Compensation (London Capital & Finance plc and Fraud Compensation Fund) Bill

Lord Sikka Excerpts

2nd reading & Committee negatived & 3rd reading
Tuesday 19th October 2021 Lords Chamber

[Lord Sikka (Lab)]

My Lords, it is a pleasure to follow the noble Baroness, Lady Bennett of Manor Castle. The London Capital & Finance scandal tells the familiar story of privatising profits, socialising losses, frauds, fiddles, mis-selling, negligent regulators and ineffective auditors, while innocent people have to pick up the tab. The much-maligned state has to come and somehow clear up the mess made by the City of London once again. I welcome the compensation for the London Capital & Finance investors, but I have a number of questions for the Minister.

There are mini-bond scandals, as the noble Baroness, Lady Bennett, said, at Blackmore Bond, Basset & Gold, the Mexican food chain Chilango and many others, but no compensation has been offered, even though the FCA failed to regulate them properly. The collapse of LCF was investigated by Dame Elizabeth Gloster, but why is there no independent investigation of other mini-bond scandals? The other scandals may be smaller, but that does not mean that the pain is any less for people who have been defrauded, cheated or misled. The Government claim to have looked at 30 mini-bond firms that have failed over the last six to seven years, but have failed to elaborate whether there was any mis-selling or fraud and have certainly offered no compensation to other investors. When will the others be compensated? If the FCA’s negligence is a defining factor, as the Minister indicated, then many others also need to be compensated. For example, Neil Woodford’s Equity Income Fund collapse in the summer of 2019 left a lot of investors out of pocket. The FCA was negligent, but there has been no compensation. The independent report on the collapse of Connaught stated that the FCA supervision was “not appropriate or effective”. It could have done more to protect consumers, the report said. The investors lost over £100 million but have so far recovered only £18.5 million through litigation. Why was there no compensation for them? Again, the FCA failed.

The FCA and its predecessor bodies also failed to properly regulate RBS and HBOS, and those frauds are part of a long-running saga of pass the parcel—nobody wants to deal with it and, again, no compensation was offered. Surely, in the interests of equity and consistency, all those negatively affected by the FCA should be offered compensation. The Minister referred to the earlier precedents of Equitable Life and Barlow Clowes. In both cases, the regulators were negligent, and that is common to all the cases to which I have referred. So once again I ask, why is the LCF, which was founded by a former Conservative donor, being privileged but the others are not?

In spite of the compensation scheme, many LCF investors face huge losses because the compensation is capped at £68,000. This is not equitable. The burden of the cap is uneven and those who have less wealth stand to lose a greater proportion of it. Women are also hit particularly hard because they generally tend to have lower wealth. Some people have also invested more than the benchmark of £85,000 and they stand to lose an even bigger amount. They may well be relying on these savings for their retirement income. Again, can the Minister explain why investors are not being fully compensated? Does justice not really demand that?

Mini-bonds are just the latest instalment of the fraud and mis-selling that has been rife in the City. The FCA is always playing catch-up. After a long list of mini-bond scandals, in January 2020 it introduced a temporary ban on the sale of mini-bonds, which then became permanent in June 2020. The FCA rationale was that

“speculative mini-bonds were being promoted to retail investors who neither understood the risks involved, nor could afford the potential financial losses.”

That occurred to the FCA in only 2020—where on earth had it been while mini-bonds were openly being marketed and sold? Why the delay in recognising the danger? Even now, the FCA does not road-test any of the financial products to see under which circumstances they wreak havoc and what damage they do. The alarm bells should have been ringing long before. For example, as early as October 2015 investors on the MoneySavingExpert site were saying that LCF’s investment “sounds dodgy”. People were being warned as early as that but the FCA took no notice of those warning signs.

In April 2021, the Government issued a consultation paper on the possibility of bringing the issuance of non-transferable debt securities—that is, mini-bonds—within the scope of financial services regulation. That consultation ended on 21 July 2021. Can the Minister update us on the current position?

In the middle of 2020, the outstanding amount in the UK invested in so-called speculative illiquid securities, which includes mini-bonds, was £1.4 billion. More than 63,500 bondholders may well be holding mini-bonds so the scandal could be much bigger than the amounts currently being assigned to LCF. Can the Minister please enlighten us as to what the ultimate cost of the mini-bond scandal will be? What retribution may be levied on the FCA for its continuing failures? The LCF compensation is being paid and indeed the word “fraud” was used earlier but when was there actually a fraud conviction in connection with LCF? A number of individuals have been arrested and released but I think nobody has been convicted so far. Can the Minister update us on the progress being made by the Serious Fraud Office on this?

Regarding compensation, paragraph 35 of the Explanatory Notes says:

“The Bill confers a new power on the Secretary of State, specifically to provide a loan to the Board of the PPF … expenditure in relation to this Bill will be repaid by the income received from the FCF levy on eligible occupational pension schemes.”


In other words, those who have behaved and are honourable will be hit by the fraudulent activities of some businesses in the City.

Eventually, a loan of some £200 million to £250 million may be given, but how will it be repaid? I looked at the Pension Protection Fund’s accounts. The FCF levy for the year to 31 March 2019 was £4.8 million and for the year to 2020 it was £6.9 million. We are talking about repaying loans of up to £250 million. Will the levy double or triple? How many years will it be before these loans can be repaid? What interest rates will be charged by the Treasury or will these be interest-free loans? I look forward to some clarification from the Minister.

The FCA has been negligent, but what is the penalty? The chief executive who presided over the FCA’s negligence has subsequently been promoted and become the Governor of the Bank of England. There is no retribution against the executives who collected vast salaries and bonuses. No action has been taken against the lawyers who advised the company on particular matters. LCF collapsed some time ago. Have any of its directors been disqualified so far? What is the Insolvency Service up to? Again, I seek an update from the Minister.

I would like to raise some questions about auditors. I sought to table a probing amendment to explore this, but the Table Office told me that that cannot be done, because this is a money Bill. That was a lesson for a newcomer such as me who is learning about the various protocols and procedures of this House, so I hope the Minister will not mind if I provide some details on the issue I have in mind.

LCF was audited by three separate accounting firms. The accounts for the year to April 2015 were audited by a small company called Oliver Clive + Co Ltd. At that point, LCF had a turnover of only £14,072, profit of only £782 and share capital of just £1,000. That is hardly enough for a company entering financial services, but that is how it was doing.

The financial statements for the year to April 2016 show a turnover of £948,201, profits of £166,916 and share capital of £50,000. The company had net assets of only £25,592. That meant that the business had little capacity to absorb any financial shocks, which you will certainly experience if you dabble in the financial markets. These accounts were audited by PricewaterhouseCoopers, which raised absolutely no concerns about the business model or the company’s legal status. These accounts probably persuaded the FCA to give authorisation to London Capital & Finance.

The 2017 accounts were audited by Ernst & Young—the auditors seemed to change every year—which raised no concerns about the business model of the company, its legal status or its ability to recover loans of £48 million or redeem bonds of £44.5 million. The equity, or share capital, of £50,000 provided no buffer against any losses. LCF was extremely highly leveraged, with a leverage ratio of 160:1. I remind noble Lords that when Lehman Brothers collapsed, it had a leverage of 30:1. Bear Stearns had a ratio of 33:1.

This was a business with a leverage of 160:1, yet the auditors said it was a going concern and raised no red flags. The FCA did not ask any questions either. What the hell was it doing? Dame Gloster told us that the FCA had no accounting expertise. You do not need accounting expertise to realise that a leverage ratio of 160:1 will lead to disaster. However, the FCA asked absolutely no questions.

LCF had a low equity base, high leverage and low cash; that was basically its business model. It relied on the inflow of new money to redeem loans from investors, a bit like a Ponzi scheme. The LCF directors’ report claimed that

“the structure, interest profile and maturity of the company’s loan portfolio is expected to provide adequate liquidity to meet the company’s commitments to borrowers as well as providing a high degree of certainty that the company will generate revenues that will exceed the company’s expenditure base”.

The auditors showed absolutely no scepticism and simply gave it a clean bill of health.

As the Minister may recall, and if my understanding is correct, businesses authorised by the FCA must engage in a tripartite meeting between the auditor, the management and the regulator. What on earth was discussed at those meetings if high leverage was not?

The audits are currently under investigation by the Financial Reporting Council. It is extremely likely that the auditors will be fined. Noble Lords may wonder where those fines go. For the audit failure investigations before 2016, the fines went to the professional body that authorised the incompetent auditor. It is a bit like a mugger being found guilty and the judgment being that they should make the cheque payable to the muggers’ association. That is what happened.

Since that was exposed by some of us, it all changed in 2016. Now, the fines go to the Treasury. Why should the Treasury benefit from the collapse of London Capital & Finance? Will the Minister give an undertaking that, as and when the fines are levied, they will be given to investors—that they will go in the pot out of which investors will be compensated and not be kept by the Treasury?

I have one other point. The London Capital & Finance administrators are in a feeding frenzy. They have already charged fees of more than £25 million, and those fees are expected to double. Can the Minister tell us what the Government are doing to curb the rapacious appetite of insolvency practitioners and other advisers, because they are removing money from investors who have already suffered?