On 28th December 2018, the Financial Conduct Authority (FCA) raised concerns about the way London Capital & Finance (LCF) were marketing their mini-bond products and the effect this could have on the business of LCF. More specifically, the FCA expressed concerns about the potentially misleading nature of LCF’s promotional activity around their mini-bonds. At the beginning of 2019, LCF went into administration after collecting £236m from approximately 14,000 customers, leaving great uncertainty as to whether these investors will see any of their cash returned to them.
The mini-bonds sold by LCF promised returns of up to 11% p.a., but administrators have uncovered that the funds collected from bondholders were funnelled through a number of suspicious transactions and ended up being controlled by a small number of individuals, including the chief executive of LCF. Not only does this represent a conflict of interest, but LCF failed to make adequate disclosures regarding the intended management of invested funds.
LCF promoted the mini-bonds as being eligible to be held within an Innovative Finance ISA (IFISA) – however, it was also stipulated that the bonds were not transferable. In order to comply with ISA Regulations, an ISA-eligible bond must be transferable.
Why were the mini-bond investments made to be non-transferable? One reason might have been to avoid having to comply with the Prospectus Regulations. As stated in the FCA Handbook, PR 1.2 (Requirement for a prospectus and exemptions), “It is unlawful for transferable securities to which this subsection applies to be offered to the public in the United Kingdom unless an approved prospectus has been made available to the public before the offer is made.”
What is the current situation?
Following the FCA’s direction to LCF in December 2018 to immediately withdraw all promotional material related to their mini-bonds, joint administrators Finbarr O’Connell, Adam Stephens, Henry Shinners and Colin Hardman of Smith and Williamson LLP were appointed in January. On 18 March, the Serious Fraud Office announced their investigation into the individuals associated with LCF, as a result of the FCA referring the matter to the National Economic Crime Centre (NECC).
The individuals involved are being pursued for criminal activity, and four arrests have so far been made. The administrators are calling on the individuals who benefited financially from the scheme to return funds for the benefit of the bondholders.
It is not clear at present whether investors will have any recourse to the Financial Services Compensation Scheme (FSCS). Per a communication from the FCA on the matter:
“Issuing mini bonds is not a regulated activity, just as is typically the case with other corporate bonds. This means investors are unlikely to have access to the FSCS in the event the firm is declared in default, but this would be a matter for the FSCS to determine.
The FSCS may only compensate protected types of claim. If the defaulting firm generated protected claims, e.g. from unsuitable advice on investments, the FSCS could compensate eligible claimants, provided all relevant criteria are met.”
What does this mean for bonds and bond holders in the wider market?
Investors should make sure they only invest using sites they trust, and above all that they read and understand the risks of investing before entering into a mini-bond investment. It is recommended that investors spread their investments across different assets with appropriate risk profiles matching their risk appetite and understanding.
The FCA have also advised in their recent communication that “[a]ll customers should remain alert to the possibility of fraud. If you are cold called by someone claiming to be from LCF or Smith & Williamson, please end the call and call them back using the number [provided by the FCA].”
How does ShareIn operate and comply with the rules?
ShareIn are directly authorised and regulated by the Financial Conduct Authority (FRN 603332), which means that we and our Appointed Representative (AR) firms must adhere to a set of overarching principles and rules issued by the FCA and uphold our commitment to Treating Customers Fairly (TCF). Whilst the issuing of mini-bonds (or other corporate bonds) is not itself a regulated activity in the UK, authorisation is required to promote mini-bonds. ShareIn undertake review of all financial promotions issued by our ARs to ensure they meet the FCA standards of being fair, clear and not misleading.
The offers made available on our AR platforms make use of the exemption set out in the Prospectus Regulations, where offers under €8m do not require a Prospectus (you can read more about the latest update to the UK Prospectus Regulations on our blog).
We’ve seen significant growth in the size and number of bonds offered on our ARs’ platforms since the introduction of the IFISA. The fact that ISA investments are transferable is made clear to prospective investors at the outset, and their understanding of this is assessed before they can enter into the investment on our AR platforms.
As co-founding members of the UK Crowdfunding Association, ShareIn take an active role in promoting a strong regulatory framework whilst also encouraging the growth of business in the crowdfunding sector. To this end, all investors on our platforms must complete an Appropriateness Test and categorise themselves as an investor before being able to invest, and must read and understand the ISA Terms and Conditions before making an IFISA investment.
The potential losses for investors clearly make for regrettable headlines for the alternative finance industry. That said, the financial services industry has made great strides to eliminate the poor practices evidenced in the financial crisis of 2008 and that ultimately resulted in the formation of the FCA. We must continue those efforts to retain and build consumer confidence particularly as new financial products emerge and evolve to challenge traditional banking and investment products.