By Rob Goodhew, Director at Kroll

Unregulated investments, many of which are high-risk and some of which are scams, have become a major problem in the UK. Since the introduction of pension freedoms in April 2015, the UK has seen a growth in unregulated, unlisted, high-yield investments being marketed and sold to members of the public, often as low-risk opportunities. While such investments might seem low risk at first glance, claims of such high returns in an era of low interest rates should raise alarm bells.

Research highlighted by the FCA in 2019 indicated that 42% of pension savers, equivalent to over 5 million people, could be at risk of falling victim to one or more of the common tactics used by pension scammers. Assuming that each of those potential victims had £50,000 to invest, the potential prize for scammers would be a staggering £250bn. It’s not suprising that scheme operators, whether scammers or not, might want to access that kind of money.

Classifying such investment schemes and their investors is not straightforward, but there are certain features that characterise the problem. There are many types of underlying businesses and assets on offer such as foreign exchange, agriculture and forestry, precious metals, and even sports betting. There has also been a proliferation of unregulated investment schemes marketed as unitised property-backed investments, such as parking spaces in a carpark, storage units, or rooms in hotels, student accommodation and care homes. Structures vary, but the investor may, for example, buy a long lease over a ‘unit’ and then lease the unit back to an operating company on a shorter lease, say 10 years, in exchange for a ‘guaranteed’ return.

Alternatively, investors might be offered high-yield bonds or loan notes with a range of maturities, again, often over a longer term meaning that capital could be tied-up for some time. Advertised returns are often up to 10% or more and some schemes include a buyback clause where the owner will buy out the investor at, say, 125% of the original purchase price.

Given the underlying income-generating ‘bricks and mortar’ assets, it’s easy to see why such opportunities might be attractive. It’s a simple proposition and it seems obvious and safe, but the reality may be quite different. If the advertised returns weren’t challenging enough in the current low-interest environment, commissions of up to 20% or more that are usually paid to sales agents or ‘introducers’ can be crippling, causing a systemic flaw in the investment model. After operating costs have been paid and possibly also the servicing of other debt, the underlying business may have to perform very well just to be able to repay the original capital invested—and all of this assumes that the investment is honest and not just a scam from the outset. Putting the initial intentions of the scheme operators to one side, cash invested may also be used to manage liquidity, fund the owners’ lifestyle, and manage losses in the various operating businesses. All of which can be a huge distraction from what should be the real focus of operating the original, underlying business.

Of course, it’s important from the outset to have a good understanding of the investment proposition beyond the glossy brochures, websites, and sales talk. It is vital that investors have a proper understanding of the true nature of the underlying business; any discretion that management might have to use capital as they wish; the legal structure; the nature of the financial instrument being offered; the involvement of introducers/agents and their fees; the involvement of regulated parties; security over underlying assets; and the rights of the investor.

Most of the drivers that contribute to the sale of high-risk, unregulated investments have existed for some time now.

• People are free to invest their pension funds as they wish. The risk is to savings in whatever form, but pensions just happen to be an obvious and important category.
• There is no requirement to take advice when drawing down a pension or investing, and research suggests that most people don’t take advice when accessing their pension funds.
• The low interest rate environment remains.
• Regulations permit the marketing of such investments to certed types of investor.

Compounding the above, Covid-19 may have made the situation worse. In addition to the obvious economic influences and stresses, lockdown has forced us to operate in a more virtual world and we are more isolated and vulnerable than usual.

The marketing of such investments to individuals is restricted to ‘high net worth’ and/or ‘sophisticated’ investors. The problem here is twofold. Firstly, investors qualifying as high net worth or sophisticated will not necessarily fully appreciate the risks associated with the investment. It also does not provide immunity to old fashioned sales tactics and unconscious bias. Secondly, the assessment of an investor as high net worth or sophisticated is essentially one of self-certification.

The authorities are well aware of the issue, but is enough being done? The Government introduced a ban on cold calling in relation to pensions which came into effect in January 2019, and the Work and Pensions Committee is currently conducting a major inquiry into the problem. However, at the same time as the ban on cold calling came into effect, the FCA was investigating London Capital & Finance which, later that month, collapsed. So, there are legacy issues, but has the problem now gone away? Unfortunately, the answer to that appears to be no. There have been public awareness campaigns, which are important, and the FCA does on occasion take action against unregulated firms, but resourcing, and the potential scale of the problem on, or outside, the regulatory perimiter means that not very much has changed. The ban on pensions cold calling was a welcome step forward, but as we will explore in future articles it may have had little impact on the sale of high-risk, unregulated investments.

It may seem obvious that these schemes would be first in line for some sort of regulatory clampdown but, six years after the pension freedoms were implemented, the problem remains. It could be argued that the investments are, for example, interests in property marketed to high net worth or sophisticated investors, and therefore permitted. In reality, many of these schemes are marketed using high-pressure sales tactics to ordinary people, who may have raised funds by cashing in pensions or other life savings, through inheritance, or even through refinancing their home.

In the event that such a scheme collapses, the fallout may be complicated by poor record keeping, complex group structures, intra-group lending and the existence of charges over the underlying assets. This means that it might not be very straightforward to establish what happened, and there may be competing claims for the remaining assets. More is clearly needed to be done to prevent it from getting to this stage in the first place, but for investors that find they have a problem with their investment, it is vital that they understand their rights under the investment documentation and be aware of their options in terms of recovering their money.