Editor's Comment: Investors shouldn’t take the hit when a broker goes bust

Look at the annual accounts of your broker and check it is well-capitalised and is not operating a high-risk business model.

We have run queries on the letters pages of previous issues of Money Observer from readers concerned about the safety of the investments they hold on broker platforms in the event of their broker going to the wall. We’ve reassured them that rules set out by the Financial Conduct Authority (FCA) mean their funds (and cash) must be held in a separate nominee account that cannot be raided by a broker or its creditors if the firm goes out of business.

However, the demise of discretionary fund manager Beaufort Securities in early March raised a whole new set of anxieties and knocked investor confidence sideways, after the news broke that administrator PwC would be charging a colossal £100 million in fees in order to return around £550 million of assets to 14,000 clients –‑and that its charges would be coming directly from clients’ portfolios. Under that original plan, 700 Beaufort accounts with a value of more than £150,000 could have suffered losses of up to 40 per cent.

In the event, following a storm of protest at the scale of PwC’s proposed remuneration and a lot of hard work by shareholder and creditor groups to persuade the authorities to think again, a revised maximum fee of £55 million was subsequently agreed by the administrator, and the Financial Services Compensation Scheme (FSCS) has now agreed to pick up the tab for 94 per cent of that. Fewer than 10 large clients are expected to have to foot any part of the bill at all.

Investors rattled

That is very good news for Beaufort’s many small customers, but it’s hardly surprising that self-directed investors who genuinely thought the only threat to their wealth was from market volatility have been rattled. The story raises some serious questions about the vulnerability of investors in the unlikely event that a middleman goes bust.

Of course, no one is suggesting that the professionals who take on the job of unwinding a failed business and reuniting clients with their cash should be doing it out of the goodness of their hearts. Administrators need to be paid. But why should nominee account clients, who will anyway have the inconvenience of not being able to access their assets for months, be obliged to shoulder the risk – particularly when there appears to be a tendency towards rampant greed as far as administrator fee-setting is concerned? It’s hardly conducive to the bigger story of encouraging us all to make our own long-term financial provision.

Surely, as one reader suggested in a recent letter to Money Observer, it would make more sense for brokers and platforms to carry insurance against the costs of administration if this happens. So should the FCA introduce some kind of mandatory scheme?

There are no plans to do so, it seems. The FCA points to the fact that what happened with Beaufort reflects current insolvency legislation passed in 2011, under which the administrators are entitled to pay the costs of distribution of client assets out of the assets themselves. ‘The law would have to be changed to introduce insurance to cover costs,’ says a spokesperson. And there appear to be no changes in the pipeline as things stand.

In reality, then, how worried should investors be? As Chris Horner, head of compliance at our sister broker interactive investor, explains, customers of well-run and well-capitalised businesses should have little to be concerned about, as generally several layers of protection exist.

‘At the forefront are the operational policies, procedures and controls that ensure assets entrusted to firms are accurately recorded and reconciled regularly to ensure they exist. Secondly, the capital requirements are designed in such a way that a firm should always have sufficient resources to wind down its business in an orderly fashion (although this principle can be quickly undone where there’s a catastrophic failure à la Beaufort),’ he says.

In addition, some firms, including interactive investor, hold insurance, even though there is no compulsion to do so. Finally, where even these measures prove inadequate, the FSCS provides cover of up to £50,000 per eligible claim, and this will rise to £85,000 in 2019, to bring it into line with the deposit scheme.

The question is whether those measures are sufficient to provide investors with real peace of mind, given the uncertainties of the Beaufort debacle. ‘The FCA actually consulted on the prospect of firms holding a “buffer” of cash to cover the risk of insolvency, such that the cost of administration would be borne by the firm, having prudently segregated that cash into the client money environment,’ says Horner. ‘However, based on the feedback they received and the changes made to the Special Administration Regime [which sets out the rules regarding distribution of client assets when an investment firm fails], no amendments were made.’

Horner is concerned about the impact of the current situation on investor confidence, and plans to put the case for a more considered, customer-centric approach to the FCA. Meanwhile, it makes sense to adopt a position of caveat emptor: have a look at the annual accounts of your broker and check it is well-capitalised and is not operating a high-risk business model. Beaufort failed on both counts.

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