Duty of Care or Fiduciary Duty to Investors?

The Financial Conduct Authority (FCA) have published two papers on their approach to consumers (i.e. retail savers/investors in their terminology). These cover whether a new “Duty of Care”, or a “Fiduciary Duty” (not the same thing) should be introduced.

Many people view financial market operators as paying more attention to their own interests than their clients, or that they do not take reasonable care to treat their clients fairly.

However there has been concern expressed that new obligations might lead to even more regulation than we have at present, which adds to the cost of investment substantially as more complex rules are introduced and more compliance officers hired to monitor the rules. For example, stockbroking charges have been rising recently due to more onerous regulation, some of it emanating from the EU.

This is not a one-sided debate in this writer’s view but a Fiduciary Duty would be simple to define as it is an established legal concept. A Duty of Care rather releases the clients of any obligation to take care of their own best interests.

The papers concerned are present below and the FCA would no doubt welcome your own comments on the subject.

Approach to Consumers paper: https://www.fca.org.uk/publications/corporate-documents/approach-consumers

Discussion Paper on a duty of care and potential alternative approaches: https://www.fca.org.uk/publications/discussion-papers/dp18-5-duty-care-and-potential-alternative-approaches

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

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Investment Platforms Market Study

The Financial Conduct Authority (FCA) have just published an interim report on their study of “investment platforms”. It makes for very interesting reading. That is particularly so after the revelations from Hardman last week. They reported that the revenue per assets held on the platform from Hargreaves Lansdown (HL) was more than twice that of soon to be listed AJ Bell Youinvest. HL is the gorilla in the direct to consumer platform market with about 40% market share. HL earns £473 per £100,000 invested while Youinvest earns only £209.

That surely suggests that competition is weak in this market. Indeed the FRC report highlights that investors not only have difficulty comparing the charges of different platforms, but they do not seem too concerned about high charges as they focus more on other aspects of the service provided. It also says on page 23 of the report: “Our qualitative research also found that consumer satisfaction levels are sometimes linked to satisfaction with overall investment returns, which tend to be attributed to the performance of the platform. This suggests some confusion about consumers’ understanding about platforms’ administrative function as opposed to the performance of investment products. So it is possible that consumers’ relatively high satisfaction levels with platforms could be influenced by the positive performance of financial markets in recent years”. In other words, the consumers of such services are very complacent about the costs they pay at present.

Another piece of evidence that this is not a competitive market obtained by the FRC was that they found that when platforms increased or decreased prices it had no significant impact on flows in and out of the platform. No doubt some platform operators will read that with joy, but others despair! 

Indeed when I made some comments on Citywire effectively saying I thought it suspicious that there were so many positive comments about Hargreaves Lansdown in response to an article reviewing the Hardman news, particularly as they were clearly much more expensive than other platforms who provided similar effective services (I use multiple ones) I was bombarded with comments from lovers of the HL service. Bearing in mind that platform charges can have a major impact on overall returns in the long term from stock market investments, you would think investors would pay more attention to what they are being charged.

One particular problem is that switching platforms is not only difficult and a lengthy process but can also incur charges. This is clearly anti-competitive behaviour which has been present for some years and despite complaints has not significantly improved.

The FRC summarises its findings as:

  • Switching between platforms can be difficult. Consumers who would benefit from switching can find it difficult to do so.
  • Shopping around can be difficult. Consumers who are price sensitive can find it difficult to shop around and choose a lower-cost platform.
  • The risks and expected returns of model portfolios with similar risk labels are unclear.
  • Consumers may be missing out by holding too much cash.
  • So-called “orphan clients” who were previously advised but no longer have any relationship with a financial adviser face higher charges and lower service.

That’s a good analysis of the issues. The FCA has proposed some remedies but no specific action on improving cost comparability and the proposals on improving transfer times are also quite weak although they are threatening to ban exit charges. That would certainly be a good step in the right direction. Note that a lot of the problems in transfers stem from in-specie transfers of holdings in funds and shares held in nominee accounts. Because there is no simple registration system for share and fund holdings, this complicates the transfer process enormously.

One interesting comment from the AIC on the FCA report was that it did not examine the relative performance of different investment managers, i.e. suggesting that lower cost investment trusts that they represent might be subject to prejudice by platforms. They suggest the FCA should look at that issue when looking at the competitiveness of this market.

In summary, I suggest the platform operators will be pleased with the FCA report as they have got off relatively lightly. Despite the fact that the report makes it obvious that it is a deeply uncompetitive market as regards price or even other aspects, no very firm action is proposed. But informed investors can no doubt finesse their way through the complexities of the pricing structure and service levels of different platform operators. I can only encourage you to do so and if an operator increases their charges to your disadvantage then MOVE!

The FCA Report is present here: https://www.fca.org.uk/publication/market-studies/ms17-1-2.pdf

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

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Aviva Preference Shares – FCA Announcement

Readers who take any notice of financial affairs will be aware of the furore over the threat by Aviva to redeem their preference shares by a “share cancellation” process – they claimed that is a different legal process, even though the shares were described as “irredeemable”. The shares concerned dropped in price to a significant extent because their high coupon interest rate meant they were trading at a premium when cancellation would have meant redemption at the original par value. Aviva have reconsidered the matter, but the interesting aspect today was a response from the Financial Conduct Authority (FCA) to a letter from the Treasury Select Committee. You can read it here: https://www.investegate.co.uk/financial-conduct/rns/fca-response-to-tsc-on-aviva-plc-preference-shares/201803280704471964J/

It basically gives lots of reasons why they cannot yet respond to some of the questions as they are still looking into the issues, but in response to Question 4 they seem not to concede that they should be involved in “the resolution of the legal questions”. In other words, they would be quite happy to leave it to an enormously expensive law suit by investors to resolve the key questions.

They do not seem to accept that they have an overriding objective to ensure a fair market for securities and that investors should not be prejudiced by small print, concealed or opaque legal terms and other sharp practices.

The response to Question 6, seems to try and excuse the problem by saying the shares were issued more than two decades ago and the FCA has taken subsequent action “in order to restrict the retail distribution of regulatory capital instruments….”. This is surely not an adequate excuse. The shares concerned were and are publicly traded and there is nothing stopping any investor (at least a “sophisticated” one) from trading in them. But even sophisticated private investors and some institutions were caught out by the unexpected threat from Aviva.

The FCA is again proving to be toothless in the face of seriously unethical practices. In other words, they are not doing their job competently and should be reformed in my personal opinion. I believed the FCA adopted an objective of more “principle-based regulation” a few years back but now seem to have abdicated that responsibility and are quite happy to let lawyers argue over the wording of a prospectus while ignoring the ethical issues. Just as they did with the RBS and Lloyds cases. It’s simply not good enough to issue the kind of response they have to the Treasury Select Committee.

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

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FCA Action, Shareholder Rights and Beaufort

Better Finance, the European representative body for retail investors have issued a couple of interesting announcements this morning. The first compliments the UK’s Financial Conduct Authority (FCA) for their action over “closet index trackers”. They are investment funds that pretend to be active managers and charge the higher fees that normally apply to such funds, while in practice they hug their benchmark index. Other European regulators have been less than prompt in taking action on this problem it transpires.

It’s not quite as positive as that though as although a number of UK asset managers have voluntarily agreed to compensate investors in such funds at a cost of £34 million, and enforcement action may be taken against others for misleading marketing material, this appears to be a voluntary scheme rather than a formal compensation arrangement.

Which are the funds complained about? I could not find any published list. But back in 2015, the Daily Telegraph reported the following as being the worse ones: Halifax UK Growth, Scottish Widows UK Growth, Santander UK Equity, Halifax UK Equity Income and Scottish Widows UK Equity Income – all bank controlled business you will note.

The second report from Better Finance was on the publication of the final draft of the EU Shareholder Rights Directive. This was intended to improve the rights of individual shareholders but is in reality grossly defective in that respect. Even if implemented into UK law, it will not improve the rights for UK investors. Indeed it might worsen them. For example Better Finance said this: “Important barriers to cross-border shareholder engagement within the EU virtually remain in place, since intermediaries will by and large still be able to charge higher fees to shareholders wanting to exercise their cross-border voting rights (admittedly subject to certain conditions) and beneficial owners of shares in nominee and omnibus accounts will still not have any voting rights (with the exception of very large shareholders), to name but two of the remaining issues.”

Let us hope that the UK Government and the FCA take more positive steps to improve the rights of UK investors which have been undermined by the use of nominee accounts and other market practices adopted in recent years.

Another recent news item from the FCA was about the forced administration of Beaufort Securities and Beaufort Asset Clearing Services. Beaufort specialised in promoting small cap companies such as those listing or listed on AIM to private investors. But the US Department of Justice investigated dubious activities in relation to US shares and has charged the firm and some individuals involved with securities fraud and money laundering. These allegations appear to be about typical “pump and dump” schemes where share prices are ramped up by active trading of the shares by the promoters of companies, such that the prices of the shares sold to investors bear little relation to fundamental value, and then the insiders sell their shares leaving private investors holding shares which the market rapidly revalues downwards. On twitter one person published charts showing the share prices of companies that Beaufort promoted to investors and it does indeed look convincing evidence of abusive practices.

These kinds of share promotions by “boiler rooms” staffed by persuasive salesmen were very common a few years back and they seem to be coming back into favour as there are a number of other companies promoting small cap or unlisted stocks to investors. Regulations might have been toughened, and such companies are more careful to ensure investors are apparently “sophisticated” or can stand the possible risks and losses, but the FCA still seems slow to tackle unethical practices. Should it really have taken US regulatory authorities to take down this company? The FCA has been aware of the market abuse in the share trading of AIM shares for some time but no action has been taken. It’s just another example of how small cap shares, and particularly the AIM market, attracts individuals of dubious ethics like bees to a honeypot.

If you have invested via Beaufort in stocks, are your holdings likely to be secure? As they may be held in a nominee account it rather depends on the quality of the record keeping by Beaufort. Past experience of similar situations does not inspire confidence. It can take years for an administrator to sort out who owns what and in the meantime the assets are frozen. The administrators are PricewaterhouseCoopers (PWC).

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

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RBS, GRG and Borrowing From Banks

I just had a read of the Financial Conduct Authority’s report on the Global Restructuring Group of the Royal Bank of Scotland (RBS). This was published by the Treasury Select Committee despite the fact that the FCA wished to delay it further. At 361 pages in length, it’s not exactly a quick read.

The operations of GRG have been the subject of many complaints – hundreds in fact from mainly smaller businesses. This was a part of GRG where borrowers in default were placed so as to “help” them. In reality their fees were raised and many of the financially distressed companies that went through the process ended up being put into administration.

The FCA report certainly supports many of the complaints. It says one in six of the cases it examined RBS had caused “material financial distress”. They suggest there were major failings in GRG’s “governance and oversight arrangements” where narrow commercial objectives were paramount. The interests of their customers were ignored and the stated objectives of GRG to support the turnaround of potentially viable customers was not pursued. In summary they conclude there was “widespread inappropriate treatment of customers”.

In other words, the interests of RBS took precedence. Bearing in mind that this was the culture in RBS under the leadership of Fred Goodwin, it’s not that surprising. I saw this myself where RBS was involved with public companies in some difficulties. The other stakeholders seemed to be ignored by RBS who pursued their own interests regardless. But should borrowers have ever expected a bank like RBS to take account of their interests?

Regrettably small businesses often rely on bank lending to fund their working capital. This is a very dangerous practice when working capital can swing violently in response to market circumstances. Even larger companies often go bust when they take on too much debt unwisely and simply run out of cash – the latest example being Carillion of course.

Since the financial crisis of 2008, people have lowered their trust in bankers. They are now rated alongside estate agents and used car salesmen. But past trusts in bankers was always misplaced. Bankers are there to make money from you or your company. When you have lots of assets and cash, they are happy to lend on good terms. When you really need the funds, they will be reluctant to lend and if they do charge high fees and impose onerous terms. The moral is: businesses should be financed by risk capital, i.e. equity or preference shares.

Companies that gear up their balance sheets with debt rather than equity (and RBS itself was a great example of the problem of little equity to support its business back in 2008), might apparently be improving the “efficiency” of their financial structure and enable higher profits but in reality they are also increasing the riskiness of the business. Investors should be very wary of companies with high or increasing debts. It might look easy to repay the interest due out of cash flow now, but tomorrow it might look very different.

You can read the full FCA report on GRG here: http://www.parliament.uk/documents/commons-committees/treasury/s166-rbs-grg.pdf

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

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ShareSoc Takes Up Blancco Complaints

As a small shareholder in Blancco Technology Group (BLTG) I reported on the events at their AGM in a previous blog post. This company had to restate their accounts following discovery that some of the previously recognised revenues were invalid. It calls into question the competence of the past audits of the company and the management of the business.

ShareSoc has now taken up the issues and has requested both the Financial Conduct Authority (FCA) and Financial Reporting Council (FRC) to investigate what happened. See this press release that ShareSoc issued for more information: https://www.sharesoc.org/sharesoc-news/sharesoc-requests-investigation-affairs-blancco-technology-group/

Shareholders in this company have lost substantial capital as a result of the failure to recognise revenue correctly, a failing all too common in IT companies and which, for some reason, auditors seem unable to spot.

If you were or are a shareholder in Blancco, you can register your interest in this matter on the ShareSoc web site so that you are informed of future news.

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

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Want to Get Rich Quickly?

Do you sincerely want to be rich? That was the sales slogan used by fraudster Bernie Cornfeld which attracted many. Or perhaps even better, do you want to sincerely get rich quickly? That is in essence the sales pitch used by many promoters of CFDs (Contracts for Difference).

CFDs are geared investments in stock market shares, bitcoins, commodities or any volatile instrument where you can magnify your profits many times. Or of course magnify your losses. You can, to put it simply, lose all your money and very quickly. Last week the Financial Conduct Authority (FCA) wrote a stern letter to CFD distributors saying in essence that their review revealed substantial failings in the rules that they should have been following.

CFD products are complex and risky and are not suitable for inexperienced or unsophisticated investors. But 76% of retail customers for CFDs lost money in the year to June 2016 according to the FCA which clearly indicates that there are plenty of suckers out there who are being exploited. One of the many problems that the FCA discovered was inadequate client qualification with many relying on broad descriptions of “sophisticated” and “financially literate”. Indeed, they often relied solely on the client’s words about their knowledge and experience and their qualification to be classed as “elective professional” clients which effectively relieves the seller of any responsibility for the advice they give.

This problem extends not just to CFD providers but historically has been a big problem in the promotion of shares in unlisted companies, the small cap companies listed on AIM and in some overseas markets. If reliance is placed on what the client says about their competence and ability, it’s rather like asking a motorist whether they are a good driver – they will all say yes.

In essence there surely needs to be a better way to tackle this issue. If that cannot be devised then the FCA is likely to get much tougher in policing the market for CFDs.

But the FCA should not be too concerned. If those who speculate in CFDs lose the ability to do so, they’ll just move onto something else like trading in bitcoins or forex – and there are lots of promoters of those around. The problem really comes down to basic financial education. Folks need to learn at an early age that there are no quick ways to get rich. If they do not then they will fall for the latest scam regardless of the actions of regulators.

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

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