Transparency Task Force Attacks FCA and Sophisticated Investor/HNWI Status

Following on from the BBC Panorama programme on the Blackmore Bond scandal the Transparency Task Force have launched an attack on the incompetence of the Financial Conduct Authority – see https://www.transparencytaskforce.org/letters-to-mps-about-blackmore-bond/ . It includes a letter you can send to your Member of Parliament asking for some reform.

I agree with most of their recommendations on how matters can be improved.

One issue I would also raise is that the Panorama programme made it clear that risky and unregulated investments were sold to individuals who would not normally have qualified as “sophisticated investors” or as high net worth individuals, as is required.

It is possible to ‘self-certify’ yourself as a HNWI or a sophisticated investor. To self-certify as a HNWI you have to earn at least £100,000 per year or have net assets (excluding your property, pension rights and so on) of at least £250,000.

To self-certify as a sophisticated investor you must: have been a member of a business angels network for at least six months; or have made at least one investment in an unlisted security in the previous two years; or have worked in a professional capacity in the provision of finance to small- or medium-sized businesses in the last two years or in the provision of private equity; or be or have been within the last two years a director of a company with a turnover of at least £1m.

These are quite low hurdles and as the investor is only making the declaration with no checks necessary or evidence provided it is wide open to abuse. The company accepting the certification only has to have a reasonable belief that it is correct.

I suggest the HNWI limits should be raised and that those who claim to be sophisticated investors actually pass a simple examination on financial matters or have a recognised business/accounting qualification to prove what they are claiming.

There are simply too many cases of dubious investments being sold to widows and retired folks who have no way to judge the prudence of the matter.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Panorama Attacks FCA over Mini-Bond Failures

The BBC’s Panorama programme last night did a good job of pointing out the failure of the Financial Conduct Authority (FCA) to prevent fraud on investors in “mini-bonds”. In this case the focus was on the collapse of Blackmore Bond where 2,000 people lost £46m when the company collapsed. But there have been several other similar cases.

Mini-bonds are unregulated investments so should only be sold to “sophisticated” investors who might understand the risks. In this case people who clearly were not were persuaded to invest in property developments with “guaranteed” returns of up to 10%. Who was providing the guarantees? A company based in Costa Rica. A lot of the investors’ money was wasted on marketing costs and management fees paid to the directors. The investors were lured into putting money in via boiler rooms and internet advertising.

The FCA were told about the abuses but apparently did very little to stop it. Andrew Bailey who headed the FCA at the time failed to act. He subsequently has been made Governor of the Bank of England – a reward for failure it seems.

For more details see:  https://www.bbc.co.uk/news/business-62504445

Comment: It is surely wrong for the FCA not to have taken action on this matter when it was first brought to their attention. Many investors put money in after that and when it was obviously a dubious investment scheme.

The FCA simply says it was outside their remit to step in as it was not a regulated business registered with the FCA but that is not good enough. In fact the promotion of mini-bonds is a regulated activity. But any action taken by the FCA was too little and too late. See https://commonslibrary.parliament.uk/research-briefings/cbp-9272/ for more background.

This is in essence another example of the managerial incompetence of the FCA in the same way that it has failed to prevent a number of frauds on stock market investors, or tackle them when they have become apparent. Likewise the promoters of the Blackmore Bonds do not appear to be facing any legal penalties.

SNP MP Peter Grant said this in Parliament: “in 50 years from now or 100 years from now, our successors will be in the successor to this Parliament bemoaning the fact that billions of pounds have been taken out of the pockets of hard-working people and used to fund a luxury lifestyle for charlatans, crooks and conmen”. That’s a fair summary of the reality.

How to ensure you don’t fall victim to such promotions? I suggest the following:

  1. Don’t put all your life savings into unregulated investments and diversification is the key.
  2. Don’t fall for promises that are unlikely to be achieved – such as promising a “safe” return of near 10% when big financial institutions are offering much less. This tells you that they are high risk investments.
  3. Make sure you have widespread investment experience before you dabble in unregulated investments such as in mini-bonds and EIS companies.
  4. Don’t trust anyone, however glib they are. Make sure they have a track record of managing money responsibly.
  5. Flashy web sites and glossy literature are warning signs, not positive endorsements.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Gamma Communications AGM and FCA News

I have received the Annual Report and Notice of the Annual General Meeting for Gamma Communications (GAMA). Despite the fact that this company specialises in electronic communications and actually say in their Annual Report that “This year we have adopted a digital first approach reflecting how we operate as a business”, they expect me to physically attend the AGM in central London at 10.00 am on the 19th May. There is no electronic attendance via web cast or hybrid meeting supported. This is a waste of my time for what is likely to be a routine event. I have written to the Chairman to complain.

Their registrar Link Group also failed to include a proxy voting form with the AGM Notice so I had to use my own. This is a repeated failing recently by Link Group which undermines shareholder democracy. They seem to be trying to force everyone to register for their electronic voting system. I don’t mind voting electronically but that should be provided by a simpler system such as that used by Computershare.

The Financial Conduct Authority (FCA) have published a press release that says “The FCA has finalised rules requiring listed companies to report information and disclose against targets on the representation of women and ethnic minorities on their boards and executive management, making it easier for investors to see the diversity of their senior leadership teams”. They have simply gone ahead and implemented new rules that were the focus of a public consultation which I severely criticised – see https://roliscon.blog/2021/08/06/diversity-but-at-what-cost/ . What feedback did they get to the public consultation? They have not said and no report has been published on it. I have asked for more information to see what support they got for these proposals which I consider to be political gestures which will have no benefit but add a lot of costs to listed companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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A New Consumer Duty from the FCA

Just before Christmas I wrote a critical blog post on the proposals by the Financial Conduct Authority (FCA) to reform the Financial Services Compensation Scheme. It generated a lot of supportive comments. At the same time the FCA published a consultation paper (CP21/36) on a “New Consumer Duty”. This seems to have similar objectives in that it is an attempt to stop consumers from being provided with misleading information, being provided with unsatisfactory support or buying products that are inappropriate or harmful.

For “consumers” read “individual investors” in the investment sector.

The FCA therefore is proposing a whole new set of rules to enforce a new Consumer Duty and the consultation paper alone consists of 190 pages of convoluted text, even though it is supposed to be principle based. It is also clear that there was considerable opposition from the financial services industry particularly as they will incur substantial costs in adapting to the new rules and maintaining them. There is also doubt as to whether it will result in any benefit as there is already an obligation to treat customers fairly and a multiplicity of other rules are already in place.

It might even increase costs to consumers as firms pass on their additional costs, and increase the risk of litigation. One aspect of the proposal is however not to provide a Private Right of Action (PROA) for a breach of the new rules or principles so consumers would have to rely on the Financial Ombudsman for any redress. This is very unsatisfactory as that organisation is hardly very effective at present and takes way too long to deal with complaints.

An example of the sophistry in this consultation paper is the discussion of two possible Consumer Principles to underpin the conduct of firms: Option 1 – A firm must act to deliver good outcomes for retail clients; or 2 – A firm must act in the best interests of retail clients. Can you divine any difference?

What are the likely costs of the adoption of this new Consumer Duty and associated rules? The paper says total one-off direct costs to comply will be in the range of £688m to £2.4bn. Annual on-going costs will be in the range £74m to £176m. The paper is remarkably unclear on the likely cost benefits to consumers.

I don’t know how much labour was put into writing this paper but it must clearly have been very considerable. I consider it a waste of effort. I doubt that consumers will be much better protected by adoption of the new Consumer Duty. The problem with the FCA is not lack of adequate rules, but an inability to enforce them vigorously. Firms devise new products that are too complex, badly understood by consumers and yet the FCA does not stop them being sold. They also approve firms and their management who should not be and fail to step in when matters are clearly going wrong.

It’s a management problem in essence and inventing new rules will not help.

My detailed comments in response to the consultation are present here: https://www.roliscon.com/Consumer-Duty-Consultation-Response.pdf

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Discrimination Against High Net Worth Individuals?

The cost of the Financial Services Compensation Scheme has been increasing substantially in recent years, as more mis-selling scandals have proliferated and firms have gone bust. This has led to complaints from those firms who fund the scheme and has led the FCA to undertake a “Compensation Framework Review”.

This includes looking at possible changes to the scope of protection such as limiting it to “mainstream” products. But a more serious proposal is that High Net Worth or Sophisticated Investors be excluded from compensation. The FCA suggests such individuals might be expected to absorb losses, might be able to take their own private action against a failed firm, or would have a better understanding of the risks they were taking when dealing with authorised firms.

But this is a very dubious argument when High Net Worth persons only need to have liquid assets of £250,000 or more to qualify. Many moderately wealthy individuals would have more than that in direct shareholdings, ISAs and deposit accounts. But they would hardly be in a position to finance complex legal actions and FSCS compensation is limited to £85,000 already.

It is not clear what moral principle is being invoked here except that it would potentially save the FSCS scheme money.

I suggest that high net worth or sophisticated investors send in a response to the FCA’s review – go to this link for information  https://www.fca.org.uk/publications/discussion-papers/dp21-5-compensation-framework-review and an online response form.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Diversity – But at What Cost?

The Financial Conduct Authority (FCA) have published a public consultation on “Diversity and inclusion on company boards and executive committees”. This summer I seen to be spending a lot of my time responding to FCA consultations and this one seems to yet another that will impose costs on publicly listed companies with no clear benefit while diverting management time. As I pointed out in my response to the Primary Markets Effectiveness Review, the imposition of more corporate governance regulations is one reason why public listings are falling as company management decide that it’s easier to remain private. That is the negative outcome of over-regulation.

What’s the latest consultation proposing? They propose to change the Listing Rules so as to “require companies to disclose publicly in their annual financial report whether they meet specific board diversity targets relating to gender and ethnicity on a ‘comply or explain’ basis”.

They also propose that companies publish standardised data on the composition of their board and the senior levels of executive management by gender and ethnic background; and to encourage a broader consideration of diversity at board level, they are also proposing to amend the corporate governance rules to expand reporting requirements to wider diversity characteristics. This could include ethnicity, sexual orientation, disability and socio-economic background.

They may also “seek to widen the scope of the targets to levels below executive management”, i.e. This means not just the board and top management will be covered in future.

In the short term the rules will require:

  • At least 40% of the board should be women (including those self-identifying as women).
  • At least one of the senior board positions (Chair, Chief Executive Officer (CEO), Senior Independent Director (SID) or Chief Financial Officer (CFO)) should be a woman (including those self-identifying as a woman).
  • At least one member of the board should be from a non-White ethnic minority background.

Although there is wide acceptance that more diversity on some boards may be preferable. By avoiding the all-white, male and elderly boards that were so common in the past, one can ensure more understanding of the modern world. And it is certainly the case that there may be some social justice in avoiding unfair discrimination against some characteristics. But is there any evidence that more diverse boards actually improve company performance?

The FCA report covers this issue in Section 3.27 onwards where they review the evidence. The evidence is not clear so they say: “Our own literature review of academic and other research published alongside our DP concludes that, overall, the empirical evidence for the impact of diverse workforces and boards on financial performance is inconclusive”. In essence the imposition of more regulation in this area may have no benefit while the disadvantages of loading management with extra responsibilities is ignored.

What concerns me most is that instead of picking the best candidates for board or senior management positions, they may be selected based on sex or ethnicity, i.e. there will be discrimination against others, which is of course illegal.

There is also a rather peculiar focus on factors that have no obvious relevance to fitness for a role. One of the oddities of public companies is that anyone with no qualifications or experience can be appointed. There is no requirement to have a business or accounting qualification. No requirement to know the basics of company law or to have had any training for the role of being a company director. Is this not most perverse?

For example I have attended several General Meetings of companies in the past where it was clear that the directors did not understand the basics of company law.

You also get peculiar results at present where the keenness to appoint more females results in some directors with little obvious qualifications for anything. They tend to end up chairing remuneration committees for example where they are dominated by executive management.

Would it not be preferable to regulate to ensure directors had basic competence in law and finance rather than happening to have the right skin colour? That is likely to be much more effective in improving company performance.

One of the most laughable aspects of the proposed new regime is that to meet the new rules on gender diversity all that needs to be done is for a current male member to “self-identify” as female. Will management be required to inquire into the details of sexual orientation when recruiting?

If we are going to start regulating management composition based on their characteristics, should we also not be ensuring a balance of ages, heights, physical fitness (no fatties allowed) or other relevant characteristics?

There are better alternatives to improving the diversity of boards other than using quotas. Education and structured experience programmes are more likely to produce a better outcome.

In summary I suggest this proposal is a complete nonsense and should be withdrawn. Readers should submit their own responses to the consultation to avoid responses being biased by the thoughts of those who wish to be politically correct.

You can see my detailed responses to the consultation questions here: https://www.roliscon.com/Diversity-Consultation-Response.pdf  

FCA Paper: Diversity and inclusion on company boards and executive committees. Consultation Paper CP21/24: https://www.fca.org.uk/publication/consultation/cp21-24.pdf

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Comments on Primary Markets Effectiveness Review

The Financial Conduct Authority (FCA) have launched a public consultation on potential changes to the regulations regarding the listing of companies on public exchanges (see link below). This is in response to concerns about the fall in the number of companies listing (the number listed is down by 40% since 2008). There is particular concern that the UK regime is tougher than other international markets and particularly deters certain types of companies from listing.

You only have to read the consultation document to understand how complex the rules on main market listing are and they are surely due for simplification. Over complex rules not just deter companies from listing but add to the costs of doing so and those costs fall on investors.

A survey by PWC in 2018 indicated that regulatory burdens and costs are the main reasons for not listing as opposed to raising finance by other means. A fall in the number of listed companies particularly affects private investors who want to invest directly in companies and wish to have a direct connection with where their money is invested.

Other factors are also involved such as the low cost of debt at present and the ability of private equity firms to act quickly and provide a less onerous corporate governance regime. But it would certainly be a retrograde step if public stock markets fell substantially in size.

Among the proposals to make listing more attractive in the UK are 1) allowing dual class structures where some shareholders can have disproportionate voting rights; and 2) relaxing free float levels required. But there is also a proposal to increase the minimum market capitalisation substantially from the present level, which surely would not help.

There are also proposals to alter the primary segment qualifications or remove segments altogether which I favour.

I support the relaxation of free float levels but am opposed to dual class structures. Dual class structures enable founders to retain control but that is not necessarily a good thing. In practice there are other ways that founders can retain substantial influence – for example by retaining significant shareholdings and board seats. I do not see that permitting dual class structures (DCSS) is necessary to make listing in the UK more attractive.

What will make listing more attractive is a simplification of the listing rules and a reduction in cost plus a reduction in the regulations such as onerous corporate governance regulations (such as the recently proposed climate disclosure regulations I commented negatively upon).

You can read my detailed responses to the FCA consultation here:

https://www.roliscon.com/Primary-Markets-Effectiveness-Review-Response.pdf

The FCA Consultation is here: https://www.fca.org.uk/publications/consultation-papers/cp21-21-primary-markets-effectiveness-review

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Changes to KIDs Proposed by the FCA

Yet another public consultation issued by the Financial Conduct Authority (FCA) in mid-summer is one on KIDs (Key Information Documents). This is relevant to private investors and is designated CP21/23 – see link below.

KIDs are imposed and regulated under the PRIIPs regulation as devised by the EU for packaged investment products such as funds and trusts. KIDs give basic financial information, risk indicators and likely future performance based on past performance. Those who purchase investment trusts for example will be asked to confirm they have read the KID before purchasing a holding.

But in reality KIDs are grossly misleading for many investment trusts.  This is because their estimate of future returns are based on short-term historic data. This has caused many fund managers of investment trusts to suggest that they should be ignored and investors should look at the other data that the companies publish to get a better view of likely future returns. The AIC has also criticised them and this writer certainly ignores the KIDs for the investment trusts I hold.

The FCA says “Our proposals should address the existing conflict between PRIIPs requirements which on the one hand require PRIIPs manufacturers to ensure the information in the KID is accurate, clear, fair and not misleading while at the same time prescribing the production and presentation of information on performance and risk which, in some cases, can be seriously misleading”.

The production of KIDs does require substantial effort on the part of fund managers so they add to investors’ costs while not being of substantial benefit to investors in many cases. The intention might have been good but excessive complexity has undermined their usefulness. The FCA admits that the mandated methodologies for calculating performance can produce misleading illustrations across almost all asset classes.

The proposal is to remove performance scenarios from KIDs which seems a very good idea. Alternative performance information is suggested be provided., such as narrative about the factors that might affect performance.  But they have avoided providing past performance data which is what is likely to be most important to investors.  

The PRIIPs regulations required the publication of a Summary Risk Indicator (SRI). But the methodology to be used seemed to rate some trusts as low risk when they are not – for example Venture Capital Trusts. So it is proposed to introduce new rules requiring an updating of an SRI if it is obviously too low.

The proposals from the FCA seem generally sensible although the AIC is still not happy. They say in a press release that: “….the SRI methodology does not work properly and needs a complete rethink. We were raising concerns about KIDs even before the rules were finalised and we have been calling for changes since their introduction on 1 January 2018. Investment companies are still at a disadvantage in having to produce these toxic disclosures, whilst UCITS funds have repeatedly been let off the hook. It’s high time the Treasury conducted a comprehensive review of KIDs rather than relying on a piecemeal approach to their reform”.

Respondents to the consultation can give their own views of course. There is a simple on-line response form.

Reference: CP21/23 Consultation Paper:

https://www.fca.org.uk/publications/consultation-papers/cp21-23-priips-proposed-scope-rules-amendments-regulatory-technical-standards

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Preventing Fraud in Accounts – FRC Tightens Audit Rules

There have been repeated examples of the accounts of public companies being fraudulent in recent years. Wirecard was probably the latest and biggest example. I have seen examples of such misdeeds twice in my investment career in my own holdings although losses have been minimal in both cases, the last example being Patisserie (£95 million missing from their accounts). But I have avoided a lot of others where the losses to some investors have been enormous. There have simply been too many such cases for investors to avoid them all however careful you are in analysing the accounts of companies. There can often be hints that something is wrong, but in many cases the fraud is so well concealed it is very difficult to detect. In both the examples I mention, the cash that was claimed to be on the balance sheet was not there, which should be a simple thing for auditors to verify.

The Financial Reporting Council (FRC)) have announced that they are tightening up the rules followed by auditors to impose more responsibility on them for detecting fraud. In the past it was unclear that auditors had any responsibility to detect fraud and some have even denied it.

The FRC claim they are making the auditor’s obligations clearer – specifically to try and identify fraud. The FRC is running a public consultation on the proposed new audit standard which you can read about here: https://www.frc.org.uk/news/october-2020/consultation-on-revised-auditing-standard-for-the

It makes for interesting reading and it actually spells out the kind of problems that auditors should be looking for. In general the proposed changes to the audit standard make sense.

Will it solve the problem of too many frauds altogether? No for three reasons:

  1. Because audit work is bid for by audit firms, while companies pay their fees, there is a strong incentive by both parties to keep the cost of the audit as low as possible. This brings pressure to bear to not do more work than is absolutely necessary.
  2. Auditors cannot challenge management too much if they are going to retain the audit brief, and there is a tendency to build a cosy trusting relationship.
  3. Auditors are protected from being sued by shareholders for incompetence by the Caparo legal judgement, and their liability even to the company can be undermined by the contracts they require signing. In other words, the legal framework under which they operate enables them to escape responsibility for incompetence.

How might these problems be solved? It has been suggested that auditors be appointed by an independent body rather than by the directors of a company. Perhaps another solution might be to set up an independent fund that rewards auditors when they identify and report fraud, with big bonuses for the individuals that do so. That would give them a strong financial incentive to discover it.

That would provide a carrot. But the stick needs to be change in the regulatory framework and the law so that auditors cannot escape financial penalties when they do not do a competent job. A simple change would be to require audit contracts to be based on a standard set by an independent body such as the FRC and not written by auditors as at present.

I hope readers will respond positively to the consultation because I can see many objections from audit firms to the imposition of new obligations, however reasonable they appear to investors.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Regulating Consumer Investments and Company Register Reform

 The Financial Conduct Authority (FCA) have launched a consultation on the Consumer Investment Market. They consider it a priority to reduce the harm that many consumers suffer from fraud in this sector. The FCA has this to say:

“We have made significant improvements to this market to protect consumers. But there are over 5,000 financial adviser firms and more than 27,000 individual advisers acting as intermediaries between the consumer and their investment. Dominated by small firms, these complex chains of interdependent products and services – some of which are beyond our regulatory remit – make it easy for bad actors to ‘hide’ and challenging for us to oversee. The consumer investment market is not working as well as it should. Too often consumers receive lower returns than they should because of unsuitable products with high fees. Too often there have been scams and scandals in this market leading to consumer loss. Too often consumers leave their savings in cash because they don’t have confidence in the alternatives. That’s why we have made Consumer Investments a priority in our current Business Plan”. They also say:

“Some of the most serious harms we see relate to investments outside our regulatory perimeter and online scams, many based overseas. We have limited powers and capabilities in this space, in particular in our ability to deal with online promotions”. This is now a major problem that the FCA has been particularly poor at dealing with as Mark Taber regularly points out.

The “Call for Input” document only has 38 complex questions so I suspect they are unlikely to get many responses from real consumers, but those interested in financial markets may care to read it. See here:  https://www.fca.org.uk/publications/calls-input/consumer-investments

The Government BEIS Department consulted previously on modernising Companies House who maintain the register of companies. The Government’s response to the consultation has now been published. You can read it here: https://www.gov.uk/government/consultations/corporate-transparency-and-register-reform

Company registration, and the identification of company directors is clearly a very essential element in preventing frauds of all kinds, but has been woefully inadequate in the past. The identify of directors is not checked and Companies House even has very limited abilities to query new applications. So you could probably set up a company called Mickey Mouse Ltd with the sole director named as Mickey Mouse. Indeed I did check to see if there was such a company registration. Yes there is a company of that name, although the sole director’s name is different.  

The report even says: “There are benefits to the UK’s fight against crime: these reforms will increase the accountability of those few that transgress. As noted, the volume of economic crime in the UK is immense and growing. It accounts for almost one third of all crime experienced by individuals. The Home Office estimates that the social and economic cost of fraud to individuals in England and Wales is £4.7 billion per year and the social and economic cost of organised fraud against businesses and the public sector in the UK is £5.9 billion.

We will be able to trace and challenge those who misuse companies through the improved information on those who set up, own, manage and control companies. In partnership with others, our improved analytical capacity will use this information to detect suspicious activity earlier and hold those responsible to account”.

The recommendation to tighten up on the identities of directors has been generally supported so that is likely to be progressed. The ability to suppress some personal information will also be enhanced to improve security over that.

In general I suggest company directors and shareholders should welcome the proposals as a step forward in modernising Companies House, but you may care to review the details.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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