On 17 December 2020, Dame Elizabeth’s Gloster’s long awaited report into the collapse of London Capital & Finance plc (LCF) was published. The investigation looked into the events relating to the FCA’s regulation and supervision of LCF, a company which issued bonds to 11,625 retail investors, with a value of over £237 million. LCF marketed the bonds on the basis that investor monies would be used to provide commercial finance to small and medium size companies and which would generate income from which investors would be paid a coupon on bonds amounting to up to 8% per annum.
In December 2018, the FCA took action against LCF and ordered LCF to withdraw its promotional material. On 30 January 2019, LCF entered administration. The Financial Services Compensation Scheme has so far paid out just over £50.9 million in compensation to LCF customers and is continuing to assess outstanding claims. The recovery of assets by the administrators, Smith & Williamson (advised by Mishcon) continues. Criminal investigations and regulatory investigations by the Serious Fraud Office and the FCA into fraud are also continuing.
The Gloster report finds that the FCA did not effectively supervise and regulate LCF and that Bondholders were entitled to expect, and receive, more protection from the regulatory regime in relation to an FCA-authorised firm (such as LCF) than was in fact delivered by the FCA. Particular issues highlighted in the Report include:
- The FCA's approach to dealing with regulated firms was to give insufficient attention to firms' unregulated activities, even where (as with LCF) the majority (if not all) of its revenue was generated from non-regulated activities
- The FCA's approach allowed LCD to use its FCA regulated status to present an unjustified imprimatur of respectability to the market, even in relation to its non-regulated bond business.
- Whilst the FCA did correspond with LCF in relation to financial promotions which breached FCA rules, the FCA failed to consider LCF’s business holistically. Instead, FCA staff analysed LCF’s breaches as though they were isolated issues.
- The FCA granted LCF permissions for activities that it did not carry on. This ought to have been evident to the FCA. LCF repeatedly submitted documents to the FCA which showed that LCF was not generating any revenue from regulated activities and had no clients from regulated business.
- In granting LCF permission to undertake regulated activities, the FCA failed properly to analyse financial information about the firm and missed clues as to the viability of its business model.
- The FCA’s handling of information from third parties regarding LCF was wholly deficient. The report considered that this was an egregious example of the FCA’s failure to fulfil its statutory objectives in respect of the regulation of LCF.
Dame Elizabeth made nine recommendations which the FCA has accepted, focusing on how it should improve its internal authorisation and supervision processes. Many of the recommendations will also impact upon how the FCA interacts with firms and could result in a different approach to enforcement.
The Report recommended that the FCA should consider a firm’s business holistically. This will mean firms will need to be ready to provide a wider range of information about their business, including unregulated activities. It seems likely that any unregulated financial services provided by firms will be more in focus for the FCA (for example unregulated lending or issuing debt securities), although it remains unclear whether and to what extent the FCA will interest itself in non-financial businesses. For example, will a motor dealer authorised for credit and insurance activities be required to provide more information about its car sales business?
The Report also recommended that the FCA should give more focus to allegations of fraud or serious irregularity even where they relate to unregulated activity. This includes the FCA improving its use of regulated firms as a source of market intelligence. The FCA frequently receives complaints about firms from former employees, counterparties or competitors. Sometimes, such complaints are made tactically as part of a wider dispute and historically the FCA has sought to avoid getting involved. Going forward, the FCA is likely to take some allegations more seriously, and firms may be forced to respond to probing queries from the FCA.
A key focus of the Gloster investigation was the FCA's continued engagement with the firm about breaches of financial promotion rules, but with no apparent consequence. The Report recommends that the FCA should have appropriate policies in place which clearly state what steps should be taken or considered following repeat breaches by firms of the financial promotion rules.
In practice, this is likely to mean the FCA becoming much more interventionist in investigating alleged breaches of financial promotion rules. Serial offenders are likely to face action, including the service of FCA supervisory notices directing firms to withdraw promotions and in some cases enforcement action, potentially resulting in cancellation of permission. As well as printed material, the FCA is also likely to increase scrutiny of real-time financial promotion (such as undertaken in call centres). Unregulated firms which are reliant on regulated firms to approve their financial promotions may find it increasingly difficult to find firms willing to provide a service which carries with it increased regulatory risk.