This week I am not writing about the investment markets, but the system of retail investment. We all have a risk if the people we give our money to negligently mis-manage it or even run off with it. There are systems in place that are supposed to protect us in a country with a highly developed financial services industry, but do they work?
Covering all angles
I will start with an allegorical situation. I own a house in a country where burglaries are reportedly (from the insurers) less common than in England, but as I live in a remote area I have a good electronic security system, pay a modest sum to a security company to send out 2 armed employees promptly if it is triggered and as a backstop have a normal house contents insurance (with a discount because of the security arrangements).
It all works – I know because I accidentally triggered a smoke detector in the small hours and had 2 large uniformed guys appear and ask me for ID docs and my password! I suppose you can get burglars in pyjamas!
I tell you this because that is how the retail investor buying funds ought to be protected in the UK – with proper security systems that respond
We pay for our own protection
Our money goes into OEICs, which are run in line with a prospectus and have an ACD (authorised corporate director) who is charged with making sure the securities are looked after and the fund manager behaves. That is the first line security system. You pay for it directly in your fees.
There is also the FCA (the regulator or response force). They are supposed to understand the market operators, monitor them, identify risks and discipline or even close down bad actors You pay for it indirectly in your fees.
Then there is the last resort insurance policy – the Financial Services Compensation Scheme. This is widely used as a ‘catch all’ to make up for all the bad practice that the FCA failed to notice. If you think adviser fees, bank charges and insurance premiums have gone up a lot lately, one reason is to pay for the escalating cost of FSCS levies – so you maybe pay for that too.
The Woodford case
In the case of the Woodford Equity Income fund, it appears that Mr Woodford was able to invest outside of the stated objectives of his fund and in breach of the FCA rules. Other industry practitioners could see that was happening and it was reported by specialist journalists. The ACD must have known it was happening, The FCA should have known it was happening.
The security system and regulation failed. Investors who are annoyed (understandably) are suggesting that they will sue financial advisers and Mr Woodford’s firm (not much use if it is closed down). Who is holding the ACD and the FCA to account?
The FCA are in my direct personal experience incapable of acting on specific warnings of potential fraud. The ACD model is being challenged by some who point out that the European SICAV model would offer better protection. But of course we are supposed to be having a bonfire of regulations post Brexit! If that happens, then it will be truly ‘caveat emptor’ – buyer beware. The current system frequently fails, but it is better than no system at all.
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