for comment.
This case is classic; it exemplifies the flaws in the system for which there are no solutions. This is a long-running sore. It is a gap in the chain of security, but there is no real way of fixing it. There is a rogue adviser. He has got through vetting, he has passed his exams and has become an approved person.
He does what he does and then disappears, leaving customers in the lurch. There are three potential sources of redress: the PI insurance, the assets of the firm and the compensation scheme.
There is nothing about PI insurance that can be as good as buffer capital. It cannot be, because if policy wordings are sloppy it means insurers would
pay out all the time.
But if advisers needed to hold the kind of capital insurers do, there would be no advisers.
What you end up with is a mutualised compensation scheme. And without a compensation scheme, there will be fewer clients.
I am troubled by the idea that people who have done nothing wrong should foot the compensation bill. It does not seem fair.
The only thing that is certain is there will be regulatory failure; the real problem is how a rogue adviser was able to get in.
Richard Hobbs is an independent regulatory consultant