The news this week that the FCA will commission an independent report into its handling of the LC&F mini-bond scandal is not an admission of guilt but it is perhaps the first sign that regulation failed investors who had the misfortune to use this company.

I’ve written before about LC&F (London Capital and Finance) but here’s a brief recap.

LC&F was an investment provider which promoted mini-bond investments. These were ostensibly to fund property developments. The products were ‘sold’ as investments and some were packaged as ISAs but they were, in effect, loans to developers structured as so-called ‘mini-bonds.’

The Serious Fraud Office is now investigating the firm after it crashed into administration in January leaving 14,000 bondholders who had invested £236m stranded. Four arrests have already been made. Whether investors will get any money back remains to be seen.

After growing pressure, the FCA announced this week that it would launch a probe into the collapse of LCF and rightly so.

The regulator will appoint an “independent person” to look into the issues raised by the failure. They will look at two questions:  whether the existing regulatory system adequately protects retail purchasers of mini-bonds from “unacceptable levels of harm” and whether the FCA’s supervision of LCF was adequate.

I can answer those two questions already: no and no.

The problem with LC&F, and firms like them, is that they fell into a regulatory black hole. The bonds are effectively structured as loans and therefore, in the eyes of the regulators, not investments. Because of this arcane definition the investors in LC&F, or in effect those people who ‘lent’ money to the company, were left adrift. Most, I suspect, thought they were ‘investing’ and not ‘lending.’

Because of rules surrounding promotion of savings products and ISAs the FCA was responsible for the regulation of the marketing of the products but not the underlying products themselves. Try to explain that one to an average person. It’s worth noting that LC&F explicitly referred to ‘investors’ and ‘investing’ on its website.

Because of all this it looks unlikely the Financial Services Compensation Scheme will compensate investors, adding to their woes, because they were putting money into loans and not investments.

The story has attracted national attention from the BBC and national newspapers and will probably rumble on for years. A lot of people have had their fingers badly burnt and some investors have lost large sums. The administrators say at present investors will be lucky to get back 20% of their money.

It’s positive that the FCA is appointing an independent examiner to look into the mess but here are some further questions I would like them to look into:

• why are firms allowed to dress up loan products as investments?

• how closely was the FCA watching LC&F? Surely there were alarm bells being sounded somewhere?

• did no-one spot these products offered virtually no investor protection?

• why were they sold in the first place?

• are there any other LC&Fs lurking in the shadows?

There’s also a wider issue here and it’s about how ISAs have drifted from their initial promise to be a savings vehicle for the masses. Successive Chancellors have insisted on adding on their own twist to the ISA range by adding new investment options, some of them pretty risky.

In the past investors had a simple choice between cash and stock and shares (which includes regulated funds). Virtually all of these were protected in regulation.

Now there’s a plethora of ISA options and some are pretty toxic in the wrong hands. Do the public understand this? I suspect not and there, as the great bard once wrote, is the rub.

Kevin O’Donnell is editor of Financial Planning Today and a financial journalist with over 30 years of experience. He previously worked for the Financial Times Group and for daily and weekly newspapers. 

• PS, I’m taking part in a sponsored 10k all night walk in Manchester to raise cash for a hospice which provides outstanding care for terminally and serious ill people. Find out why  here: bit.ly/2Er343F

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