Should investors who buy high-risk bonds be compensated when things go wrong? The obvious answer is no, with the clue in the word “risk”. But what if a bond is marketed to small investors with a “quarterly interest rate”, and is approved for inclusion in an Isa, and is promoted by a financial advice firm authorised and regulated by the Financial Conduct Authority. Would you expect the bond to lose not just the interest, but all the money you deposited?
This is the type of scenario in which many investors in so-called “mini-bonds” have found themselves. About 11,000 investors in London Capital & Finance’s mini-bonds could lose a total of up to £236m, in one of the worst financial scandals for a decade.
Four years ago we first reported on the £7.5m lost by investors in Secured Energy Bonds, followed soon after by the collapse of £8m worth of “Providence” bonds.
More recently investors in Kevin McCloud’s HAB mini-bonds have been warned of hefty losses.
Mini-bonds are just an IOU to a company, are rarely secured on anything, and are usually completely illiquid and cannot be traded. They are simply too risky for the average small investor.Even if the interest rate on the bond is 8%, it’s hardly enough to compensate for the evidently high risk of losing your shirt. As I wrote in 2015, if you see a promotion for a mini-bond, “just bin it”.
But I also highlighted the peculiar role of the promoters of these bonds, who carry an FCA-regulated halo, but who are selling products which are completely outside the regulatory environment and have zero investor protection. In the case of Secured Energy Bonds, they were promoted by an FCA-regulated company that was the “security trustee” that would safeguard the assets. Except they didn’t.
SEB investors got the cold shoulder from the financial ombudsman in 2016, but a redoubtable group, led by Fiona Pitkeathly, weren’t going to give up. Last year, in a remarkable U-turn, the ombudsman service conceded that the FCA-regulated promoters should have spotted the flaws in the bond’s security. Inevitably the promoters subsequently threw themselves into liquidation, but hey are now receiving payouts from the Financial Services Compensation Scheme.
SEB investors are of course delighted. But as Pitkeathly points out, their problems could have been avoided but for a glaring hole in regulations.
As things stand, when an FCA-authorised firm approves an investment as “fair, clear and not misleading” on behalf on a non-authorised firm, this is, bizarrely, not classed as a “regulated activity”. This means that firms that negligently or intentionally approve these investments are not subject to any regulatory sanction. If they were, there would be a lot more self-policing of these products.
The FCA is itself subject to an independent investigation over its handling of the LC&F debacle. Given how the ombudsman ruled in favour of SEB investors, it’s difficult to see how the FCA can wriggle out of responsibility for the much bigger losses incurred by LC&F investors.
p.collinson@theguardian.com