SFO widens investigation into £236m minibond scandal

Partner Bambos Tsiattalou discusses the SFO’s recent arrests in connection with a £236m minibond scandal.

Bambos’ article was published in Compliance Monitor, 4 September 2019, and can be found here.

In March 2019, the SFO made four arrests in connection with the collapse of the high-risk lender London Capital & Finance (LCF). At that stage it was known that its sales agent Surge had been paid 25% commission on the funds raised for LCF, with administrators Smith and Williamson putting the total at approximately £60 million.

Following the arrests in March, Surge confirmed that no one in the company had been spoken to by the police. However, on 19^th June 2019, Paul Careless, the millionaire founder of Surge, was arrested, interviewed and released pending further investigation.

Mini-bonds allow companies to raise capital by borrowing directly from the public. The promised returns can be attractive; in this instance customers were promised returns of 6.5-8% on their investment. Such high yields come at a cost with investors typically exposing themselves to a much higher risk. The return on any investment is dependant upon the success of the company. If the company fails, the investor may see no return at all. Mini-bonds are also not normally protected by the Financial Services Compensation Scheme (FSCS), and so if the issuer is unable to repay the capital, there is no guarantee that investors will get their money back.

Investors in LCF were led to believe that their money was being invested in a large number of companies, but the arrests in March concerned individuals connected to the small number of businesses into which investor’s money was actually placed. Investors were also told that the mini-bonds qualified to go into an ISA. Again, this proved not to be the case.

Firms are required to be authorised by the FCA if they undertake any of the regulated activities listed in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. As issuing mini-bonds is not a regulated activity, LCF did not need to be regulated to do so. However, it did need to be regulated to issue promotion of them.

On 10^th December 2018, shortly before the collapse, the FCA ordered LCF to stop marketing its fixed-rate investment bonds and ISA products before freezing its assets three days later on 13^th December 2018. The FCA sited concerns that included the fact that LCF bonds were being marketed as ISA eligible when they were not.

The FCA has powers to prosecute a range of criminal offences with the general policy being to pursue through the Criminal Justice System all cases where criminal prosecution is appropriate. When deciding whether to bring a criminal prosecution or to refer to another prosecuting authority, the FCA will apply Code for Crown Prosecutors.

Authorities to which the FCA can refer include the SFO and the CPS, who are also concerned with cases involving financial crime and/or regulatory misconduct.  Where a matter involves serious or complex fraud the appropriate prosecuting authority will usually be the SFO. The SFO may investigate any suspected offence which appears on reasonable grounds to involve serious or complex fraud and may also conduct, or take over the conduct of, the prosecution of any such offence.

In such circumstances the FCA will usually undertake a dual track approach, with both regulatory and criminal offences under consideration. In this instance, the FCA referred the LCF matter to the National Economic Crime Centre (NECC) and on18th March the SFO, that has officers based at the NECC, announced that they had launched an investigation into certain individuals connected with LCF. That investigation has been running and will continue to run alongside the FCA’s own enquiries.

Where agencies are deciding whether to institute criminal proceedings, they will have regard to the usual codes or guidance relevant to that decision. When making a decision whether to commence proceedings, relevant factors will include:

• whether commencement of proceedings might prejudice ongoing or potential investigations or proceedings brought by other agencies; and
• whether, in the light of any proceedings being brought by another party, it is appropriate to commence separate proceedings against the person under investigation

Following the collapse of LCF, the FCA issued warnings about the risks of investing in peer-to-peer lending or ‘mini-bonds’. The regulatory authority has itself also been burnt by the scandal, it having emerged that the financial watchdog had failed to regulate the firm on receipt of warnings some three years before the collapse. In March of this year, the FCA Board launched an independent investigation into the issues raised by the failure of LCF. The investigation is to cover questions in two areas:

• whether the existing regulatory system adequately protects retail purchasers of mini-bonds from unacceptable levels of harm
• the FCA’s supervision of LCF

On 22^nd May 2019, exercising its powers under s.77(1) and (2) and 78(5) and (6) of the Financial Services Act 2012, the Treasury gave direction to the FCA to launch an independent investigation into the relevant events relating to the regulation of LCF:

“In accordance with section 77(1) of the Act, the Treasury consider that it is in the public interest that the Financial Conduct Authority (“the FCA”) should undertake an investigation into the relevant events relating to the regulation of London Capital Finance plc (“LCF”) and it does not appear to the Treasury that the FCA has undertaken or is undertaking into those events”

The Treasury considers ‘relevant events’ to be the events and circumstances surrounding the failure of LCF and the supervision of LCF by the FCA during the relevant period.

At paragraph 3 of the direction, the Treasury set out the scope of that investigation:

“3. (1) The investigation must focus on whether the FCA discharged its functions in respect of LCF in a manner which enabled it to effectively fulfil its statutory objectives, and must consider the following matters –

• whether the FCA adequately supervised LCF’s compliance with its rules and policies;
• whether the FCA had in place appropriate rules and policies relating to the communication of financial promotions by LCF
• whether
• the FCA had established appropriate policies for responding to information provided by third parties regarding the conduct of LCF
• whether the FCA received such information during the relevant period, and
• whether those policies were properly applied;
• whether the permissions that LCF were granted were appropriate for the business that it carried on.

(2) The investigator may also consider any other matters which they may deem relevant to the question of whether the FCA discharged its functions in a manner which enabled it to fulfil its statutory objectives

Subject to reasons for any delay and a revised target date for conclusion, the investigation is to be completed within twelve months (paragraph 7 (1) – (3)).

For LCF investors the most important question will no doubt be whether any of the connected companies will be in a position to repay the loans. Earlier this year, administrators Smith & Williamson warned that most of the businesses LCF invested in had been unable to provide proof that they would be able to do so. Only one company, Independent Oil & Gas, looked like it would be able to repay its loan in full, representing only 20% of the total invested.

As a result of mini-bonds not being regulated investments, investors were initially told that they would not be able to make claims to the FSCS. However, the scheme has been exploring possible grounds of compensation for those affected, indicating that it may be able to pay compensation to investors if LCF was found to have provided advice when it was not regulated to do so. The focus of FSCS is whether any “regulated advising, arrangement or other activities which may trigger compensation” took place. As part of that exploration, the FSCS wanted to “better understand” the relationship between LCF and the company founded by the recently arrested head of Surge, Paul Careless. In particular, authorities will be considering whether customers were actively advised that the mini-bonds were a suitable investment for them, or whether they just took the orders.

LCF paid Surge Financial millions to develop its online comparison sites promoting mini-bonds. Although not charged or subject to bail, the recent arrest of its millionaire founder is perhaps demonstrative of the aggressive approach being taken by the SFO in ensuring a thorough investigation takes place. With a reported turnover of £50 million last year, the investigation of Surge’s involvement in LCF will no doubt be of particular importance to those individuals unable to make a case to the FSCS.

It is of course right that anyone concerned in conduct that causes such devastating losses should be held to account after a thorough investigation. It is also right that given the cost to the public purse of such investigations and any subsequent prosecutions, the regulatory bodies put in place to protect against any such wrongdoing should come under scrutiny if they fail in their statutory objectives.