The law firm Shearman & Sterling has written a letter this week to the Financial Services Compensation Scheme, outlining a new legal justification for compensating London Capital & Finance investors en masse. Shearman & Sterling are reportedly acting pro bono for some LCF investors.
At the heart of their argument is a recent clarification by the FSCS that investors with a claim relating to FCA-regulated activities carried out by LCF are still covered by the FSCS even if LCF was not authorised to carry out that activity.
The specific activity in question was regulated advice.
Over the last month or so, LCF investors have been encouraged to pore over emails and rack their brains in case they can argue that they received investment advice from LCF call centre workers to invest in LCF minibonds. This would constitute misselling, which would open the doors to the FSCS.
Unfortunately, this is a low-percentage strategy which will not help the vast majority of LCF investors. By many accounts, LCF salespeople worked to a script which deliberately avoided straying into advice, just as any financial services call centre employee would.
The fact that some call centre workers may have gone off-script in order to close a sale does not change the fact that LCF was not a financial advice firm, did not advertise financial advice, was not authorised to give advice, and employed no advisers with recognised financial advice qualifications.
However, the fact that the FSCS will potentially pay out for claims in relation to regulated activities, regardless of whether LCF was authorised to carry out those activities, has inevitably raised the question: what if LCF was carrying out other regulated activities which would cover all LCF investors?
Shearman and Sterling think they have the answer. They are arguing that by arranging the minibonds, LCF was effectively “dealing in investments as principal” and “running a collective investment scheme”.
Unfortunately both these arguments have glaring holes.
The glaring problem with the second part is that UK securities legislation is specifically designed to avoid minibond issues being classified as collective investment schemes. An example of this specific exemption can be found in The Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001, Section 5 of the Schedule.
As for “dealing in investments as principal”, the only investments that LCF dealt in with were its own, and dealing in your own investments is again specifically excluded from the definition of this regulated activity, this time by Section 18 of FSMA (Regulated Activities) Order 2001.
More generally, if LCF was running a collective investment scheme, then every issuer of an unregulated minibond is running an illegal collective investment scheme, and all of them (and the FCA) are in a whole heap of shit.
But luckily for all concerned (except hapless investors), the whole point of the concept of a minibond in UK legislation is to allow every Tom, Dick and Harry to promote unregulated unlisted investment securities to the public while allowing the FCA to ignore it. Minibonds are not FCA regulated and are not covered by the FSCS.
Perhaps in an indication of the desperate quality of its argument, S&S resorts to appeal to emotion, claiming investors “rightly understood that the FSCS would stand behind their investments”.
This is complete nonsense as LCF’s website specifically stated that investors were not covered by the FSCS. And when FSCS-protected accounts on the high street pay no more than 2.5% per year, the idea of an FSCS-protected account paying 8% falls squarely into the category of “too good to be true”.
London Capital & Finance Plc is incorporated in England and Wales under the Companies Act 2006 as a Public Limited Company with registered number 08140312. Investments into the LC&F bond are not protected by the Financial Services Compensation Scheme (FSCS). – London Capital and Finance website circa Feb 2018
LCF investors were by and large convinced that FSCS protection didn’t matter, e.g. because LCF loans were backed by assets worth more than LCF’s liabilities (which turned out to be nonsense).
Shearman & Sterling continue “LC&F therefore presents exactly the situation that FSCS was established by Parliament to address.”
The FSCS was not established by Parliament to bail out Ponzi schemes. If it was, investors could happily sign up to Ponzi schemes en masse, knowing that if they got in early enough they would cash in, and if they didn’t they would be compensated by the FSCS.
There was no reason to think LCF was backed by the FSCS until it collapsed, at which point investors suddenly had a desperate need to think it was. This in turn has created a demand for a firm of lawyers looking for business to concoct legal reasons to think it was. This is a pretty thin attempt at finding some.
Hope and pseudolegalism springs eternal
Nonetheless there is hope for LCF investors yet. However the reasons why compensation may yet be awarded are political, not legal.
The investors naturally want compensation. Many MPs also want their constituents to be compensated. The FCA is also desperate for LCF investors to be compensated, because if they are, the bottom falls out of the political pressure being directed at the FCA, and the impetus for sackings and top-down reform.
If investors are bailed out they will stop writing to their MPs, and MPs will stop asking questions in Parliament, and when the FCA’s “independent” inquiry eventually reports several years later that the FCA could have done better but it was mostly the system’s fault, the conclusions will fall squarely into the long grass.
The main body which would stand against LCF investors being compensated would be the financial services industry, who will pay for it, via an interim levy to the FSCS. But no major financial services company will come out and condemn LCF compensation because it would be a PR disaster.
And the big firms in the financial services industry will not notice the cost of an LCF bailout, as they will simply pass it straight to the general public without it touching the sides.
IFAs and other smaller financial firms will notice, whether or not they pass on their FSCS levy to their clients, but nobody listens to them.
So the political impetus for a bailout is almost irresistable, and all that is left is to find a legal pretext for one. Who knows, Shearman and Sterling may have found exactly that. It is tissue-thin but the Government has spent much larger sums on much shakier grounds. And it is highly unlikely that such a bailout would be challenged in the courts by its funders as unlawful.
The best bet for the financial services industry is to lobby the government to bring UK securities laws out of the 1920s, in the hope of avoiding future £200m+ invoices.
I am fascinated by this argument …. and this “More generally, if LCF was running a collective investment scheme, then every issuer of an unregulated minibond is running an illegal collective investment scheme, and all of them (and the FCA) are in a whole heap of shit.”
To determine if LCF caan be considered a collective then one would need to test it against the criteria in FSMA 2000 s. 235 as Lord Vos did with FCA vs Capital Alternatives in 2015. That would be a fascinating exercise. I wonder if S&S are planning on arguing that case?
Sorry Stephen, have to side with the author on this one. Para 5(1)(a) of the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001/1062 provides that debentures “issued by a single body corporate other than an open-ended investment company” aren’t capable of being a CIS.
A question (not a challange) @adamsmith – are they capable of being an NMPI though?
[Baffled readers can look up the definition of NMPI at https://www.handbook.fca.org.uk/handbook/glossary/?filter-title=non+mainstream+pooled+investment%5D
I wouldn’t say so; having ruled out a CIS, the only other real contender within the NMPI definition is “a security issued by a special purpose vehicle”, where an SPV has to be “explicitly established for the purpose of securitising assets” [https://www.handbook.fca.org.uk/handbook/glossary/G1113.html for other readers keeping up].
Based on my – admittedly hasty and superficial – reading of LCF’s articles of association I can’t see anything to engage s31(1) of the Companies Act 2006 (“Unless a company’s articles specifically restrict the objects of the company, its objects are unrestricted”) so there’s a clear argument that it wasn’t “explicitly established” as described above; I’d compare and contrast with, e.g., an Irish DAC.
Sorry, that was me replying but not typing straight…
The issue is not that every ponzi scheme results in FSCS protection. But one with FCA authorisation selling HMRC badged ISAs certainly is.
The difference here is that LC&F used the most of the FCA approved badge and that they were approved as a ISA manager. It is a disgrace that it is so easy to be FSA approved and ISA manager. FCA and HMRC should collectively take responsibility and pay compensation sooner rather than later. Lessons must be learnt to protect future pensioners putting their life savings into such schemes. FCA did receive warnings years ago but did nothing.
I agree totally. The investors were mis-sold the investments and lied to. ISAs were not ISAs . Investments were not made in British SMEs, as promised. The Security Trustees appear to be part of the scam. The FCA authorisation was only nominal, and not the security backing it suggested.
It seems to me that the conclusion “these arguments have glaring holes” is reached by ignoring the reasons given for why the exemptions should be disregarded, e.g. with regard to ‘dealing in investments in principal’, the MiFID over-ride, and with regard to ‘operating a collective investment scheme’, the necessary elements for a valid contract to exist were lacking, thereby voiding its categorisation as a bond investment.
A fascinating set of comments. For the record, I was not arguing LC&F was a CIS, I was just wondering how S&S were planning on arguing it was. I presume S&S have a plausible argument for it.
Lord Vos, in FCA vs Capital Alternatives 2015, argued that one has to look at the substance and not just the form. So although the form of Capital Alternatives was not an open ended investment company, to circumvent the legislation, in substance it was shown to be operating as a collective and therefore was a collective. i.e. if it walks like a duck and quacks like a duck – it’s a duck.
For S&S to put forward their argument LCF is a collective, they have to show it’s operatiing as a collective regardless of its form, in which case, if I am reading it right, the exclusion in Para 5(1)(a) of the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001/1062, quoted by Adam above, doesn’t apply. The key phrase, I think is “…other than an open-ended investment company”. If you start from the premise LCF is an OEIC because it operates as one, then surely the debentures issued “[are] capable of being a CIS.”
Is that not where S&S must be coming from? S&S just have to show it was a collective, I’m not saying it was, I am just wondering how they will do that.
If S&S can show LCF was a collective then, as Brev says, “More generally, if LCF was running a collective investment scheme, then every issuer of an unregulated minibond is running an illegal collective investment scheme, and all of them (and the FCA) are in a whole heap of shit.” I hope S&S can pull this off!
I would love nothing more than to see this lot “in a whole heap of …”. I personally think the FCA are a waste of tax-payers money! There are too many vulnerable victims of scams facing financial ruin and guilty of nothing but ignorance to see through the lies, and the FCA just let it happen even when they are warned of the scam.
I’m still not sold on the Capital Alternatives argument. IIRC this was the case where the agricultural product grown on each “investors” piece of land generated the revenue, and there was clear evidence that this product was pooled. LCF’s investment structure appears to be substantially different from that and I foresee a judge distinguishing the facts at an early stage.
We’ll have to see how this one plays out. Right now, with Shearman & Sterling reportedly working this case pro bono, i find it hard to characterise it as anything beyond grandstanding and a write-off against their marketing budget.
While I have every sympathy for the victims in the LCF case, I’d be wary of raising their hopes to much with this legal action.
@AdamSmith. I agree, It was very easy to see in the Capital Alternatives case how the investment was pooled and therefore a collective. I too cannot see how Shearman & Sterling are going to argue that LCF was a collective but since they have said it, I assumed they had something plausible and I just wondered what it could be. I hadn’t considered they were “grandstanding”. If they have nothing, other than a cheap attempt to grab a headline then shame on them because then they are giving false hopes to victims.
I can relate to how the victims feel right now. However, if S&S do have a convincing argument this would be a welcomed turning point for the unregulated mini bonds and the parasites running them that are just popping up like weeds out of control!
Stephen,I do not believe this is a cheap attempt at grabbing headlines.The partner of the firm in question has a relative,who invested in this scam.He is representing his father,primarily.The fact that,if he convinces the FSCS,it will be other bondholders who will benefit as well.
The bondhders were only aware of the case last week.
@Peter ok, so not a headline grab then. The partner of the firm in question is presumably a very experienced lawyer and presumably has a convincing argument to show LCF operates a collective. I’d love to hear it.
In my opinion the FSCS are unlikely to be easily convinced because of the much wider consequences – as Brev explains in the article. It would most likely have to be tested in court. I would most likely be pushing up daisies before that ruling came out.
Good luck to the victims anyway. Justice is a rare commodity in the scamming underworld. I’m not sure victims ever see any if I’m honest. I hope the “partner” pulls it off.
Stephen,Thomas believes he has a robust case,but urges caution to bondholders…”it is slowly opening the door again”after the FSCSclosed it earlier.
I have read the full letter to the FSCS 3 times,but the technicalities of the 2 regulated activities go above my head.I think Thomas argues that the MiFDI overrides the FSMA2000,which Brev talks about.Have you seen his letter?
I am a bondholder and thank you for your good wishes on this.
@Peter, I have only seen the letter dated 21st Feb that’s on the LCF website. Not seen any other letter. An argument that MiFID overrides FSMA is an interesting one, but no, not seen it.