Two independent investigations into the Financial Conduct Authority’s (FCA) handling of the London Capital Finance (LCF) mini-bond mis-selling and the collapse of the Connaught fund have revealed a raft of serious regulatory failures.
The Connaught review found that the FCA’s actions put in place to remedy the effect of the collapse of the collective investment scheme – including putting out consumer alerts, contacting IFAs, and varying some permissions – were “well-intentioned but insufficient to protect those persons who invested in the fund before May 2011, or who did so in the following period leading up to the collapse of the fund in 2012”.
The review, however, did acknowledge that investors managed to recoup a considerable portion of their investments. According to the FCA, the outstanding principal invested at the time of liquidation was £79m and investors have since received £80m, including £59m in redress through a settlement the FCA secured from one of the fund operators, Capital Financial Managers.
The other operator Blue Gate Capital, has been ordered to pay £203,007 to Connaught investors on 18 December 2020.
Plethora of failings
Additionally, the LCF review discovered several other regulatory and oversight failures, including the fact that senior managers at the regulator were aware of LCF’s unregulated activities and its risks, but this “did not result in changes at an operational level to remedy the problem”.
The report also identified that several staff members involved in the handling of the LCF case were not appropriately trained.
For instance, the FCA’s contact centre call-handlers reassured callers that “LCF’s bond issues were reputable”. “Such reassurance reinforced LCF’s ability to abuse the imprimatur of respectability and integrity which it had obtained from FCA-authorisation in order to attract investors to its non-FCA authorised bond business,” Dame Elizabeth Gloster said in the report.
Even the first case officer in charge of LCF’s first variation of permission application noticed a number of concerning aspects in the business, but “had not received training on how to consider LCF’s business holistically by examining its financial information”, Gloster added.
But these were not the only failures. Gloster went on to say that LCF breached the watchdog’s financial promotion rules “on multiple occasions”, yet the FCA only wrote to the firm on each instance without taking any further action.
This is because “the FCA’s policies regarding repeat offenders of its financial promotion rules were unsatisfactory”, the review found.
One of the reasons Gloster identified for the wrongdoings, was confusion regarding fraud, as many within the FCA, including the first case officer for LCF, believed allegations of fraud would be “principally a matter for the police”.
As a result, some of the report’s recommendations were to provide appropriate training to staff members and a change in mindset when dealing with fraud allegations.
FCA chair says regulator is ‘profoundly sorry’
FCA chairman Charles Randell said: “There are a number of things we could have done better in our supervision of these two firms and both reports highlight the need for the FCA to continue to change to better protect consumers from harm.
“We accept all the recommendations that have been made to the FCA and we are profoundly sorry for the mistakes we have made.
“The collapse of LCF has had a devastating effect on many investors and we will do everything we can to conclude our investigations as quickly as possible and support the recovery of further funds for investors.
“The FCA has always prioritised supervising regulated activities which affect the most vulnerable in our society, who often have very limited financial choices. We also introduced measures designed to prevent harm for those consumers who had more ability to choose.
“These reports not only highlight operational mistakes; they also indicate that the measures we introduced may not have been as effective as we wanted and challenge the balance that we struck at that time.
“The FCA board and I have every confidence that continuing the transformation of our organisation is the right way to bolster trust in the FCA and realise our ambitions for change.”
CEO owns up to ‘significant and necessary’ changes required
FCA chief executive Nikhil Rathi added: “My colleagues and I are committed to implementing the recommendations and lessons learned which will require significant and necessary changes to the way we regulate, our use of data and intelligence, and our culture.
“We know that the FCA must make faster and more effective decisions, prioritise the right outcomes for consumers, markets and firms, and reform our approach to intelligence and information sharing.
“The FCA is always going to have to make difficult, risk-based choices about where to allocate resources and to strike a balance between regulatory action and consumer choice and responsibility. I hope that the mistakes the FCA made in these cases do not detract from the work and dedication of my colleagues over several years.
“We have demonstrated that when we act boldly, we deliver for consumers, markets and firms. With the continued dedication of all at the FCA and with the support and oversight of the FCA board, I know that we can make the changes we need in the coming months and years to respond to these reports and deliver for UK consumers and markets.”
LCF bondholder pleased with the review
One of the LCF bondholders told Portfolio Adviser sister title International Adviser they were pleasantly surprised by the review.
“The report is better than we could ever have imagined,” they said. “From the very outset, we identified countless policy failures and deficient processes that allowed [LCF] to abuse their FCA status unchecked.
“We were absolutely sure it was a case of gross regulatory failure and are very relieved to hear we will be able to claim compensation through the FCA complaints scheme.”
Economic secretary to the Treasury John Glen revealed that, according to LCF’s administrators, investors are likely to get back as little as 25% of their original investment.
Additionally, the Financial Services Compensation Scheme (FSCS) is still continuing to issue decisions on LCF claims and, as of the start of December 2020, it “has paid out just over £50.9m in compensation to 2,584 LCF bondholders”, he said.
The regulator will also consider claims from LCF investors through its complaints scheme, Glen added, “which is available to bondholders who believe they have suffered financial loss as a result of actions or inactions of the FCA”.
Policyholders were ‘failed by an organisation they trusted’
Tim Fassam, director of government relations and policy at trade body Pimfa, said: “This report makes for a sobering read for all parties concerned. Chief among this, we have to remember those LCF policyholders who ultimately have been failed by an organisation they trusted with their savings and a regulator whom they trusted to undertake its statutory duties.
“Lessons need to be learned and recommendations acted upon to ensure that future failings like this do not occur. It is to the FCA’s credit that they have recognised the seriousness of these reports and committed to acting on all relevant recommendations.”
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