When I opened my morning paper and read that staff at the Financial Conduct Authority HQ had been condemned by their Chief Operating Officer for leaving liquor bottles in sanitary bins, abusing the cleaners, and defaecating on toilet floors, my first thought was:

“I’m not going to write an article about this. It’s a trivial employee discipline issue, and Bond Review is better than that.”

Then I came to my senses, mixed myself a glass of Old Cynic, and started mashing keys.

So, the news here is that staff at the headquaters of the Financial Conduct Authority have been excoriated by one of their most senior directors for

leaving cutlery and crockery in the kitchen areas, overflowing bins, stealing plants and charging cables from desks, catering and security teams being subject to verbal abuse, colleagues defecating on the floor in toilet cubicles on a particular floor, urinating on the floor in the men’s toilets and leaving alcohol bottles in sanitary bins

according to Chief Operating Officer Georgina Phillipou.

Who probably wasn’t told, when she accepted the job of one of the most senior officials at the financial regulator of the United Kingdom, that it would involve attempting to potty train thousands of highly qualified financial regulators.

On a message posted on the FCA’s Intranet, the Chief Nursery Officer continued:

I did think long and hard about whether to disclose all these behaviours because they are so distasteful and shameful but keeping quiet has not got us far in terms of changing behaviours. This kind of behaviour is unacceptable and will not be tolerated here.

Whether the “look at what you just did” school of discipline works on the UK’s foremost financial supervisor remains to be seen. But it’s worked on millions of dogs, so best of luck to Ms Phillipleasedontpouonthefloor.

Broken windows

Obviously it’s very easy to make cheap jokes about civil servants trashing their office, which is why I’m doing exactly that.

But there is a more significant point here.

In the 1990s a social science theory known as “broken windows” came to prominence in New York City. The idea was that if you tackled low level crime, such as bricks being thrown through random windows, people would start taking pride in their neighbourhoods, and more serious crimes would be nipped in the bud.

In essence, broken windows theory is that you have to make people on the ground care about their environment, and only then can you hope to improve it.

Whether broken windows theory ever led to a reduction in the crime rate is disputed, as any experiment involving a dataset as chaotic as the crime rate always will be. But the theory itself is logically sound.

As to how this theory applies to the FCA, it’s simple. If you can’t trust regulators to not shit on the floor, or swear at the dinnerlady, how the hell you gonna trust them to deal with scammers and crooked bankers?

The Financial Conduct Authority’s job is to ensure billions of pounds in UK capital flows to where it’s needed, and that the 70 million people in the UK can open bank accounts, save into pensions, wave cards and generally interact with the financial system without worrying if they’re going to lose their money by doing so.

If that isn’t enough to get FCA employees out of bed in the morning, without reaching for the bottle on the bedside table, then we are screwed.

And if this isn’t enough to get FCA employees out of bed in the morning, that’s not their fault, that’s the fault of senior management, and the culture they created. That’s not me talking; that’s the gist of the FCA’s own Senior Managers and Certification Regime, due to come into force next month.

SM&CR breach ahoy

After a systemic failure to intervene in unregulated investments flouting UK law on promotion to retail investors, resulting in a billion worth of lost investments in 2019 alone, the FCA is under scrutiny like never before.

The FCA’s failure to stop unregulated high-risk investments being marketed to retail investors who cannot bear the risks is a failure of culture. Part of its job, part of its statutory responsibility is to protect consumers and ensure market integrity.

In treating unregulated investments with a policy of masterly inactivity, by ignoring them as insignificant and not its problem, it has overseen billions worth of lost money and ruined lives. This policy did not come from its loose-breeched employees, but from the top.

There may be some people thinking: “Give over Brev, you can’t leverage a few rogue employees into a screed about financial services regulation. We’ve all worked in large organisations at some point in our lives, there’s always a few nobheads in an organisation of thousands.”

Well, maybe I can’t, but I’m going to leave this to Bond Review’s readership.

Do you work in a large company?

Do your work colleagues shit on the floor?

I used to work in a large financial firm, and I’ve seen my fair share of bad behaviour. I’ve had to dive under a table at a Friday social. But my colleagues didn’t steal chargers from the electrical outlets, they didn’t assault the catering staff, and they didn’t shit on the floor.

An organisation rots from the head. The FCA is now literally putrescent.

The approaching change of CEO is not enough, and messages circulated on the intranet are also not enough. A top-to-bottom change of culture is needed. Until it happens, expect more flogging of unregulated investments to retail investors without consequence, expect more ruined lives, and expect more shit on the floor.

An article in Private Eye about the cryptocurrency Ponzi scheme OneCoin caught my eye last week.

OneCoin was one of the earliest and biggest cryptocurrency Ponzi schemes. You handed over money in exchange for OneCoin tokens, which OneCoin and its agents claimed would steadily increase in value, allowing you to cash in your tokens later for more money (or money’s worth).

Large recruitment commissions were also paid in a multi-level marketing (aka pyramid) system.

OneCoin never made any serious attempt to claim that it had external revenue to fund its ability to pay investors more than they’d invested – plus recruitment commissions. Using new investors’ money to allow existing investors to cash out more than they’d invested, while also paying multi-level commissions, made it a Ponzi scheme.

The Ponzi element collapsed in early 2017 as withdrawals exceeded the money left in the system and OneCoin closed its “exchange”. The scheme continued to limp on as a pure pyramid; victims were encouraged to continue exchanging money for OneCoin tokens in the hope the exchange would someday re-open.

So far, so cookie-cutter cryptocurrency Ponzi scam.

OneCoin is believed to have taken in £4 billion from investors around the world, of which about £100m came from the UK, mostly ethnic minority Muslim enclaves, in an example of “affinity fraud”.

In affinity fraud the scammer convinces the mark to invest on the basis that they should trust him as a member of their community, instead of the mainstream financial and legal system. Often the community is a religious one whose members have already been groomed to trust community leaders over facts and reality.

One UK OneCoin recruiter / victim, Jen McAdam from Glasgow who says she and her family lost six-figure sums in OneCoin, made a series of YouTube videos calling out the scam.

OneCoin hired notorious defamation experts Carter-Ruck to send her a letter claiming they “refute all allegations that they are offering a scam” and that McAdam should remove her videos or face expensive legal action.

McAdam stood her ground, declined to remove her videos and heard no more from Carter-Ruck.

So far, still so cookie-cutter cryptocurrency scam.

Where it gets interesting is that Private Eye notes that the Financial Conduct Authority issued a scam warning against OneCoin in September 2016.

Shortly after Carter-Ruck sent its SLAPP attempt to McAdam, the FCA withdrew its warning.

Despite its warning being 100% accurate, and that OneCoin continued to be promoted to UK investors, mostly ethnic minorities.

Despite the FCA having statutory immunity in the UK, which means it cannot be sued for libel for issuing a scam warning against you, unless a court can be persuaded that it acted in bad faith or unlawfully. This is a virtually insurmountable bar, and it is beyond doubt that OneCoin was not going to manage it.

The FCA has refused to comment on whether the removal of the OneCoin scam warning followed any lobbying from OneCoin’s end.

Yet nonetheless, somehow and for some reason it was persuaded to remove an entirely factual scam warning.

Searches of the FCA register for “OneCoin” or “OneLife” produce no results to this day, other than unrelated regulated businesses unfortunate enough to have adopted the name “OneLife”.

When a scam as blatant as OneCoin can somehow persuade the FCA to withdraw an entirely factual warning, is it any wonder that we hit a brick wall when we try to persuade the FCA to protect unwitting consumers from more sophisticated and subtle Ponzi schemes?

Any novice DIY investor should start their research by standing in front of a mirror and repeating to themselves:

The authorities do not care if I get scammed.

The authorities do not care if I get scammed.

The authorities do not care if I get scammed.

Anyone who says “If this was a scam the authorities would have shut it down” is scamming me.

If 2016 was the Year of Dead Celebrities, 2019 is shaping up to be the year of the Collapsed Investment Scheme.

Starting with the biggest of the lot, the collapse of the £230 million London Capital & Finance, we’ve seen the following schemes switch their lights off in 2019.

All have the following factors in common: they all issued investments not regulated by the Financial Conduct Authority, they all sourced investment predominantly from retail investors rather than institutional sources, and they all went into administration or another form of “official” shutdown in 2019.

Most had defaulted on their obligations before 2019 but the key is that the Government or a creditor officially brought the curtain down through a legal administration process in 2019.

That’s just shy of a total of a billion pounds of retail investors’ money at risk of loss, depending on what (if anything) is recovered from the various administrations. And it’s only August.

Now, we need to beware of seeing patterns in what is just randomness. Humans are very good at seeing patterns where none exist.

In 2016, the death of David Bowie at the relatively ripe old age (for a famous musician) of 69 was followed by a year of low-grade hysteria in which every death of a celebrity was hailed as further proof that 2016 was “the worst year ever”. Dispassionate analysis showed that just as many well-loved celebrities died in any other year.

So is this normal? I’m struggling to make a list for 2018 that comes anywhere near the above. Privilege Wealth collapsed for £42m, Essex and London was shut down for £20m… any additions to this list on a postcard please.

It may well mark the worst year for the world of unregulated investment schemes promoted to the public since 2014, when the FCA won its case against Capital Alternatives, and Secured Energy Bonds went to the wall (the UK entity went into administration in early 2015 but the Australian parent collapsed in 2014).

Prior to that the worst year would probably have been 2009, when the global crash did what global crashes do and showed everyone who was swimming naked. Arch Cru (you remember, Greek shipping, Capita Fund Managers, and all that) was one of the highest-profile unregulated casualties in the UK in 2009.

What was that about patterns in randomness?

There’s probably an economics paper to be written there about the nature of 5-year cycles of investor demand in the unregulated sector. But Einstein arguably already wrote the conclusion decades ago: “The definition of insanity is doing the same thing over and over and expecting a different result.”

At time of writing the somewhat-distracted UK Government has not announced any measures to

• require any investment security promoted to the UK public to register with the FCA (as in the USA), and provide full, regular and independently-audited disclosure regarding its financial position
• sack senior FCA management and impose a new senior management team with a mandate to change the FCA’s regulatory culture from the top down, so that it focuses on stopping those who are breaking the rules instead of micromanaging those who aren’t
• reverse the disastrous reforms instigated by the Liberal Democrats in 2011 which allowed anyone to register a limited-liability company in the UK at the click of a button (before 2011 you had to use a registered company-formation outfit)
• close all Intelligent Finance ISAs immediately to new business and reserve tax relief for regulated investments
• close the Companies Act loophole that allows companies to delay filing accounts indefinitely with no sanction
• ban all advertising platforms, broadcasters and publishers (this means you, Facebook and Google) from carrying ads for unregulated investments, on pain of a substantial fine payable to the FSCS

But in the Government’s defence, the Chair of the Treasury Select Committee did make it clear a few months ago that she is very, very cross.

None of the above measures would stop losses to unregulated investments entirely (the UK is a free country and nobody is going to stop me withdrawing all my money and throwing it into the sea), but it would severely reduce losses to retail investors like those detailed above.

Which is the entire point of the billion-pound-plus that the UK public spends every year on the regulatory system via the premiums, charges and interest it pays via regulated companies, which in turn pay for FSCS and FCA levies.

Alternatively we can all just sit here and see what kind of weird and wonderful nonsense collapses in 2024.

With total losses from unregulated investments in 2019 about to hit £1 billion by my count, this seems an appropriate time to debunk a couple of myths that are commonly believed about the victims of unregulated investment schemes which collapse and lose their investors’ money. Not least by the investors about themselves.

Myth #1: The victims of collapsed investment schemes were greedy

In the HYIP world of schemes offering returns of 1% a day or double your money in a year, this is arguably true.

However this isn’t a blog about HYIPs (there is enough coverage of those already). This is about unregulated investments offering yearly returns which are most commonly in the region of 8%-10%. They are occasionally higher but they can also be as low as 5% or even lower.

These returns are not set in the way that mainstream investments set their returns. It is not a question of supply and demand. The return needs to be high enough to tempt investors away from cash accounts and mainstream investments, but not high enough to automatically scare them off thinking “too good to be true”.

The evidence of the last ten years shows that the sweet spot is somewhere around 8% per year. Some collapsed schemes have offered lower and some higher, but 8% is the median.

Returns of 8% per year have been achievable – though not guaranteed – from mainstream, diversified, non-geared capital-at-risk portfolios.

Since 1991, the average return from a diversified, non-geared portfolio of 80% global equities and 20% bonds over a 5-year period* has been 8.15% per year.

Investors in that portfolio would be spread across thousands of shares and bonds worldwide and would have minimal risk of losing money in the long term, unless they cashed it in during a low point due to panic or poor planning.

That does not mean that anyone investing in mainstream equities can expect a return of 8%. Over that timeframe, the chance of getting better than 8% in a 5-year period was little better than a coin flip. In 55% of 5-year periods, the above portfolio did better than 8%; in 70% it did better than 6% and in 87% it did better than cash.

What it means is that the idea of an investment which has a potential return of 8% and minimal chance of losing all your money (providing you can hold for the long term) is not too good to be true.

“But it’s still greedy to expect a return of 8% from a supposedly guaranteed investment.” True. But many of these investments aren’t described as guaranteed. They have risk warnings all over the place. But the risk warnings are presented in such a way that inexperienced investors are encouraged to ignore them. And the people selling them over the phone will say things like “that’s just something we have to include because regulations, don’t worry about it”. Of course, once the investment has collapsed, these phone conversations never happened.

“But it’s still greedy to expect a return of 8% from an investment that’s only 3-5 years – a capital-at-risk investment needs to be held for at least 5 years, preferably 10 to expect inflation-beating returns”. Investors are almost never hoping to put their money in for three years and then take the money out and spend it all. Nobody invests in this kind of scheme just so they can turn £10,000 into £10,800. They are most commonly investing either money that has been accumulated in cash for many years, or a windfall (e.g. inheritance or pension lump sum) which they do not expect to spend in the immediate future. They typically expect to carry on investing for 5 years or longer – and if their investments pay out after the agreed term, they often reinvest.

It is true that returns of any level can never be guaranteed in the future – and certainly not 8% per year. The FCA currently considers 5% to be a reasonable “mid-range” expectation for standard stockmarket investments.

But the crucial point is that if it is greedy to think you can get a return better than cash without risking the loss of all your money (in the absence of total financial collapse), all of us are greedy.

The mistake the victims of collapsed investment schemes make was not to want a better return than cash without losing all their money, but trusting the wrong people to deliver it for them.

Which leads us neatly to Myth no. 2.

Myth #2: The victims of collapsed investment schemes were stupid

Or foolish or naive or whatever word you want to describe a person who picks the wrong person to trust.

If I spar with a black belt in jiu-jitsu and he repeatedly dumps me on the mat, does that make me a weakling?

Naturally not. I might be in great physical shape. But I’m up against a guy who has been sparring with other people for years, who knows exactly how to manipulate another person’s body and has practised his techniques to the point they are second nature. I should expect to be dumped on the mat. That doesn’t suddenly turn me into a weakling.

The people who run and market fraudulent unregulated investment schemes live by persuading investors to part with their money.

They have been doing it for years. Their survival and their lifestyle depends on it.

They know all the moves, they know all the techniques, they know how to exploit cognitive bias. They know every question an investor might come up with and they have an answer for all of them.

They are black belts at turning investors’ minds against them.

Not all the people behind collapsed investment schemes are particularly intelligent, just as their victims are not particularly stupid, and thousands of jiu-jitsu black belts are physically average. But it is what they are good at, and being good at it does not require being particularly smart.

This is a question of technique, not intelligence. Investors have been outsmarted, but that does not automatically make them stupid.

Being financially inexperienced or naive is not a crime, and does not deserve to be punished with the loss of all one’s money.

*Source: Portfolio consisting of 80% FTSE World TR and 20% Bloomberg Barclays Global Aggregate Bond. Average 5 year return is the average of the return over the 8,781 complete 5-year periods spanning 1-1-90 to 15-1-19. To be strictly fair we should knock around 1% off the index returns for charges, but as unregulated investments are frequently promoted with terms like “No fees or charges”, I’m not in a strictly fair mood.

A theme that appears in nearly every review I post is the importance of due diligence when investing in unregulated or unlisted investments.

When a company asks a potential investor to lend them money, they are in a state of what economists call information asymmetry – in plain English, the borrower knows stuff the investor doesn’t.

There is an incentive for the borrower to conceal unflattering information from the lender in order to be able to borrow money from them at a lower interest rate.

However, the lender knows this and should not only demand that the borrower does not conceal information, but independently verify everything the borrower has told them is true. They can do so because while the borrower wants to borrow at the lowest possible rate, they also do not want the lender to walk away.

Ideally, at the end of the due diligence process the information asymmetry vanishes, and both the borrower and lender are in possession of all the facts, allowing a fair interest rate to be set.

Once due diligence is completed the investment does not become risk-free. The lender should never think that they can hand over their money thinking they have established that the investment is a guaranteed winner. If that was the case, the borrower would be paying almost cash-deposit rates of interest.

However, what the lender can do is reach the point at which there is no point doing further digging, and either has to accept that the interest rate on offer is worth the chance of losing all their money, or walk away.

The problem is that “due diligence” is a much abused concept. Time and again you see people losing money because they think they were doing due diligence when they weren’t.

What they were actually doing is pseudo-diligence, i.e. something that felt like due diligence but in reality wasn’t.

Due diligence mostly involves independently verifying that the information given by the borrower is actually true.

Pseudo-diligence mostly involves letting the borrower ladle on more information without verifying that any of it is actually true.

Pseudo-diligence is a classic example of the Dunning-Kruger effect, which can be simplified as “thinking you are cleverer than you are”.

Here are some examples of what people mistake for due diligence and what due diligence actually is.

This is by no means an exhaustive list. Nor it should be interpreted as a guide to “how to do due diligence”. Any more than a list of punches and kicks would be a guide to how to practise karate. The above table is to illustrate the scale of the job. Banks and institutional investors pay a lot of money to experienced and qualified corporate finance professionals to carry it out.

Investors who are not confident in their ability to carry out the above should usually stick with mainstream regulated diversified funds.

When you don’t need to do due diligence

Due diligence becomes redundant when the company’s securities (shares or bonds) are being traded thousands of times a day on a regulated market.

This is because the Efficient Market Hypothesis applies. All the information investors need has already been disclosed to the market or discovered by other investors and baked into the market price.

At this point “doing your research” becomes another exercise in Dunning-Kruger futility. All it achieves is to give the investor a false sense that they know more than the market.

But with small unlisted firms this does not apply. No-one else is going to do due diligence on behalf of the investor (if anyone else has, they aren’t going to signal the results via the market price) so it remains the investor’s job.

Alternatively, if the investor doesn’t have the necessary expertise, they should stick with mainstream, regulated and diversified funds.

Nature abhors a vaccuum and economics abhors the money of someone who lends it out without paying any attention as to whether they’ll get it back. Sooner or later someone will take advantage of them.