FCA faces investigation over LC&F and mini-bond regulation, where now for income investors?

The Bonds that still have not come in from the cold; why investors keep getting the flu

Just over two-years ago Mr Bond wrote the article ‘The Bond That Came in From the Cold’, in it Mr Bond asked, ‘is there a third-way’?

By this he meant a mini-bond but one where the ‘invitation document’ is based around the Prospectus Directive (PD) providing investors with:

• the transparency and disclosure required
• with either actual security or 2-years plus accounting history
• proper financial covenants
• invitation document should be renamed, this sounds like an invitation to a garden party, a very toxic one

Sadly, no one ever embraced the idea, however with the recent debacle of London Capital & Finance (LCF) going into administration and losing investors up to £236m, there is more reason than ever for this to become the expected standard.

By way of background, LCF ran a series of web adverts promising 8% returns from its ‘Secure ISAs’ and in addition a comparison website – run by a company with links to Surge PLC – would compare the 1% and 2% return ISAs from high street banks with the investments at LCF.

Brighton-based Surge received 25% commission – which amounted to £60m – to run the marketing campaign; full details of the story can be found at ‘Thousands of Investors Face Losses as London Capital & Finance Files for Administration’ and ‘SFO Arrests Four Over London Capital & Finance Collapse’.

LCF was authorised by regulator the Financial Conduct Authority (FCA) – but the FCA said the authorisation was to provide consumer financial advice, not the sale of bonds or ISAs; the FCA subsequently ordered the advertisements should stop running.

Investors were told the funds – and therefore risk – would be spread across hundreds of companies but, according to Companies House records, LCF loaned money to just twelve – four of which have never filed accounts, nine are fewer than three years old, and nine had loans from LCF in 2017.

Much of the cash was loaned to companies that then ‘sub-loaned’ to others. Bondholders have raised concerns about connections between the directors of companies that received money and those who ran LCF.

Now this highlights numerous failings and issues:

1. A mini-bond is not an eligible asset for an ISA, which begs the question, where was the FCA who regulated the marketing of the bonds?
2. The use of the words, ‘safe’, ‘secure’, ‘secured’.

• The use of the word ‘safe’ should be banned full stop.
• The use of the word ‘secure’ should also be banned, it has no-place in finance
• ‘Secured’ does have a definition and use in finance. It means that lenders (bondholders) are secured by assets pledged by the Issuer, which are held in trust for bondholders by a security trustee

3. Whilst Surge may not be guilty of anything other than greed it highlights the points that Mr Bond discusses below.

Firstly, payment of ANY fees concerned with the bond MUST be disclosed in the offering document.

Secondly, how can anyone expect to carry the cost of a 25% fee, and repay 25% more than they receive at maturity? It doesn’t work!

So, where does all this leave us? Sadly, there are several failings here; the regulator was asleep at the wheel and should have done better, but investors must bear some responsibility.

They have a duty of care to themselves; they simply cannot expect to be protected at every turn.

But regulation, or more accurately the lack of regulation has been the biggest failure; investments of this nature are not regulated, in the future they must be.

The advert, the financial promotion, and the firms making it are, currently the only part regulated. Looking at the adverts they do look to be unfair and misleading, but that is self-regulated by the compliance departments of the firm making the promotion. Given that they were committing a fraud it isn’t likely that compliance was too worried about the adverts, if indeed there was compliance in more than name only.

Are there solutions?

• Well, it’s very difficult to protect against fraud but not impossible
• If the bonds had been listed, or required approval by the regulator then you would have had a responsible third-party vetting them
• ALL fees must be disclosed, non-disclosure should be a criminal offence

2-years ago the implementation of the third-way was both necessary and correct; the situation with LCF simply endorses the fact.

Mr Bond doesn’t want to stop ‘small’ company’s issuing bonds, or investors from benefitting from the yields they can offer, but they must all be regulated. Continuing to allow these to fall out-of-the-scope of regulation simply invites the wrong people into the market.

Perhaps, the bond that came in from the cold, should be allowed to only live twice! Shhhhocking.

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