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The FSA has failed over Arch cru

The Arch cru debacle has not ended with the FSA’s arm-twisted £54m compensation package funded by Capita, HSBC and BNY Mellon.

There is no reason why investors who were conned into a deeply flawed product should suffer 30 per cent losses because of the incompetence of regulators and managers.

The story in a nutshell is that a bunch of ex-investment bankers persuaded a rent-an-authorisation auth-orised corporate director to set up an Oeic investing in unconventional investments. It did so by making those investments through “cell” companies set up as plcs listed on the Guernsey stock exchange. Because these cell companies were listed on a “recognised” stock exchange, they were eligible investments for an Oeic. The cell companies invested not just in private equity but also in shipping loans and other schemes that only invest-ment bankers could consider to be investments.

The whole structure was designed to sidestep the FSA’s rules that banned illiquid investments such as private equity being held within open-ended funds. If the regulators had looked through the form to the substance, it should never have authorised the fund. In line with the FSA’s general practice of mechanistically following rules, however, it did authorise it.

The ACD changed to Capita, which seemed oblivious of the compliance issues involved until the roof fell in. Capita claimed the cell companies were not their responsibility but it now seems the auditors of the fund consider that they should have been accounted for as part of the fund from the outset. If they had been, Capita would have been liable without limit for any and all investor losses, since the fund would have been in breach of FSA rules, which it is the ACD’s responsibility to enforce.

The FSA employs plenty of people with the qualifications and skills to understand the nature of the Arch cru scheme. None of these people took action to stop the authorisation of the fund, nor took steps to close it down when it became clear that it was in effect in breach of the FSA’s rules, nor did senior management of the FSA respond to well informed criticisms of the Arch cru fund by experienced senior fund managers. Take all this into account and you have to ask why anyone should believe that more intrusive regulation or regulation of product governance processes as proposed by the FSA will make any difference. If someone cannot use a revolver, why would you trust them with a Kalashnikov?

Arguing that investors who were “missold” the Arch cru product get compensation from the FOS or that the new compensation package gives investors most of their money back, are both inadequate responses to the issue of a toxic product that should never have been authorised. As a matter of public policy, the regulator should surely have launched a proper investigation into the allegations of impropriety that have been widely circulated concerning transactions within Arch cru funds.

The FSA’s approach remains that if people follow the rules, any problems are nothing to do with the regulator. This is a recipe for endless gaming of its process regulation by financial engineers and chancers, with the bills for failure allocated to the industry via the FSCS. Only if the regulator owns up to its responsibility for ensuring that authorised financial products pass minimum safety tests will it be doing a decent job of consumer protection.

Chris Gilchrist is director of Churchill Investments and editor of The IRS Report

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Comments

There are 22 comments at the moment, we would love to hear your opinion too.

  1. Refreshing to read such frank and accurate condemnation of the FSA and its role in this scandal.

    I am one of the 20,000 investors involved and, by coincidence, there is a letter in the post to my MP asking him to support his fellow MP Alun Cairns in raising this matter in Parliament.

    Hopefully this article will help in building pressure for a proper enquiry and force the FSA to “do their job.”

    As a result of this investment I have learned to my cost that the phrase “Regulated by the FSA” is no guarantee of anything and risk “profiling” – this fund was marketed as “low-to-medium” – for small investors like myself is a complete waste of time.

    As for Capita and their role in this, words fail me!

  2. The investment bankers knew exactly what they were doing and if they are not in jail already should be facing long Jail time.

    Capita…..nothing surprises me anymore and the more and more the industry rely on them for servicing the bigger the risk of total collapse there is.

    The FSA. If they stopped employing public school boys/girls with double and triple barrelled names and tried to recruit individuals from the industry (life office or advisers) with knowledge of how companies actually operate they will never get to the heart of what is rotten in this industry.

    “Investment bankers” is rhyming slang for a reason!

  3. David Trenner - Intelligent Pensions 4th July 2011 at 1:03 pm

    Good article. Now lets see what Mr Sants has to say …. I am not holding my breat!

  4. David Trenner - Intelligent Pensions 4th July 2011 at 1:13 pm

    Or even my breath!!

  5. It’s also worth remembering that a “cautious” fund is unlikely to be cautious if it delivers returns of 2-3 times cash. If something looks this good, make sure you understand why and how before recommending or investing. There are still investments out there with remarkably similar claims and while high levels of compesation are being paid (Keydata etc) there’s little incentive to do the right thing.

  6. It’s simply another example of the incompetence of the cretins in the FSA. It’s that simple.

  7. Chrisopher Marsham 4th July 2011 at 1:18 pm

    At last the kind of appraisal of the FSA we have all been waiting for and have been blogging about for years. The same could be said for the FSA’s regulation of Key Data. As advisers and investors we naively assumed that the nature of the underlying investment(s) and credibility of the providers had been thoroughly assessed before allowing the ‘regulation’ tab. How wrong we were and are. I have been saying for years just because an investment is regulated by this body unaccountable to nobody, it does not mean it is either ‘safe’ or a ‘good’ investment. Gilchrist’s article is worth sending to all our MPs demanding an enquiry. After all Equitable Life investors finally got some kind of recognition just becuase EL failed to see that paying high WP bonuses were unsustainable as were selling ‘guarantees’ by the bucket load.

  8. The entities already identified above are certainly deserving of the blame. However, this does not absolve advisers who, if doing their jobs properly instead of trying to chase “too good to be true” returns, would/should have raised many red flags themselves before permitting their clients to invest.

    I know of one major UK fund platform that steadfastly refused to make these funds available for distribution due to the (now) obvious concerns over opaque underlying investments and lack of liquidity. This platform took a lot of heat from IFA’s who were demanding access to these funds thus demonstrating how little effort many (not all) advisers (plus those platforms who DID make these funds available) put into to vetting what is being recommended to clients.

    The FSA’s lack of credibility is a frequent topic of discussion on this board. So if everyone deems them so incapable then surely advisers have a valuable role to play as the “last line of defence” in ensuring that investments are suitable.

    Advisers deserving of the title should perhaps be a bit more willing to accept responsibility and less quick to point fingers.

  9. Not unlike Keydata in structure, you can legally run the following little scam, under FSA rules and with their implicit blessing. This drives a cart and horses through the whole pointless, yet expensive exercise that is regulation.

    Set up IFA Ltd, and get authorisation.
    Get loads of customers who are in on the deal to invest 50% of FSCS limit in shares from a single company.
    Write in reasons why letter that you guarantee a 100% return in two years.
    Take 10% of sums invested as commission.
    Sell the deal like mad to create your retirement pot for 2 years and then put Ltd co into liquidation.
    Either shares have gone up more than 100% by some luck or…the FSCS picks up the tab for your company in default. Clients must all get their principal plus their expected gain because those were the terms offered in Keydata/Icesave.

    There you are. Totally regulated so you have all the credibility the FSA want their seal of approval to give you; and losses fully reinsured under the compo scheme.

    Indeed, with the return of principal and (over-promised) return now part of the established compensation package, I can’t see why any investor would put their money on deposit or with NS&I, when you should look to find the maddest, most over-ambitious regulated product and have a punt on that.

  10. Anonymous | 4 Jul 2011 1:38 pm

    Please send me the brochure, it sounds too good to miss.

  11. A very thought provoking article by Chris and it would be nice if it had some kind of effect on the FSA, but I doubt it.
    If any adviser put some money in one of these OEICs, some is fogiveable, but a bucket load is another matter. I have some clients we advised to place monies in Keydata, but none with bucket loads.
    It does however beg the question as Chris has raised, whether the label “authorised and regulated” has any value. If the FSA are a risk based regulator, surely the bigger the risk to the consumer (ArchCru and Keydata), the more important it is the FSA actually look underneath the bonnet to ensure a firm which handles client monies (such as the above named) actually have put the 2 litre engine in and not just a sewing machine and pocketed the rest!
    This is what they shoudl have been doing, rather than farting about looking at the minutiae of what an individual IFA or IFA firm does. Now they are trying to make the purchased accept a 1.1 litre engine replacementm, rather than make sure they correct engine is located, purchased and fitted OR give the consumer his money back.
    The damage has not been done by IFA oversight, it has been done by those authorised to handle client monies who have been negligent at best and complicite at worst (And that includes the FSA itself)

  12. Yes, all rather sad reading:

    Completely agree with the sentiment expressed. All that is required is financial engineers able, but sufficiently lacking in integrity, to put investment schemes or scams together to avoid the attention of the FSA, because such schemes are legally permissible.
    The FSA refuse to get off the fence and regulate products in any way.

    A regulator which does not regulate is unlikely to lead to faith in investment markets or help consumer protection.

    The bail-out or safety valve, is the FSCS levy which is a poor substitute for proper regulation.

    By the way, does any one understand the KPI’s behind Mr Sants excessive performance bonus? The corporate integrity aspect, or lack of it also appears to be part of the regulatory problem.

    For a free-market liberal investment environment to work, there must be appropriate checks and balances. If we don’t wish to adopt and implement these as a society, then we are only a shade of grey away from the sort of society that is in turmoil in the Arab Spring.

    Anyone for taking to the streets? Bring your smart phone and start recording!

  13. Julian Stevens 4th July 2011 at 9:14 pm

    Since when did the FSA own up to responsibility for anything that’s gone wrong on its watch? Never (except for a few belated crocodile tears from Adair Turner over RBS).

    And the FCA will be just as bad, because the government has already announced that it will be accountable solely to its own board which, of course, means accountable to absolutely nobody.

  14. If the regulators had looked through the form to the substance, it should never have authorised the fund.

    The FSA employs plenty of people with the qualifications and skills to understand the nature of the Arch cru scheme.

    The FSA’s approach remains that if people follow the rules, any problems are nothing to do with the regulator.

    I have no truck at all with ‘holier than thou’ comments by individuals such as Clive Moore, and claims handlers telling people to go round suing their IFAs.

    These funds were IMA Cautious managed, along with many others, FSA approved, along with many others, and Capita managed compliance, along with many others. Buyers expect some level of risk knowing these compliances are in place, but what happened, happened because in around 8 years, not one compliance officer got off their backside to investigate this operation.

    Applying Chris Ghilchrist’s articles to other life.

    If one is building a new aircraft such as the Boeing 787 Dreamliner, the certifications are fierce. FAA regulators comb through looked through the form to micro-inspect the substance, and if they say no, the plane doesn’t fly.

    The FSA abrogated that responsibility with these funds by not safety inspecting them in the same way.

    If the FAA then get involved in the aftermath of an air crash, they are deeply involved with, in fact take the lead on forensic examinations of compliances and the reasons behind them in case a check box here, or a procedure there was faulty. It clashes with the FSA’s approach that if people follow the rules, then any problems are nothing to do with the regulator makes them unfit to regulate anything.

    But since the FSA’s mission statement, and reason for being is contained in Howard Davies’ words “”The Financial Services Authority will aim to be a world-leading financial regulator, respected for its professionalism and integrity both at home and abroad” a judicial review will certainly determine this to be a failure of the regulator, let alone a failure of regulation.

    Let that review commence.

  15. Another Pissed Off IFA 4th July 2011 at 11:17 pm

    In a society in which the victims of crime are victimised by the criminal justice system does anyone honestly expect the FSA to actually try and stop things like the Arch cru affair?

    The idiots at the FSA get paid handsomely whether they do anything useful or not.

    Dream on.

  16. Retired CF Arch Cru Investor 5th July 2011 at 10:08 am

    Bravo Chris !
    The apparent “Take It or Sue us” Deal cooked up by the FSA&Capita is an apalling prospect for the many retired and elderly Investors who believed their savings were invested in Low Risk/Absolute Return/Secured / FSCS-FSA supported Capita supervised etc funds.
    If the FSA and a FTSE Company like Capita cannot be trusted to protect elderly savers without the worry of having to contemplate individual legal action to simply get their money back ,who can ?
    Like many others we have approached our MP in the hope that both the FSA and Capita will be encouraged to offer rather more Fair & Reasonable compensation —after over 2 years of “Investigation” !

  17. If the Food Standards Agency approved a food product for consumption which turned out to have toxic effects on the customer, the media would surely seek an enquiry or at least heads to roll.

    Oh that our regulator had to face some responsibility for its own failures.

    IFAs, however, were the “shopkeepers” on this sale and cannot expect to get off scot free for recommending a product that was too good to be true.

  18. When advisers were recommending these products to their clients I suspect that the due dilligent process was lacking. When you recommend funds to your clients you must know what they are invested in. If you do not and I suspect that most advisers that did recommend did not know what these funds were. It was prehaps a quite call up of first quartile funds on Trustnet or whatever and plonk them into the clients portfolio. This appears to be quite common practice and is not acceptable. You must know about the funds you are investing your clients money in and a factsheet from Trustnet or provider is not enough. If advisers are not prepared to do this then they should be sub contacting thier investment business out to those that do. If you know what the funds are investing in then you will know if it is suitable for your client. advisers who invested in the funds should be having a closer look at thier client files to see what process was done to recommend these funds. I suspect that there was not much thought put in.

  19. Steven Farrall (Adviser Alliance) 6th July 2011 at 2:15 pm

    It’s not that the FSA has failed over Arch Cru, it’s that the FSA has simply failed – as we predicted it would back in 2001. Central planning always fails and all functionaries as institutionally ignorant. The vast majority of ‘the market’ knew Arch Cru was rubbish and avoided it. If investors again bought something that was clearly too good to be true why should anyone bail them out?

  20. Dathan Steele 8th July 2011 at 6:53 pm

    @ Steven Farrall. ‘….If investors again bought something that was clearly too good to be true why should anyone bail them out?’.

    Err, because they were ADVISED to buy the funds, by IFAs who were supposed to be professionals following a compliant process. They were buying a UK regulated fund, which was supposed to have all the protections of an OEIC structure…… and overseen by the UK regulator.

    This will put the man on the street off investing, as they will see the corrupt city backed by an incompetent ‘regulator’ as something to avoid at all costs!

  21. Good article by Chris but it is still missing the point to an extent. Yes the FSA should be responsible for carrying out due diligence on new funds and ensuring the appropriate risk warnings are displayed in a clear and succinct manner. However let’s not forget private equity can be a fantastic asset class and play an important role in a client’s portfolio if used correctly. It’s just like property which is authorized but most certainly not liquid. Please don’t stamp on the asset class because the more asset classes means more diversification and less risk which is the number one rule to pragmatic and rewarding portfolio management.

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