Unregulated UK Investments, What Clients Should Do

Marketing unregulated investments to individuals is restricted to high net worth and/or “sophisticated” investors. However, potential investors qualifying as such may not necessarily fully appreciate the risks associated with the investment.

When certain regulations on UK pension investments were
removed in 2015 by David Cameron’s administration, it encouraged
the growth of various unlisted, high-yield investment
offerings. Since the 2008 financial smash – and before –
regulators have tried to balance the need to protect retail
clients from making unsuitable and potentially mistaken
investments, without closing down lucrative
opportunities. 

This article examines certain unregulated investments and
abuses of investors’ trust, and what clients and advisors should
do. The authors are from Kroll, the global risk
management and security consultants. They are Rob Goodhew,
director, restructuring advisory, Ben Boorer, associate managing
director for business intelligence and investigations, and
Patrick Crumplin, director, expert services. The editors of this
news service are pleased to share these views. The usual
editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com

Unregulated investments, many of which are high-risk, not only in
the sense of the asset class but also potentially in terms of the
underlying assets, some of which are just outright scams, have
become a major problem in the UK. Since the introduction of
pension freedoms in April 2015, the UK has seen a growth in
unregulated, unlisted, high-yield investments being marketed and
sold to members of the public, often as low-risk opportunities.
While such investments might seem low-risk at first glance, not
least because of the security and assurances set out in the
promotional materials, claims of such high returns in an era of
low interest rates should raise alarm bells.

Research highlighted by the FCA in 2019 indicated that 42 per
cent of pension savers, equivalent to over five million people,
could be at risk of falling victim to one or more of the common
tactics used by pension scammers. Illustratively, if each of
those potential investors had £50,000 ($65,269) to invest, the
potential prize for those promoting and running such schemes
would be a staggering £250 billion. It’s not surprising that
scheme operators, whether scammers or not, might want to access
that kind of money.

Classifying such investment schemes is not straightforward, but
there are certain features that characterise the problem. There
are many types of underlying businesses, schemes and assets on
offer such as property development, foreign exchange,
cryptocurrencies, agriculture and forestry, precious metals and
even sports betting. In terms of property development, there has
been a proliferation of unregulated investment schemes marketed
as unitised property-backed investments, such as parking spaces
in a carpark, storage units, or rooms in hotels, student
accommodation and care homes. Typically, investors are offered
high-yield bonds or loan notes with a range of maturities, often
over a longer term, meaning that capital could be tied up for
some time. Advertised returns are regularly up to 10 per
cent or more and some schemes include an attractive buyback
clause.

Given the underlying income-generating “bricks and mortar”
assets, it’s easy to see why such opportunities might be
attractive. It’s a logical proposition that appears safe, but the
reality may be quite different. If the advertised returns weren’t
challenging enough in the current low-interest environment,
commissions of up to 20 per cent or more that are usually
paid to sales agents or “introducers,” together with sometimes
equally high management fees or other payments to the scheme
operators, can be crippling, potentially causing a systemic flaw
in the investment model. After operating costs have been paid and
possibly other debt serviced, the underlying business should have
a strong enough performance to be able to repay the original
capital invested – and all of this assumes that the scheme runs
perfectly and is not just a scam from the outset. While some
unregulated investment schemes might be well-intentioned
initially – potentially adding to the attractiveness of the
scheme at the time of promotion – they may go on to face
challenges with their investments and their operations. 

This can result in problems snowballing over time to the point
where the situation is irrecoverable. It may be the case that
investors find out about such issues too late after attempts have
already been made to remedy the situation; by that time,
investments might have become compromised, with value lost.

Of course, it’s important to have a good understanding of the
investment opportunity beyond the glossy brochures, websites and
sales talk from the beginning. Investment propositions can appear
immensely attractive and credible, but it is vital that investors
have a proper understanding of the true nature of the underlying
business, any discretion the management might exercise to use
capital, the legal structure, the nature of the financial
instrument being offered, the involvement of introducers/agents
and their fees and regulated parties, security over underlying
assets, the trading history of the management team, and the
rights of the investor.

Most of the drivers that contribute to the sale of high-risk,
unregulated investments have existed for some time now.

•    People are free to invest their funds as they
wish. The risk is to savings in whatever form, but pension
freedoms have significantly increased the amount of funds
available which has attracted the attention of investment scheme
promoters seeking capital.
•    There is no requirement to take advice when
drawing down a pension or investing, and research suggests that
most people don’t take advice when accessing their pension
funds.
•    The low interest rate environment
remains.
•    Regulations permit the marketing of such
investments to certain types of investor.

Compounding the above, COVID-19 may have made the situation
worse. In addition to the obvious economic influences and
stresses, lockdown has forced us to operate in a more virtual
world, and we are more isolated and vulnerable than usual.

Marketing unregulated investments to individuals is restricted to
“high net worth” and/or “sophisticated” investors. However,
potential investors qualifying as high net worth or sophisticated
may not necessarily fully appreciate the risks associated with
the investment, and those classifications do not provide immunity
to old fashioned sales tactics and unconscious bias. Further, the
assessment of an investor as high net worth or sophisticated is
essentially one of self-certification and takes moments to
complete. In reality, many of these schemes are marketed using
persuasive or even high-pressure sales tactics to ordinary
people, who may have raised funds by cashing in pensions or other
life savings, through inheritance, or even through refinancing
their home.

The authorities are well aware of the issue, but is enough being
done? The UK government introduced a ban on cold calling in
relation to pensions that came into effect in January 2019. At
the same time, the FCA was investigating London Capital &
Finance, which collapsed later that month. So, there are legacy
issues, but has the problem now gone away? Unfortunately, the
answer to that appears to be no. There have been public awareness
campaigns, which are important, and the FCA does, on occasion,
take action against unregulated firms, but resourcing and the
potential scale of the problem outside the regulatory perimeter
means that not very much has changed. The ban on pensions cold
calling was a welcome step forward, but it may have had little
impact on the promotion of high-risk, unregulated investments.

On a more positive note, the Work and Pensions Committee recently
conducted a major inquiry into the problem of pension scams,
making a range of recommendations in relation to reporting,
prevention, enforcement and victim support. Additional
legislation has also recently been passed or is in the pipeline.
The Pension Schemes Act 2021 received royal assent earlier this
year, providing for new preventative regulations and new
enforcement powers for the pension regulator. Separately, the FCA
recently issued a discussion paper to canvass views on changes
that can be made to strengthen the FCA’s financial promotion
rules for high-risk investments and for authorised firms which
approve financial promotions. Positive steps indeed, but all of
this takes time to put in place and to become effective.

In the meantime, if such a scheme collapses, the fallout may be
complicated by poor record keeping, complex group structures,
intra-group lending and the existence of charges over the
underlying assets. This means that it might not be
straightforward to establish what happened, and there may be
competing claims for the remaining assets. More clearly needs to
be done to prevent it from getting to this stage in the first
place, but for investors who find they have a problem with their
investment, they must understand their rights under the
investment documentation and be aware of their options in terms
of recovering their money.

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