Broken system

Why financial services regulation needs reform

City of London, financial district

In 2019, five million people across the UK were identified as being at risk of being targeted for their pensions, equating to 42 per cent of pension savers. As the coronavirus crisis brings market falls and a rise in the number of vulnerable clients, regulators expect scams to increase exponentially.

The stakes are high: in 2018 victims of pension fraud reported they had lost an average of £82,000 each.

The Financial Conduct Authority warns cold-calls, exotic investments and early access to cash are among the most persuasive tactics used by rogue operators, and those who consider themselves financially savvy are just as likely to be ripped off.

Advisers have had to fork out £213m this year to fund the fallout and bills are still rising.

Pension scams and rip-offs have flourished since the government allowed people to access their pensions freely in 2015 under pension freedom rules. To date £33bn has been withdrawn from pensions under the rules and by 2018 consumers lost an average of £82,000 each to scams.

Regulators have already come out to warn more people will be targeted for their pensions now that stock markets are heading in the wrong direction.

The Financial Conduct Authority warns scammers typically persuade people to invest their money into high risk unregulated investments. By the time it transpires that the pension is lost, the fraudsters and their facilitators have often left the market, leaving consumers, regulatory bodies, and ultimately the industry to pick up the pieces.

In a hearing in March 2020 the then head of the FCA, Andrew Bailey, told MPs on the Treasury select committee he thought the pension freedoms had been introduced too quickly, adding the regulatory system has been in a "catch up process" since.

The cost to advisers meanwhile has been eye-watering, with some firms seeing their FSCS levies double or triple year after year. Professional indemnity insurance bills have soared, even for those without any claims against them.

But while advisers argue the system is not working for them, there are major problems from consumers' perspectives, too.


1. Regulated channels are exploited

High risk unregulated investments fall outside of the FCA's remit. But providers can only gain access to a person's pension if they work with regulated financial advisers.

These collaborations can be difficult for the regulators to spot, leaving it to whistleblowers to expose them.

By the time the rip-off is revealed, the regulated scammers have often disappeared and can't be held accountable for their actions, while the unregulated are typically based abroad.

But it doesn't stop there. Once the investment is complete, investors are often re-targeted by regulated claims management companies that offer help with arranging compensation payments from the Financial Services Compensation Scheme for a hefty fee of 30 per cent or more.

The FCA last year stopped at least one such firm on suspicion that it was colluding with the original seller of the investment.


The whistleblower

Since quitting her job at a pensions firm three years ago, Leigh Hardy has made it her vocation to expose pension scams and rip-offs involving hundreds of UK pensioners. In her previous role she became aware of a concerted effort among some providers to siphon millions of pounds of pension money into unregulated schemes. These efforts increased markedly following a court case in 2016, which ruled pension schemes could not refuse a member's transfer request even if concerns about the possibility of a pension scam exist.

Leigh has collected evidence that firms are targeting people at both ends of the investment chain. Joining the dots of directorships listed on Companies House for months, she sketched out a map of connected companies, both regulated and unregulated, on her living room wall. Eventually this became so big she had it painted over.

Leigh believes scammers are savvily exploiting shadow areas between the regulated and unregulated space.

I believe the FCA looks after what's in its remit, the police look after what's in their remit, and one of the biggest failures across the board is that none of the regulatory bodies, the Fos, FSCS and FCA, are interested in the unregulated. Everybody just wants to stick to what they do. But crime is getting more complex and the unregulated play such a massive part. We've got introducers, other unregulated businesses that siphon money; some unregulated firms in the chain are not even financial services firms.

The unwitting target

One investor who has been targeted repeatedly is Dennis Holmes. He was cold-called with an offer to help him make a PPI claim. Upon agreeing he became the target of an offshore property scheme eyeing up his pension.

At the time PPI was quite a thing, and as I am not up to doing a claim myself I accepted and they came round to chat. They then asked about my pension and I explained I didn’t really want a pension review, as the RAC looked after it and my Sipp was doing ok when I received my annual statements. But they insisted that they had to do a pension review as part of my PPI claim."

The scheme arranged for a regulated financial adviser to 'help' Dennis transfer £33,000 of pension money into the unregulated investment. He was assured he was getting independent financial advice and the pension would be administered by a well-known reputable company. He never saw his adviser face to face. But his details were passed on to yet another company that got in touch after his investment showed signs of failing.

I have been contacted by another company saying they can help me to reclaim my mis-sold investment - only to find out that they have directors linked to the exact people who sold me into [the scheme] in the first place.

Following the investment Dennis left his home in Hertfordshire for a new life in rural Lincolnshire, as he no longer wanted to be surrounded by people working in finance.

When I say I have little faith and trust in anybody working in the financial industry you can see why. If I had anything to invest I would rather invest it under my pillow than trust anybody in that industry, which is a shame because I’m sure there are some good people working in finance and pensions.

2. The devastating impact

Pension scams are costing savers an estimated £4bn a year. Analysis from the regulator has found 22 years of pension savings can go in just 24 hours, as savers are trigger happy when it comes to making decisions about pension offers, often after being cold-called.

The FCA warns investors are often lured in with promises of high investment returns. But this is not always the case.

Increasingly they are offered technical help with consolidating their pensions and the ability to pass the funds to their children after they die.

Fraudsters know how to exploit people's general lack of knowledge when it comes to pensions. The trick is to reassure people that they and their family will be helped if they make the investment.

Once it becomes apparent that their pension is lost, investors' lives often take a dramatic turn.

The regulated salespeople often leave the industry, and the unregulated investment company keeps them at bay with promises of future returns that typically don't materialise. Investors willing to fight for their money are threatened with legal action.

The FCA will typically refer them to the Fos or FSCS. Both of these bodies are unfamiliar to the typical investor. As there is often uncertainty over the help for which they qualify, the process can take months if not years.

It is easy to see how these investors might fall prey to CMCs.

All the while victims are being charged fees for the UK-based Sipp through which they invested, and which cannot be cancelled as long as the investment is held within it, valueless or not.

As many pension investors are targeted at age 55, when they gain access to their pension funds under pension freedom rules, by the time they realise their predicament they have approached pensionable age, leaving their retirement at the mercy of the scammers.


The trusting target

Elaine Jenkins's husband, Steve, was cold-called by a representative of an offshore hotel development company in 2012, who told him he could help him consolidate all his pensions into one £120,000 pot and put a large part of it in a 'safe' investment. This would yield enough for his and Elaine's retirement while allowing him to pass the money to their children should anything happen to him.

I remember the adviser sat in my kitchen telling us what a brilliant investment it was and how he wished he had the money to make an investment. I was so convinced we'd done the right thing I was on the verge of asking him to buy another apartment with another small pension. But he never pursued it. That was because it wasn't a big enough pot of money.

When the investment did not return dividends as promised three years later, the pair realised they had made a mistake. A separate financial adviser told them they had invested in a high risk unregulated investment.

We were both shocked and felt sick. My husband was very worried about what he’d done with his pensions and often said he felt stupid and let me down and had possibly jeopardised the future we had planned together.

Steve died suddenly in August 2017. While dealing with his death, Elaine notified the offshore company that she wanted to sell her investment. She was given several assurances but to date has not seen the money returned. Elaine also used the regulatory channels, and after a year of chasing was awarded £50,000 in compensation by the FSCS in September 2018. The FSCS put her overall loss at £70,000.

I can't estimate the hours it's taken me, and the worry as well. I can remember from June to September just being on the phone chasing the pension company, chasing the FSCS, and chasing the management company to get information. When someone dies like Steve did it is a lot to get your head round - and on top of that I had all of this to deal with. I'm fighting against the injustice. Steve died thinking he'd let us down but he hadn't, he'd been scammed.

Elaine wants policymakers to do more to protect vulnerable people from being ripped off.

There needs to be an alert system when people are trying to transfer out of their pensions, where someone independent goes in and says 'have you thought about this'. We just transferred our money out and there was no one to stop us. We were told we were getting independent advice and no one said 'stop, don’t do this'.

3. The safety net is tearing

The safety net for consumers, the FSCS, which pays out on claims against regulated firms and products that have failed, has helped more than four million people, paying out more than £26bn in compensation since its inception in 2001.

The scheme has a limit of £85,000 per investment claim (£50,000 prior to April 2019), meaning the average person in 2018 still made a sizeable loss of £32,000, with many losing far higher amounts.

But the lifeboat system is buckling under its own weight. Its funding has become unsustainable against a backdrop of rising scams, and there is a perception the system is not working effectively to rescue people who have been scammed through no fault of their own.

Financial advisers have seen the cost of funding the service increase by 13 per cent this year, to £213m, with some individual firms seeing their fees increase by 400 per cent year-on-year.

The issue neared boiling point in early 2020 when a concerted effort to lobby for a comprehensive overhaul of the system began.


The helpers

FSCS chief executive Caroline Rainbird and chairman Marshall Bailey are keen to make the system work for consumers and the industry, highlighting consumer trust and confidence as the keys to achieving this aim. Recognising the vulnerability of its claimants, the scheme says it has stepped up its focus on empathy in its claims handling. But cases are increasingly complex and need to be examined thoroughly before any decision to compensate victims with the industry's money can be made, according to Ms Rainbird.

At least 80 per cent of our customers are what we would call vulnerable. With some claims they are complicated, we need to assess them, we need to make sure we have the right amount of evidence and we will help people with that. What we can do is manage expectations and commit to the deadlines we do give on communicating with those investors.

Ms Rainbird says the fee increase for the advice industry was regrettable but necessary to crack down on rogue firms and compensate consumers stung by pension-related fraud.

Behind all these complex terms and these large numbers and all sorts of things is a person who is vulnerable and wild, upset, frightened, angry and just generally not in a good place, and none of us should lose track of that. We see each and every day stories, letters from people. We should never as an industry forget as we go about doing our business that these are people whose futures have been fundamentally changed.

4. The system is for gaming

Phoenix - in ancient stories, an imaginary bird that set fire to itself every 500 years and was born again, rising from its ashes.


Not all advisers that have mis-sold or misrepresented an investment disappear forever. A growing phenomenon in the financial services industry is a practice called 'phoenixing', whereby directors of advice firms concerned about looming complaints against them shut up shop and start a new firm, taking with them clients and the business's assets but not its debts. Any claims falling on the defunct firm are then rerouted to the FSCS.

In 2019, regulators formed a taskforce to clamp down on adviser phoenixing. By the end of the year the FSCS had identified 136 potential cases that it passed on to the regulator. At least seven advisers had been blocked from reauthorising by January 2020.


The knowledgeable target

Jackie Naghten invested parts of her pension in a recycling scheme on the Isle of Man on advice from her regulated financial adviser. After the investment failed the adviser phoenixed, leaving her with an estimated loss of £470,000, of which she got £50,000 back from the FSCS. The adviser is back in business, advising new (and old) clients on where to invest their cash and pensions.

A successful businesswoman and former executive at a large high street retail chain, Jackie is no stranger to finance. She was advised to transfer out of her pension during a time of extreme vulnerability and stress as her husband had entered the final stages of his life following prolonged illness. Jackie trusted her adviser, thinking she would be protected by the regulatory bodies if anything went wrong. She maintains she was never told the investment she had made was unregulated and high risk.

When filing a claim for bad advice, Jackie realised she could not claim on the adviser's insurance as his firm was no longer in business. She was never told her adviser had started a new business, instead ultimately reading about it in a newspaper article. Shocked by the news, she took it upon herself to find out what had happened and to seek justice.

I spent probably three months solidly investigating and putting the whole story together. You really immerse yourself in it and you understand all the nuances and all the difficulties around it, and then it completely consumes your life and you are a bit dysfunctional almost. It's a hugely time consuming exercise. I have a certain personality and resilience that makes it possible for me to do this but not everybody is like that. I think a lot of people just want it to go away and bury their heads, they feel ashamed, they don't understand it, they haven't got the time. They don't understand how it's been allowed to happen, how that person can get away with it.

Jackie says the financial system is too complicated for people to navigate. And trying to make sense of it can be a stressful and disheartening experience.

My message to the regulatory bodies is it needs to be much more consumer friendly, there needs to be greater clarity for customers understanding what they are getting themselves into. There also needs to be a real look at the process IFAs engage in because a lot pretend to be independent [but really] it is just Joe Blow coming to take your money.

5. The policing bodies play catch up

The regulators, government and police say they are doing everything they can to clamp down on bad actors and outright scammers.

In 2012 they set up a taskforce named Project Bloom to respond strategically to the rise of pension scams. This work led to a cold-calling ban on pensions, stricter HMRC checks on the registration of suspected scams, and interventions on pension schemes suspected of being used by scammers. The taskforce was instrumental in winding up a number of rogue companies through the courts and disqualifying directors connected to pension schemes, clawing back millions of pounds of pension money for hundreds of victims.

Recognising that consumer education is key to beating scams and rip-offs, in 2014 the FCA and the Pensions Regulator launched the 'ScamSmart' campaign, an information campaign across TV, radio and online. Last year the campaign claims to have educated 180,000 people about the signs of a scam.

To tackle bad actors within the regulated industry, such as phoenixes, the latest partnership between the FCA and other regulatory bodies was launched last year. The group seeks to spot rogue operators through data sharing and analytics and wants to use machine learning in future.

In April this year, regulators again teamed up to warn the public about scams. They fear more will be targeted amid the coronavirus crisis as their assets have fallen, making them more susceptible to alternative offerings.


The regulator

Fraudsters will exploit the coronavirus to prey on anxiety and fear of savers and investors, especially those who may be vulnerable. That’s why we’re urging anyone who is thinking about transferring their pension to check who they are dealing with and only use firms authorised by the FCA. Mark Steward, FCA executive director of enforcement and market oversight

The police

Education is the most important tactic in stopping fraud. Once we’re made aware of a fraud, steps are quickly taken to identify who is involved and take control of any assets from the scam, so what is left can be returned to the victims. Unfortunately, victims often don’t report they have fallen victim to a scam in time to recover any of the assets from the criminal. This is why it’s so important that anyone who suspects they might be a victim, to contact Action Fraud immediately. Action Fraud spokesperson

The policymaker

We know that cold-calling is the pension scammers’ main tactic, which is why we’ve made them illegal. If you receive an unwanted call from an unknown caller about your pension, get as much information you can and report it to the Information Commissioner’s Office. [We] urge all savers to seek independent advice if you’re thinking about making an important financial decision. Treasury/DWP spokesperson


An adviser's view

Ricky Chan, director at IFS Wealth & Pensions, believes the current financial advice regulatory framework already affords a lot of consumer protection, and that seeing a regulated IFA or Chartered Financial Planner generally leads to better client outcomes.

However, unregulated investments have been subject to much attention over the past few years, particularly via Sipps. Mr Chan believes there should be an outright ban on such investments. He also thinks FSCS funding should be reformed.

The issue is that these unregulated and extremely speculative investments, which typically are storage pods, car parking spaces, developments in the Caribbean and so on, were and are clearly unsuitable for pension funds. But the FCA has resisted an outright ban for no good reasons. Apart from greed, I cannot see why any prudent adviser or investor would look to invest in these. As they have led to an increasing number of FOS & FSCS complaints and compensation, a ban should be the only option.

Many good advisory firms are suffering as a result of significantly higher regulatory costs and professional indemnity insurance fees, due to the actions of a few rogue advisers and firms. This has led to calls to reform the current unsustainable funding of the FSCS, which I agree is something that is much needed.

Policing is not easy as there are too many advisers and firms, and the FCA’s remit is ever increasing, so it relies a lot on whistleblowers and tip-offs. And although it’s disturbing and unethical when these unregulated investments are mis-sold to clients, these were a minority of cases (relative to number of positive client outcomes) and increasingly will become even rarer as Sipp providers have now tightened their due diligence on the underlying investments.

In my opinion, extra disclosure simply does not work – there is already evidence that at present, there is already an information overload from the abundance of paperwork, disclosures, documents that must be disclosed to clients. And pension providers already send out 'scam warning' templated letters to clients that are transferring pensions away. But many clients do not even read these.

Additionally, if a firm or adviser is a rogue operator, they would get around any new rules anyway. So I’d suggest that the only feasible solution is to ban these speculative, unregulated investments outright. It would protect the profession and consumers over the longer-term.


6. Conclusion

The government and regulators have recognised a growing issue and stepped up their game to crack down on scammers and others out to rip people off.

But the problem is they rely on the regulated entities to play gatekeepers, and on consumers themselves to safeguard their money.

There are signs the regulator's messages are simply not reaching their target audience. Consumers want more intervention in the process of selling financial products.

The industry, too, is increasingly frustrated about the regulators playing catch-up and the growing bills being levied upon them.

It is clear that something more radical needs to be done. Experience has shown that by the time the regulators are in a position to act, it is often too late.

By the time the sun rises on the fraud, the scammers have long gone.