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Who pays for bad advice? Unraveling an IFA firm collapse

The case of a collapsed advice firm reignites debates over who should pick up the mis-selling bill

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.

FSCS failures

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.

Outstanding bills

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.”

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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.”

Next steps

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.

Richard_Hobbs_2014
Richard Hobbs

Expert view

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

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Comments

There are 12 comments at the moment, we would love to hear your opinion too.

  1. Julian Stevens 8th June 2017 at 9:46 am

    This article seems to go a very long way round the houses to conclude that the sales of these unregulated products weren’t covered by the firm’s PII. Thus, the firm was in breach of a fundamental regulatory rule whilst the regulator stood by and did nothing about it. So, of just what value is the GABRIEL system?

  2. As I have repeated so many times; what we should have is a system akin to the old Lloyds rules. Directors and principals of firms should stand guarantee in the event of PII not covering any claims. To this end they should have to show personal net assets of sufficient size and liquidity to match their obligations. £20k min solvency is a joke. I’m not saying that the assets have to be in the form of current Cap Ad, just that assets have to be declared in the Gabriel returns and be reasonably realisable. If that means having to sell the house (even if it is owned jointly) so be it.

  3. Regulator fines wrongdoers.
    Fines go into a redress pot.
    Pot pays compensation to affected clients (and other victims of regulated firms).
    Job done.

    The problem is that it makes sense, is easy to implement, provides for natural justice and keeps everyone happy. So you can see why it’ll never happen…

  4. “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.” – Except they’re unregulated, so what do you do if they’re not including the health warnings? (Which they won’t, for obvious reasons.) Call the police?

    • Julian Stevens 8th June 2017 at 11:42 am

      Any proposals to regulate or not regulate products are completely pointless. It’s ADVICE that’s regulated, regardless of what product is recommended.

  5. Richard Anderson 8th June 2017 at 11:28 am

    Its easy to blame ‘a rogue adviser’, but on the assumption that the applications were submitted through CIS, then by extension the firm condoned the investments. Where were the ‘systems and controls’?

    • Exactly Mr Anderson. If it was a “rogue” adviser, management must have failed to spot it. If they did spot it, did they turn a blind eye because their cut of the money was a bit too attractive to turn down? It doesn’t look great either way.

      I would be interested to know what proportion of firms that fail and call on the FSCS because they’ve peddled this junk are directly authorised and small(ish). My perception may be wrong, but I sense that this is where this particular risk lies and firms like this can go under the regulatory radar.

  6. The FCA should create and maintain a whole of market register of specified investments for retail investors.

    Product providers pay to register their products and will be fined/sanctioned if they promote an unregistered investment to retail customers in the UK. Financial advisers subscribe to the register and may not recommend any investment not on the register.

    Providers of ISAs, bonds and SIPPs may only admit registered investments into the relevant product for retail investors.

    Make it a criminal offence to advise or recommend any unregulated product to a retail client promoted by an unauthorised person.

    Unregulated investments promoted by an authorised person must be registered.

    Require each firm to have a four eyes sign-off.

  7. The problem at the heart of the issues are there is No Corporate Governance or professional integrity at the head of these organisations. This to include insurance companies and banks – who know they can pay their find to the Government and walk away. These financial institutions provide an Agency agreement to those who sell their products and as Principals under Law of Agency it is they, the Directors and Chairman and their shareholders who should foot all the bills. Instead we have a complex arrangement for blaming the advisers – who are “Agents” left to get on with it or manipulated to deceive.EG Endowmnent policies – which failed due to theinsurance companies engineering their premiums and No Disclosure of the actual returns ( They call the “actuarial calculations” at scottish widows. The victims call it deliberate deceit – Fraud by any other name – covered up by Regulators like the FCA as “agents ” for their Government. These con merchants are permitted to continue under the protection of the Government Agents FCA PRA PIA FSA and their like – whose management often go on to companies like Barclays Bank to be complicit in avoiding the Rules for Barclays profits ( this to include other banks ) It would appear to be a Government Rip Off as it is the Government who allow it change legislation to permit Fraud and make it appear acceptable. I do wonder where the Courts and Legal Systems stand in these situations. Are they equally corrupt ?

  8. It is pretty ridiculous how rogue advisers leave the mess for the industry to clean up. The FCA should be banning regulated advisers from giving advice on unregulated products/funds. There has to be a better approach to regulation for the clients’ and industry’s sake.

    • The problem isn’t UCIS per se. Some are actually pretty sound and, for the right client looking for a bit more diversification, can be quite suitable. The problem are:-

      1. a small number of firms recommending them without having conducted the necessary due diligence.

      2. Said firms often not having the necessary PII cover (so when the complaints start arriving they quickly go to the wall) and

      3. The regulator failing in its statutory obligations to identify and home in on such firms.

      If the regulator was doing its job properly, we wouldn’t be burdened with the costs of endless boatloads of uninsured liabilities being taken on by the FSCS.

  9. To be fair, bad advice, and the collapse of a company is not mutually exclusive, although in a lot of cases one does follow on from the other……now that IS the and should be the focus point !
    Regulation is broken (smashed) in this respect,

    Now cutting away the guff in the article, the head line is more than enough to raise debate….. who pays ?

    Quite simple; the clients of existing financial services firms.
    I know many fellow IFA’s like myself, increase charges to accommodate any levies. I get a bill, I pay said bill collected by a rise in charges to my clients….

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