Ben Rees, Technical Director of the Investment Fraud & Mis-selling group, examines the FCA’s clampdown on firms misusing regulatory approvals in a bid to protect consumers from being misled about exposure to financial risk in Compliance Monitor.
Ben’s article was published on 14 July 2022 and can be found here.
The Financial Conduct Authority (FCA) recently announced that it will use new powers to more rapidly cancel or amend firms’ permissions to carry out regulatory activities. Where it believes that a firm is not using a permission, the FCA will provide two warnings. In the absence of a satisfactory response or action, the FCA will be able to cancel or amend the permission just 28 days after the first warning.
This new initiative is part of a wider clampdown on firms which misuse regulatory approvals in a way that misleads consumers. The FCA also believes that this will support the FCA’s “use it or lose it” initiative, which was introduced in January 2021. The city regulator will now use its new powers to enable it to revoke businesses’ permits to carry out regulated activity much more quickly than before.
This initiative sought to have firms review their Part 4A permissions and to cancel permissions they were no longer using, or amend the permissions where they were no longer using some of them. This can be done online using the FCA’s Connect service.
The FCA noted the importance of such reviews and amendments in terms of compliance, saying: ”Reviewing your permissions – and maintaining only those you need – helps to assure you that you will continue to meet the threshold conditions, are demonstrating effective oversight of your business, meet your obligations under the Senior Managers Regime and are providing accurate information to consumers.”
Under this initiative, since May 2021, the FCA carried out 1,090 assessments to check whether firms are in fact undertaking the financial activity for which they have been granted permission. This process has already resulted in 264 firms applying to voluntarily cancel their permissions while a further 47 have modified their permissions to carry out regulated activities. The new 28 day activity should help to expedite this process and indeed any other regulatory initiatives. Previously, it would reportedly often take three months or more before a firm’s permission could be cancelled.
The FCA says that moving swiftly is important when tackling such conduct, and that the shorter time frame, “will strengthen consumer protection by reducing the risk of consumers misunderstanding or being misled about their exposure to financial risk and how much consumer protection they have.”
Mark Steward, Executive Director of Enforcement and Market Oversight at the FCA, said, “Businesses with permissions they don’t need or use, risk misleading consumers. These new powers will enable us to take quicker action to cancel permissions that are not used or needed. Firms should regularly review their permissions, ensure they are correct, and that they are acting in accordance with them. If they are not needed or used, they should seek to cancel them.”
Where firms have historic permissions but do not use them – and fail to review, cancel or amend them themselves – the change in rules means that such firms will be “streamlined” by the FCA much faster. This should have a positive knock-on effect in terms of combating those firms who seek to obfuscate their real permissions and authorisations to commit offences or criminal frauds.
Of course, these changes have already been the subject of consultations and the technical detail of the relevant changes to the FCA’s handbook and enforcement guide were published in the PS22/5 in May 2022. These changes have been made by the FCA further to the enhanced powers to cancel authorisations granted to it by the Financial Services Act 2021. This legislation empowered the FCA to vary or cancel authorisations where there is a failure to respond to a warning within the 28 day period. However, it’s important to note that such a decision may be reversed upon the application of a firm when the FCA considers it “just and reasonable” to do so.
This regulatory change is welcome since a number of recent high-profile scandals have happened, at least in part, due to the ambiguity of the FCA’s permissions regime. One prominent example is the London Capital & Finance (LCF) scandal. LCF, the firm at the centre of this scandal, was in fact regulated by the FCA, and therefore it was able to promote itself as such. However, the actual permissions it held with the FCA did not actually permit the type of activity that was ultimately undertaken. In essence, while LCF was indeed regulated by the FCA, the “mini bonds” it issued were not. However, many of the consumers caught up in the scandal invested, reassured by the true, if misleading, statements that the company was regulated by the FCA.
The plain reality is that consumers are frequently blissfully unaware of the complexities of the authorisations regime. Many simply see “Authorised and Regulated by the FCA” as a confirmation that the firm is highly regulated and therefore permitted to provide the advice and services offered. In some cases, such claims are outright fraud, in that fraudulent online advertisements often make such claims. In other cases, companies are in fact authorised by the FCA, but for a different activity entirely.
Those firms which improperly act outside the scope of their permissions and authorisations are frequently not caught until it is too late. It is often the case that, by that stage, many consumers have lost substantial amounts of money. In March 2019, LCF’s administrators reported that 11,625 bondholders had invested some £237 million in its products but that that the holders of “mini bonds” would likely only receive a return of as little as 20% of the investment they had originally made.
What is more, many such victims of misleading advertising, or misleading claims to be regulated for a particular activity, may not even be able to use the FOS or FSCS to seek redress or compensation. This is the case, for example, in cases where the firm was not properly authorised and regulated in the first place. In the LCF case, this was the case for many investors, since the holders of mini bonds were not eligible for compensation by the Financial Services Compensation Scheme (FSCS) on the basis that the mini bonds were not actually a regulated investment and no regulated adviser was involved in the sale of the mini-bonds to the consumer.
The LCF mini bond holders were fortunate to gain the sympathy of the UK Government, which in December 2020 announced that the exceptional circumstances of the LCF scandal meant that a dedicated compensation fund was warranted. However, the Government said that compensation would be capped at £68,000, which is substantially below the £85,000 FSCS compensation cap.
The report by Dame Elizabeth Gloster into the FCA’s regulatory conduct as regards the LCF scandal was quite damning of the regulator. The FCA is clearly keen to learn from its mistakes. Indeed, the FCA specifically states that this latest regulatory change came about as a result of the report into the LCF scandal.
An easy way for consumers to reduce the risk of fraud is to check the Financial Services Register before investing with a particular provider. This register enables anyone to instantly check whether a company is in fact regulated by the FCA, and it also gives detail as to which services they are regulated to provide. Both legal and financial advisors should help to make their clients aware of this simple service which, if more widely used, could help to protect consumers. However, this does not protect against fraudulent cloned websites of legitimate service providers. When consumers are concerned about the legitimacy of a website, they should search for a legitimate provider and attempt to establish that they are dealing with a genuine website.
A more thorough policing by the FCA of the way that permissions are used is certainly welcome. Likewise, having a swifter process to correct the position when permissions are unused or misused, is a positive move. Such changes should however be combined with efforts to create greater public awareness of what firms can and cannot do, and the risks of investing with unregulated firms. In tandem with this, there is also a need to more generally raise awareness of the ever-present risk of fraud and misleading claims being made in the advertisement of investments. It is, however, welcome news to see that the FCA seems determined to learn the lessons of scandals such as the LCF debacle. These latest changes represent another step in the right direction.