Financial Services Authority and Connaught Income Fund

Wednesday 7th May 2014 Westminster Hall

11:00

[Alun Cairns (Vale of Glamorgan) (Con)]

It is a pleasure to serve under your chairmanship for the second time today, Mr Brady. I welcome the Minister to her role, and welcome her involvement in this important issue.

As you can see, Mr Brady, this debate has drawn much attention from colleagues and investors alike. Naturally, investors want explanations of what went wrong and why. Colleagues who have looked into the case recognise the scale of the wrongdoing, and want to know how it happened and about any recourse available to their constituents.

This issue has developed over some time, but this is the first time we have had the opportunity to raise concerns about it and ask questions on the record. The Connaught Income Fund was launched in April 2008. It was promoted and operated by Capita Financial Managers Ltd, which was also the custodian of investors’ assets. Its original name was the Guaranteed Low Risk Income Fund, series 1—something that proved not to be the case. It was a UK-based unregulated collective investment scheme. By definition, these funds are not subject to direct regulation. However, elements of the process and funds were regulated, which means that the regulatory framework and responsibilities are not necessarily straightforward—in fact, they are complex—and that there is a responsibility on the Financial Services Authority.

[Guy Opperman (Hexham) (Con)]

I congratulate my hon. Friend on securing this important debate. Both he and I have fought Capita for more than three years following the Arch Cru disaster, which entailed similar losses, and several constituents of mine lost money through Connaught. Does he agree that it is appropriate to invite the Minister to seek the police’s involvement and to find out whether an investigation should take place?

[Alun Cairns]

I pay tribute to my hon. Friend’s work on Arch Cru as secretary of the all-party group on the Arch Cru investment scheme, and on his involvement in issues relating to Capita. He raises pertinent points that I will come on to, so I am grateful for his contribution.

[Albert Owen (Ynys Môn) (Lab)]

I am grateful to the hon. Gentleman for giving way to me so early. I have to leave, having been in the previous debate with him for an hour and a half.

Is the hon. Gentleman as concerned as I am that so little information is available on Capita, and particularly on the signing-off of the information memorandum? That is a matter of great concern to a number of my constituents and, I am sure, to constituents of hon. Members of all parties.

[Alun Cairns]

I am grateful to the hon. Gentleman for raising important points about Capita that I will come on to. A central factor is what knowledge it had at various stages.

[Chris Ruane (Vale of Clwyd) (Lab)]

I congratulate the hon. Gentleman on securing this debate. Is this the same Capita that won the personal independence payments contract with the Government, for Wales and the west of England?

[Alun Cairns]

I am grateful to the hon. Gentleman for his contribution, but of course Capita Financial Managers Ltd is different from other subsidiaries of Capita. The parent company will be the same; there are several subsidiaries. The point was well made, and I accept it in the way that it was intended.

I should like to pursue the matter a bit further before accepting any other interventions, to provide some background. The proposition was that investors’ money would be loaned to borrowers requiring short-term residential bridging loans. Loans would not exceed modest loan-to-value guidelines, no sub-prime lenders or properties would be financed, and all loans would be secured by first charges against those properties. Specifically, there was to be an average loan-to-value rate of 56%. People were told that it would seldom be above 70% and that anything above 80% would have guaranteed exits. All interest and fees would be taken up front, and there was a guarantee from Tiuta, a company that I will mention shortly, to meet any shortfalls.

The borrowers would pay an interest rate of 17.9%, while investors would receive quarterly distributions of between 8.15% to 8.5%. Capita appointed Tiuta plc and Connaught Asset Management Ltd, both UK companies, to identify suitable borrowers and approve the loans. However, investors’ funds were used differently. Money was transferred to Tiuta, rather than being released directly to the borrowers’ solicitors. It is even suggested that there was no differentiation between the firm’s funds and those of the investors; investors’ money was used to meet the working capital needs of Tiuta, and to pay directors’ salaries, bonuses and pension contributions.

In many cases, where bridging loans were made, the borrowers, properties or loan-to-value ratios were not as committed to in the promotional literature. It is believed that Tiuta proposed loans and drew down the money, but did not proceed with the lending. It is suggested that Connaught provided a monthly statement to Tiuta’s management accountant, switching the true loan book and the approved one.

In March 2009, Capita became aware that the original information memorandum was misleading. The fund should not have been described as low-risk, the guarantee from Tiuta was of no value, the money was used largely for purposes other than bridging loans, and the auditors of the fund were not engaged. In addition, the loans that had been made were not as described and were being rolled over.

In August 2009, after Capita met Connaught’s senior management, investors were informed by Capita that it was resigning as operator of the fund. It was to be replaced by Mourant Fund Services Ltd, but for some unknown reason Mourant did not complete the transaction. Perhaps it became aware of the problems with the fund.

[Guto Bebb (Aberconwy) (Con)]

I congratulate my hon. Friend on securing this debate. Is it not a significant concern for all of us who have been looking at this issue that, in 2009, it became apparent that Capita had significant concerns about the way that the fund was being operated, but those concerns were not conveyed to those who had invested in the fund?

[Alun Cairns]

I pay tribute to my hon. Friend for his support in investigating this matter. He raises an important point. There is a serious question about what Capita did and did not know, and what it should have communicated to the investors, to whom it had a responsibility.

[Bill Wiggin (North Herefordshire) (Con)]

I draw the House’s attention to my entry in the Register of Members’ Financial Interests. My constituent, Mr Sudworth, who is a victim of this fraud, asked me a question; I wonder whether my hon. Friend knows the answer. Does the Financial Conduct Authority outsource some of its work to Capita?

[Alun Cairns]

I am grateful for my hon. Friend’s question. I do not have the answer, but he points to a general defensive approach that has been taken by the FSA and the FCA. We are seeking greater transparency to get the answer to many such questions, so that we can identify where the responsibility lies.

Perhaps Mourant became aware of some of the issues that have now become apparent. Instead, Capita passed responsibility on to Blue Gate Capital Ltd, which agreed to the appointment in September 2009.

George Patellis was appointed chief executive of Tiuta in April 2010. He became concerned about the quality of the financial reporting at the company. In January 2011, a shortfall of at least £20 million was identified, suggesting insolvency. He also became aware that Tiuta had retained the proceeds when some loans had been redeemed, and of Land Registry DS1 inconsistencies.

Mr Patellis appointed BDO to investigate in January 2011, and it confirmed his initial concerns. He then resigned and alerted the FSA to the situation, to report financial irregularities at Tiuta. As a result, a case was opened by the FSA and supervisory engagement with Tiuta began. The FSA required Tiuta to engage investigative accountants to monitor its financial performance. That may relate to what my hon. Friend the Member for North Herefordshire (Bill Wiggin) mentioned. Tiuta was responsible for reporting to the FSA monthly. However, instead of undertaking independent investigations, BDO, which had secured the role, relied on information supplied by directors of Tiuta, which then produced a series of reports that persuaded the FSA that the firm should be allowed to continue to trade.

In May 2011, the FSA issued a consumer alert because marketing materials indicated that the fund was low risk, and that returns were guaranteed. The marketing material was amended for independent financial advisers, and Blue Gate was made aware of the issues with the security of the loans. In March 2012, Blue Gate notified the 1,200 investors that the fund had been suspended due to an inability to pay quarterly interest payments to investors. Tiuta was placed in administration in September 2012.

It is suggested that investors face losses of at least 70% of the £106 million that was invested. In addition, investors have to date lost up to £20 million in unpaid quarterly distributions. Since then, a number of MPs have written to the FSA—and now the Financial Conduct Authority—and the Treasury to establish whether there is a regulatory responsibility to investigate the fund, and whether there is any potential for compensating investors.

Having considered the background, I will make a number of points and ask a few questions of the Minister. Although I recognise that the Connaught fund was an unregulated investment scheme, various elements were regulated, as I mentioned at the outset. The advice process was regulated. I am not suggesting for a minute that advisers were responsible for the failings and misappropriation of funds. There is a need, however, to clarify where their responsibility ends.

In fairness to IFAs, they depend on the key financial documents, which were not accurate or adhered to, yet questions should be asked about why unregulated funds were recommended to investors in the first instance. The time for advice on such funds is clearly very limited. What did Capita know in August 2009 when it sought to pass on its responsibilities? What action did Capita take to ensure proper management of the fund at earlier stages? If Capita had doubts or questions, why was that not communicated to investors? Was Capita’s letter to investors misleading, or did Capita withhold information indicating there was unsecured and unauthorised lending from the fund?

[Guy Opperman]

Is it not incumbent on the Minister to clarify the legal position of investors on that specific point? If investors are to sue for their loss, they need to know the date of the knowledge of the fund’s decline. Secondly, they need to know the state of the assets at that time and the extent to which the FCA will assist in the recovery.

[Alun Cairns]

There could clearly be a statute of limitations that affects investors, on which I hope the Minister can offer advice.

There was obviously a gap between Capita’s original letter of 20 August 2009 advising investors of its intention to pass responsibility to Mourant and the letter of 24 September advising that Blue Gate would become responsible. Should Capita have suspended the fund when it realised that it was not being managed in accordance with the financial information documents?

As we have discussed, this is not the first time that Capita has needed to answer questions about its role. As the authorised corporate director of Arch Cru, Capita was forced to compensate investors to the tune of £32 million. Terms, how that sum was reached and Capita’s responsibilities and failings have still not been disclosed, but a sum of that size suggests some form of culpability.

Questions should be asked about the actions taken by the FSA, and now the FCA. Some investors believe that the FSA and FCA have taken little action, but the Minister’s predecessor, my right hon. Friend the Member for Bromsgrove (Sajid Javid), advised me in general terms of some of the work they undertook. That needs to be published to reassure people and to allow further questions to be raised about what could have happened.

[Chris Ruane]

Does the hon. Gentleman believe that the FSA has let down Connaught investors? Is he aware of the case of Burges Salmon, which was a similar scam of which the FCA has washed its hands and for which it has taken no responsibility? Does he think that the FCA needs to be looked at?

[Alun Cairns]

I am not familiar with that case, but greater transparency on the FCA, into which the FSA has now evolved, would be helpful and may dispel the criticisms. We simply do not know the specific actions that it took, if indeed it took any at any point. I hope that there has been more than evolution; there needs to be a different culture at the FCA to ensure that the failings of the past are not repeated.

What about the FSA’s actions following the intervention of George Patellis? The Financial Services and Markets Act 2000 gave the FSA a statutory duty to maintain market confidence, ensure public awareness, reduce financial crime and protect consumers. We can also ask questions of the police. Surely there are sufficient grounds for the police to investigate the matter, given the misappropriation of funds.

Finally, is the Minister able to advise us of any statute of limitations that falls on investors? That is the point raised by my hon. Friend the Member for Hexham (Guy Opperman). Ultimately, is any recourse available? In closing, I underline that although the saga has gone on for an awfully long time for investors, this is our first opportunity to discuss it in Parliament. I would like to think that this is the start of parliamentary scrutiny, and certainly not the end of the matter. I look forward to the Minister’s response.

11:10

[The Economic Secretary to the Treasury (Andrea Leadsom)]

It is a great pleasure to serve under your chairmanship for my second outing in Westminster Hall, Mr Brady. I congratulate my hon. Friend the Member for Vale of Glamorgan (Alun Cairns) on organising this debate on an incredibly important subject. I also have constituents who have lost a huge amount of money as a result of the devastating investment they made. It is important that we get to the bottom of the matter and try to ensure that, if possible, investors can be compensated in some way. Those who are responsible should face the maximum justice available.

This is an important issue not just for my hon. Friend’s constituents and mine. I see many Members in Westminster Hall today whose constituents have also suffered as a result of investing in the fund, so it is important that the FSA, as was, and now the FCA take the matter extremely seriously. I reassure him and all other Members here today that that is indeed the case.

Many investors have lost their life savings as a result of the events involving the Connaught funds, which has caused real hardship for people across the country. As my hon. Friend made clear, the Connaught funds comprise three separate funds: the Connaught Income Fund series 1, series 2 and series 3. In total, approximately £145 million was invested in the funds, which, as we know, were unregulated collective investment schemes. By definition, such schemes are not subject to direct regulation by the FCA or, previously, the FSA.

[Guto Bebb]

I visited the FCA with my hon. Friend the Member for Vale of Glamorgan (Alun Cairns) to look at the issue in question. We were shown a flowchart identifying the selling process for this investment. The number of elements that were regulated and the number not regulated implied that there was significant confusion about the way the regulatory process actually works in the UK.

[Andrea Leadsom]

My hon. Friend makes an extremely relevant point. As I was looking into the matter in some detail yesterday, I was struck by exactly the same thing. There were regulated elements and unregulated elements, and of course we have ended up with a disastrous scenario in which people have lost a lot of money and it has become difficult to get to the bottom of everything. I will try to unravel that a bit.

As I said, because of the unregulated nature of some of the entities involved, many of the usual protections and safeguards that protect investors in regulated funds were absent. That is why the promotion and distribution of such schemes are subject to strict controls. Unfortunately, it seems that in this instance even those controls did not prevent a large number of individuals from investing in the fund. In addition to the questions that have been raised, to which I will return in a moment, I would like to address two main issues: first, the actions taken by the FCA to try to protect consumers, despite most of the entities involved being unregulated; and secondly, the ongoing work for the benefit of consumers and investors to secure a fair and proper outcome.

First, despite the schemes being unregulated, the FCA has taken a number of steps to try to protect consumers. In May 2011, the FSA altered Tiuta’s permission so that it could no longer carry out any new regulated mortgage lending and issued an alert to consumers telling them what they should do if they thought they had been mis-sold the fund. In June 2011, the FSA wrote to all financial advisers who sold the fund, asking them to review the sales and to contact consumers where there might be risk of unsuitable advice. It also set up a page on its website for consumers and firms to receive information on the fund. In August 2011, it required Tiuta to instruct Connaught Asset Management Ltd to change its marketing materials so that they no longer described the fund as “low risk” and “guaranteed”. The FSA took the view that those descriptions were misleading. Finally, in June 2012, it altered Tiuta’s permission to ensure funds from redeemed loans returned to the series 1 fund.

[Chris Ruane]

In August 2012, Capita, the parent body of the Connaught fund, was given a contract by the Department for Work and Pensions worth hundreds of millions of pounds. Who should pay for the losses? Should it be Capita, or should it be the 1,200 individuals who were falsely sold the investment? Will the Minister use her position with the Secretary of State for Work and Pensions to ensure that Capita does the right thing and compensates those individuals?

[Andrea Leadsom]

I am grateful to the hon. Gentleman for making that point, which I will certainly look into further. Those two organisations belong to the same parent company, but are in fact different subsidiaries. As he might be aware, Government contracts are awarded in line with EU procurement rules.

In addition to the work by the FCA, I can also confirm that other law enforcement agencies are looking into this matter. I will urge the police to consider the case very carefully. I know that Members are interested to hear whether the police are looking at this matter, and I can confirm that they are. The FCA has been working closely with law enforcement agencies to identify and pursue avenues that will yield the best outcome for investors. It continues to look into the matter, and its work is very much ongoing. In the meantime, it is encouraging any investors who believe they might have been mis-sold a product to contact their independent financial adviser. It has disclosed information to the police and the administrators of the firms involved to help them with their inquiries.

A number of points were made during the debate, and I will try to address them. I was asked whether Capita Financial Managers Ltd was negligent in its operation of the fund and whether it breached its obligations under the Financial Services and Markets Act 2000, the operator agreement or its duty of care to consumers. The Government and the FCA take those allegations very seriously, and the FCA is carrying out its own inquiries, but the requirements on the operator of an unregulated fund are limited under FCA rules. I was asked whether the FCA has made a restitution order against Capita. I stress that the FCA is considering all the different avenues by which those who have suffered could obtain compensation. I was asked about the information provided by George Patellis.

[Mr David Davis (Haltemprice and Howden) (Con)]

In a number of these cases, some involving Capita and some involving others, it has been clear that the financial structure of the company has been set up with limited liability subsidiaries to prevent the compensation demands from going back to the parent. Will she ask the FCA to look at the acceptability of that approach, with a view to future concerns like these? It seems to me that it is a way for the company to get the benefit from a reputation, without meeting the liability that goes with it.

[Andrea Leadsom]

I completely agree. There are questions to be asked about how this apparent ability to avoid culpability has been allowed, whether steps can be taken to ensure it cannot happen again and whether there are compensation issues. The FCA is looking into all those matters, but I will take up the point my right hon. Friend makes.

I was just talking about the action the FSA took when it received information from George Patellis. The FSA met with other parties to discuss his concerns, and as a result of those discussions, it became seriously concerned about the financial position of Tiuta plc. Having considered the regulatory options in respect of Tiuta plc, in May 2011 a requirement was added to the permission of the firm that it should cease any further regulated mortgage lending. In the same month, the FSA issued the consumer alert on the fund. A further alert was issued to financial advisers asking them to consider the suitability of advice they had given to consumers who had invested in the fund and to take action accordingly. In light of the fact that very little of Tiuta’s business was regulated, the FSA considered those steps to be appropriate and proportionate at the time. I certainly take on board the point made by my right hon. Friend the Member for Haltemprice and Howden (Mr Davis) about whether that was, with hindsight, acceptable.

On the other questions I was asked, Capita issued an information memorandum that consumers believe to be fraudulent, as the fund did not operate as it said it would. I was asked what action the FCA is taking against Capita. As I said, the FCA is considering all avenues by which investors might be compensated. Unfortunately, I cannot comment on that further at this time. One point I make, because the question has been implied, is that IFAs are not supposed to sell unregulated investment schemes to retail investors. The circumstances in which unregulated schemes can be promoted to consumers are generally restricted to certain types of consumers, such as sophisticated investors and high net worth individuals, for whom the products are likely to be suitable. The FCA has brought in new rules, banning the promotion of unregulated collective investment schemes to ordinary retail consumers. IFAs have the responsibility to promote the fund only to eligible individuals. That is an important point.

My hon. Friend the Member for Hexham (Guy Opperman) asked whether the police are involved. I confirm that they are. A question was asked about the deadlines for issuing complaints. The fund was incepted in June and July 2008 and suspended in March 2012. Action can be taken either six years from the cause of action, which will start to expire from June 2014—all those investors who invested in the early days of the fund need to take careful advice if they wish to make a complaint about that product, because the deadline is fast approaching—or three years from the date of knowledge of the cause of action, which is likely to expire in March 2015 or, at the latest, September 2015. I urge those consumers who feel that they were mis-sold the fund to look carefully at these deadlines. If the case goes to court, it depends on those courses of action. Insolvency reviews of those companies will be reporting in the near future. We do not have a more specific date for that.

Once again, I would like to thank sincerely my hon. Friend the Member for Vale of Glamorgan for instigating this debate on this important case, which is upsetting for many investors. I hope I have reassured him that the Government are fully aware of his concerns and that we take this issue seriously. We are absolutely determined that our financial services sector serves consumers in a right and fair way, and that investors receive the protections they need.

11:28

Sitting suspended.