Discretionary fund manager Beaufort Securities failed spectacularly in March 2018. Yet, up until that point, it had been following the FCA’s strict rules on ring-fencing clients’ assets and money in nominee accounts set apart from the company’s own.
The widespread assumption was that clients could breathe easy since FCA rules ensured clients’ assets could not, and would not, be raided by a broker or its creditors if the firm went bust. Hence the consternation when Beaufort Securities’ clients learnt that PwC, which was appointed as administrator to wind up the company, would use ring-fenced client assets (see boxout on nominee accounts) to cover £100m in insolvency fees
and it could take no less than four years to recover their funds. Understandably, this has concerned individual investors.
There was further worry when it emerged that the FCA had been aware Beaufort Securities was foundering for some time; some feared that it had only allowed the firm to stay afloat so that the US Federal Bureau of Investigation (FBI) could conduct an undercover investigation. (Serious fraud charges have since been brought by the US against some Beaufort Securities staff.)
A campaign to fight Beaufort Securities' clients' corner was swiftly launched by the shareholder activist group ShareSoc and backed by former Conservative minister Lord Lee, who has raised the issue in Parliament. Lord Lee commented: “This drives a coach and horses through what were thought to be the existing safeguards. Cash, self-invested personal pensions (SIPPs) and individual savings accounts (ISAs) are all potentially affected.”
What is the legal position of nominee accounts?
Nominee accounts allow a broker to ring-fence clients’ assets so that they are clearly separate from the firm’s own assets. On the face of it, this shields client funds in the event of a company failure. However, the surprise for many investors is that the law specifically makes provision for insolvency fees (which may run into tens of millions) to be taken from their funds.
The legal basis for the payment of administrators’ expenses from client assets is set out in a statutory instrument, rule 135 of the Investment Bank Special Administration Regulations 2011. This permits administrators to deduct costs of distribution from all client assets a firm holds on behalf of clients, whether the assets are held in the name of the client or in the name of a nominee. It says, however, that client assets may be used only to pay the expenses that administrators have “properly incurred as a result of the work undertaken to ensure assets are returned as quickly as possible," as Lord Bates describes.
In June 2018, after strenuous efforts by the creditors’ committee coupled with behind the scenes influencing by the FCA, a softer line emerged from the administrator:
PwC announced that the insolvency would cost no more than £55m and be concluded within two years. Furthermore, the Financial Services Compensation Scheme (FSCS) has now agreed to pick up the tab for 94% of that, so fewer than a dozen clients (all of them big) would be forced to take a ‘haircut’.
PwC says that the £100m was only ever a “worst case scenario forecast” and took into account any litigation over US criminal inquiries plus outgoings, such as paying retained Beaufort Securities staff. “Creditors were told that the expected eventual costs and timescales would be significantly lower, especially if a distribution plan to creditors for later this year could be agreed and ratified by the creditors' committee,” commented a PwC spokesman. “The expectation was for the actual cost to be much lower, which of course was the case with the revised estimate of £55m. It remains the case that the administrators' fees will be a minority of the overall cost.”
If an immediate crisis for investors has been averted, troubling questions persist. There are the inevitable queries about the external auditor’s role: shouldn’t it have seen Beaufort Securties’ problems coming, and shouldn’t it be liable for the collapse? (See our article on auditor and accountant responsibilities
Auditors are comparatively rarely held liable for company failures. Audits are backwards looking and essentially state that the financial statements contain no ‘material misstatement’ and give a true and fair opinion.
In 2015, EY settled a suit over its audit of Lehman Brothers for a modest US$10m payment with no findings of wrongdoing against the company, for example.
With regards to the FCA, ShareSoc’s director, Mark Bentley, believes that the regulator “should have put UK investors’ financial interests ahead of an investigation by the FBI”. The FCA responded to this in a written statement to The Review
, saying that it first intervened at the broker in October 2016 and that its later action “took place in parallel with the US Department of Justice’s action against Beaufort Securities and various other parties, and we did not permit the firm to trade at the expense of clients”.
The question of how best to reassure clients remains. Some observers believe that the lesson of the Beaufort Securities case is that even where an unexpected loophole appears, the authorities will, when push comes to shove, step in to protect the individual investor. There are nowadays many layers of protection for the non-institutional investor. The FSCS, for example, provides cover of up to £50,000 per eligible claim
, and this will rise to £85,000 in 2019, to bring it into line with the deposit scheme.
If that does not satisfy an investor, it may be worth recommending firms, such as Interactive Investor, which voluntarily take out insurance cover that would pay out in the event of difficulties. Similarly, investors can choose to avoid smaller brokers.
None of this satisfies ShareSoc and Lord Lee. They met John Glen, Economic Secretary to the Treasury, recently. Among the measures they urged on him to forestall worries that further loopholes to the detriment of investors might at some stage emerge was that the government commit to meeting any future losses in similar circumstances. The minister accepted the need to maintain investor confidence and did not rule out further action; but the shareholder activists failed to wring any specific commitments out of him.
The authorities are clearly aware of the anxieties of individual investors and seem prepared to cushion them from losses in circumstances such as Beaufort’s collapse. But with the law as it stands, in principle the small investor could in future again end up footing the bill for the costs of winding up a firm – and those seem eye-watering.