London Capital & Finance administrators get off to unpromising start

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It has only been a week since four practitioners at Smith & Williamson were appointed as administrators of London Capital & Finance – by London Capital & Finance itself – but already the administrators have made a poor start in reassuring creditors that they are on their side and not the people who appointed them.

First, on the second day of their appointment, Smith & Williamson referred to London Capital & Finance’s investors as “sophisticated or high net worth” in a statement to Professional Adviser.

Exactly how many of LCF’s investors qualify as high net worth or sophisticated will only become clear when the FCA or the administrators get round to reviewing what evidence LCF has retained on file that its investors did, in reality, meet those criteria. FCA regulations require them to hold such evidence for any investors who invested on that basis (COBS 4.12.9 onwards).

For the moment, however, it is clear from the FCA’s Second Supervisory Notice, and the personal statements of LCF investors on the Facebook action group and elsewhere, that a significant number of LCF’s investors did not qualify as high-net-worth or sophisticated. Given that this contributed to LCF calling in administrators in the first place, parroting the idea that LCF’s investors were mostly high-net-worth or sophisticated when the administrator has not had nearly enough time to establish that is a clear blunder.

Smith & Williamson has since rowed back from its claim that LCF investors were HNW/sophisticated, saying it should have been better worded.

This statement was then followed by an interview on the BBC’s Money Box programme on Sunday 3rd Fenruary between BBC presenter Paul Lewis and Smith & Williamson’s Finbar O’Connell. After a brief interview with an LCF investor (who made it very clear that he was not a sophisticated investor, and had invested money that he couldn’t afford to lose), and a brief overview of the numbers, O’Connell made an astonishing statement:

PL: How many companies are involved?

FO’C: It is actually only twelve companies, which is good in a way, becuase it means our focus on the borrowers we have to deal with is quite a small number.

PL: Ye-s, but the small number implies that the risk isn’t being spread […] These were supposed to be low risk, if you lend to twelve companies you’re entirely dependent on those twelve companies to get your money back.

FO’C: Yes, as you say, as regards spread, it is twelve companies, security is in place, we’re meeting those entities next week, and we’ll know more after that.

One of the most basic principles of investing (which Paul Lewis is clearly aware of) is that diversification reduces the risk of an investor losing money, without necessarily reducing the potential return. Other things being equal, the more individual companies invested in, the better. These should also be uncorrelated as far as possible – which does not apply if most of the companies you lend to are linked to your company.

It may well be understandable if Smith & Williamson are secretly quite pleased that LCF has very few underlying borrowers because it makes their job easier. It is however not what the creditors will want to hear – and remember that Smith & Williamson are working for the creditors. To go on national radio and state to the listeners (many of which will be LCF investors looking for more news) that it’s good that LCF’s loan book is chronically under-diversified because it gives them less work to do is an extraordinary self-serving gaffe.

O’Connell goes on to say that the administrators have already established that the money invested in LCF’s twelve borrowers matches the total invested by investors – “the numbers all add up”. Paul Lewis asks if this means that if investors will be safe if all these companies return interest and capital on time (acknowledging “that’s a lot of ifs”): O’Connell replies “that is the hope”.

The fact that the administrators have matched the amount invested by investors with the amount loaned out rather misses the point that LCF paid 20% of investors’ money to Surge Financial, who ran its call centres and comparison websites promoting LCF via misleading comparisons with deposit interest rates. (The 20% figure has been confirmed by the Evening Standard and is backed up by note 10 in LCF’s most recent accounts.)

To enable LCF to return all investors’ capital and interest, LCF’s borrowers therefore not only need to return capital to LCF with sufficient interest to cover the interest offered by LCF, but also cover the 20% commission, and any other costs incurred by LCF (such as those of its sponsorship).

Conclusion

Smith & Williamson has a statutory duty to work in the interests of creditors. When an administrator is appointed by the directors of the firm that has just become insolvent, they have extra work to do to convince creditors that they are working in their interest, not those of the people that appointed them.

Especially when you consider that S&W will spend the larger part of their time interacting with the directors, in order to establish the financial position of the company and any avenues for recovery. This means it is essential that creditors can be confident that the administrators will robustly challenge the directors.

This is not a good start.

Misleading statements by LCF is partly what got LCF investors into this situation in the first place (source: FCA’s Second Supervisory Notice). In which case you have to ask why S&W initially blindly accepted LCF’s assertions about the sophisticated / HNW status of their investors, and the idea that everything is hopefully fine because LCF’s borrowers will repay their loans on time (and with sufficient interest to cover not just LCF’s commitments but to recover the amounts paid out as commission).

Footnote

O’Connell does accurately state in the interview that the existence of a Security Trustee with security over LCF’s assets doesn’t actually help investors, as the investors have a claim against LCF anyway. This is an obvious point but you wouldn’t know it from the number of unregulated bond issuers that go big on the existence of a “Security Trustee” in their adverts.

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