FCA asleep at the wheel as Woodford ‘does an Arch Cru’?

At outset, it is important to understand that this article is not intended as criticism of Neil Woodford, there is already enough of that going around – writes DIY Investor’s Christian Leeming.

The fact is, that over the years he has proved to be an outstanding fund manager; unfortunately, this is an issue bought about by regulatory failings.

The Woodford funds were launched in March 2017, this was the most successful launch ever in the UK and a suitable coronation for the most successful UK fund manager of his generation.

Unfortunately, it also represents you another potential failing for the regulator and the depositary of the funds.

As was originally reported in March this year by Citywire, the equity income fund within the Woodford umbrella has exceeded the 10% maxima for investments in unquoted holdings.

‘over the years he has proved to be an outstanding fund manager; unfortunately, this is an issue bought about by regulatory failings’

By way of background, this umbrella is authorised under the UCITS rules which envisages fund investing only in quoted securities, with limited permissions for cash, derivatives, other funds, and unquoted assets.

Specifically, Citywire revealed in March that Woodford has listed his stakes in unquoted companies in Guernsey as a means of remaining within the regulator’s rules on funds’ unquoted holdings, which must not exceed 10%.

Without the Guernsey listings, Woodford’s stake in unquoted companies in the Equity Income fund would stand at 18.4%.

Basically, they have taken assets that are illiquid and put them into a Guernsey listed company that counts as a transferable security, the assets of this company are the shares that the fund should not be holding.

Put another way, they have gamed the system to exceed the 10% maxima allowed under the UCITS rules

It was reported that, ‘The FCA has been in discussions with Link Funds and TISE regarding the circumstances around the listing of certain of the fund’s assets on that exchange,’ the regulator said.

‘Where the FCA believes there are circumstances suggesting serious misconduct or non-compliance with the rules it may open an investigation.’

It may become a point of law as to what crime, if any, has been committed, but question should be asked of both the regulator and depositary as to how this was missed.

It is unusual to see such funds buy shares in Guernsey listed businesses and, had either of them looked through the structure, the sleight of hand would have become obvious; presumably the investments would then have been stopped by either party.

‘taken assets that are illiquid and put them into a Guernsey listed company that counts as a transferable security’

Other than a lack of due diligence of behalf of both parties, there is a more worrying issue, i.e. this is not the first time an issuer has sought to use Guernsey listing as a way of gaming the investment and borrowing powers allowed of UCITS funds.

The Arch Cru funds used the same ‘trick’ to access private equity and other investments outside of the UCITS rules.

To my knowledge this was the first-time this structuring trick had been used, possibly it was excusable for the powers that be to miss it once, but a second time smacks of carelessness.

We now have a position where, at its high-point, investors were holding £10bn in a fund that was non-compliant.

And this is not just retail investors, it has been reported that Kent County Council has a holding of around £238 million.

Whichever way you look at this it isn’t good:

• The most renowned fund manager of his generation has sought to game the UCITS rules,
• The FCA and the funds depositary have obviously not learned for the Arch Cru mess, making the same error again.
• Major mandates such as County Councils, St James’s Place, and Hargreaves Lansdown all appear to have significant shortcoming in their due diligence process.

The real question is why aren’t these issues spotted and stopped at outset, rather than only when investors start losing money? Why are those in a position to regulate not doing so?

Perhaps they were blinded by the name, ‘Woodford’?