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.