How much can advisers really be expected to know about problem investments before they turn sour?
Keydata and Arch cru collapsed separately six years ago, but important new details about who and what caused the multi-million pound failures are still filtering out.
Advisers were among the first to be blamed, if not for causing the investments to collapse, then for the depth of the impact the failures had by mis-selling the investments, on the grounds they should have known they were high risk.
Keydata’s Latest Truth
The latest ‘truth’ about Keydata – which sold bonds invested in second-hand life policies (charmingly referred to as ‘death bonds’) before it collapsed in June 2009 and cost the industry almost £400m in compensation – is that its finance director hid the investments’ performance problems.
Craig McNeil was “masking problems” with the bonds, issued by Luxembourg firm SLS and sold under the Keydata brand, from the then regulator, the Financial Services Authority (FSA).
That’s according to its successor, the Financial Conduct Authority (FCA), which in September fined McNeil £350,000 and banned him from working in financial services for life.
The FCA has also indicated it plans to fine former Keydata chief executive Stewart Ford £75m and ban him from any role in financial services for errors related to the investments’ sales and, ultimately, failure.
In the FCA’s opinion, Ford, Keydata sales director Mark Owen and compliance officer Peter Johnson, also misled the FSA on a number of occasions in relation to the performance of the investment products.
They also sold the failed products as eligible for ISA status when, in fact, they were not. This ultimately contributed to the investments’ failure, the FCA said.
McNeil and Ford have come out fighting.
McNeil is calling the FCA’s ruling “a stich-up”, claiming he did notify the FSA about SLS and blaming Keydata’s problems on “an elaborate fraud”. Ford is appealing to the High Court against the fine and counter-suing the FCA and administrators PwC for £700m.
But the question has to be, if Keydata was hiding poor performance and investment eligibility from the regulator, as the regulator now says it was, could retail financial advisers be reasonably expected to discover that as part of their due diligence before recommending the bonds?
And was Keydata inherently high risk, or high risk because everyone involved in its management were, according to regulators, on the fiddle?
Arch Cru Claims
In light of similarly new evidence, near identical questions can be asked in respect of that other massive financial failure, Arch cru.
In August, blame for Arch cru fund pricing errors – a fatal flaw at the heart of the £350m investment failure – was laid at the door of the fund’s administrator, Bordeaux.
For its part in the Arch cru scandal, the Guernsey Financial Services Commission (GFSC) – where the fund was listed – fined Bordeaux £150,000, and its directors Peter Radford, Neal Meader and Geoffrey Tostevin, £50,000, £30,000 and £30,000 respectively.
Prior to Arch cru’s collapse in March 2009, financial advisers and potential investors in the absolute return fund range were shown impressive performance graphs, with a diagonal, straight line travelling from the bottom left corner to the top right representing the fund’s continually rising net asset value (NAV).
But the NAVs on display, produced by fund administrator Bordeaux, were inaccurate and “not properly reflective” of the actual value of the fund, the GFSC found.
This means that, during 2008 and 2009, investors and potential investors were not given up to date information on which to base their decisions, and so continued pouring money into an investment that one of its creators, Jon Maguire, apparently knew was in enough trouble in November 2008 that he pulled his pension out of it.
So the question becomes: how much could advisers be expected to anticipate or discover about the false NAVs in their due diligence?
Sound Due Diligence?
Given the action taken against advisers who sold Keydata and Arch cru, such as being chased by lawyers for the FSCS and fined and banned by the FCA, the answer to that question seems to be (in the eyes of regulators at least): they should have known.
If that is the case, advisers’ understanding of what constitutes sound due diligence needs an overhaul to include deeper probing of investments.
The FCA is currently undertaking a review of advisers’ due diligence.
At the moment, its position is that advisers
- should conduct their own research on products and providers regularly;
- that they shouldn’t recommend products they don’t fully understand; and
- that they have “appropriate management information” in place to monitor the advice given for new or higher risk products.
Advisers who sold Arch cru and Keydata have been accused of over relying on shiny marketing brochures from the companies themselves and not doing even a basic level of due diligence.
But in light of the examples above, are we saying advisers can’t rely on any investments’ published NAVs?
And what about fraud?
The accusations of that crime in the case of Keydata remain to be proved, but last week sentencing finally took place in a case where the ruling has been made.
Richard Aston Clay and Kathryn Clark, the convicted fraudsters behind the Arck LLP investment schemes (Arck investment) – branded an “elaborate scam” by the Serious Fraud Office (SFO) – were sentenced to 12 years for defrauding investors of £50m.
However the FSCS has determined that financial advisers are liable for investors’ losses in the unregulated overseas property investment scheme, and has begun inviting claims.
One can argue in each of the cases – Keydata, Arch cru, Arck – that the investments in question were complex and unusual and as such deserved special attention before being recommended.
It has also been said that even more than a cursory glance at those investments would have revealed red flags that, if listened to, would have substantially reduced the fallout from the funds’ failures.
Alternatively it can be argued that all investments are in their own way complex and unusual – so do they all deserve forensic investigation to ensure the fund administrator is not plucking performance figures out of the air and the managers aren’t spending investors’ money on fast cars and expensive liquor?
Blame Game
Advisers were among the first to be blamed for mis-selling the investments, on the grounds they should have known they were high risk.
But high risk of what? Of fraud? Of deception? Of being a scam?
As more details of who did what, how, and when in the financial sector’s big failures are uncovered, the more questions need to be asked about where the finger of blame was first pointed.
And if, in light of this new information, advisers have a fresh case of their own to bring against those doing the pointing.
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