When should the FSCS, the Financial Conduct Authority (FCA) or the investor be accountable for financial scandals and losses at FCA-regulated firms? A legal expert and industry insider describes shortcomings in the UK structure and how it should be reformed.
The UK’s framework for investor compensation and the accountability of financial regulators is at a constitutional impasse. It was originally intended that the Financial Services Compensation Scheme (FSCS) would cover investment losses at failed FCA-regulated firms, but several recent scandals have exposed loopholes in that regime. When the FSCS does not apply, the complaints scheme governing the Financial Conduct Authority (FCA) comes into focus. The FCA has recently promulgated new rules purporting to limit and cap its own liability under that scheme, contradicting the position of the Financial Regulators Complaints Commissioner (FRCC), which has twice recently found such a notion to be unlawful. The FCA’s liability for uncompensated losses of investors in situations of regulatory failure was avoided for London Capital & Finance (LC&F) and Premier FX, by the government and taxpayer stepping in and by the FCA calling on the deep pockets of Barclays Bank, respectively. The FCA’s responsibility to investors for its failures will at some point come to a head, possibly in the Collateral scandal. In that case, the firm was incorrectly listed on the FCA’s register, a clear regulatory failure, and the FSCS has said it will not cover the losses. A raft of complaints on that scandal still sit with the FCA for a final decision and no obvious deep pockets exist to fund investors’ losses.
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Back in February 2022 and considering LC&F, the FRCC determined that FCA guidance, which purported to cap and exclude the regulator’s own liabilities to victims of financial scandals, was “fundamentally flawed” and “frustrated the statutory object and purpose underpinning the complaints scheme”. In a December 2023 decision on Premier FX, the FRCC reiterated its position, stating that such guidance “should not be applied so as to fetter the powers” of the FRCC. The FCA’s decisions not to compensate victims of the LC&F and PremierFX scandals were held by the FRCC to be founded on legal error. However, the FCA in both cases refused to follow the FRCC’s recommendations. Instead, the FCA has doubled down on its position. Earlier this year, new FCA rules came into effect which would enshrine a limitation on any potential liability of the FCA. These FCA rules, unlike the previous FCA guidance, will be binding on the FRCC – if they are constitutionally valid.
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The FCA supervises 45,000 financial services companies. It is perhaps inevitable that some of these firms will be bad apples or unlucky. Some firms will fail and investors can end up with losses. The Financial Services Compensation Scheme (FSCS), funded by industry levies, protects retail investors for up to £85,000 or greater amounts for temporary balances. This framework gives confidence to ordinary investors and a safety net to those who lose out. Separately, the FRCC itself oversees a complaints scheme against regulators and can make recommendations for financial awards against the FCA, where it is a cause of investor losses.
There have been numerous recent cases, including LC&F, Premier FX, Lendy and Collateral, where FCA-regulated firms have failed but the FSCS has determined that the claims fell outside its protective scope. Many people have lost their life savings, with catastrophic outcomes, including several suicides. These uncompensated losses fall into two main categories: payment services and unregulated investments. In every one of these cases, the firms were regulated and supervised by the FCA or appeared so to be. They were listed as such on the FCA’s register. The public seem to have assumed that this meant FSCS protection applied; and that an assurance arose from FCA supervision.
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Payment services firms often handle large cash balances, in a manner akin to banks. Some users of Premier FX, a failed payments firm, lost the proceeds from the sale of their homes when it collapsed in 2019. However, the FSCS does not apply to failures of such firms, probably due to an oversight when the EU’s payment services regulation was implemented in the UK. With FSCS funds unavailable, the FCA required Barclays Bank, a service provider to Premier FX, to cover most (£10m) of the uncompensated investor losses in that case. Another regulator, the Prudential Regulatory Authority, has recently closed this loophole in part, to protect payment services users from bank insolvencies. However, this does not address all failures of payment firms themselves. In LC&F, £237m of ISA-eligible ‘non-transferable bonds’ were sold to retail investors through price comparison websites and other mainstream channels by an FCA-regulated firm. These investments were later held by the FCA to be a permissible class of unregulated investment, meaning that the FSCS did not apply. Ultimately, a taxpayer-backed scheme was established, covering 80 per cent of what the FSCS would have paid out. In both PremierFX and LC&F, investors were not paid out in full, the FCA was found to have failed to supervise the firms properly, the FRCC recommended an additional award from the FCA and the FCA refused to pay it.
The current impasse between the FCA and FRCC can be traced back to 2019-2020. At that time, the FCA faced an exposure of up to c.£400m of investor losses outside the FSCS scheme, compounded by findings of regulatory failure in the Gloster Report and in other reports made into various scandals, which implied regulatory causation. In many ways, the FCA created this rod for its own back. Perhaps influenced by a desire to distance itself from responsibility for some of these scandals, the FCA controversially declared non-transferable bonds to be a valid class of unregulated product in 2019. By taking this view, the FCA was able to save some face, arguing that it was not the FCA’s job to supervise this market. However, at the same time, the FCA potentially exposed itself to hundreds of millions of pounds in value of investor claims under the FRCC regime. Its reaction was to propose new rules, which would cap the FCA’s liability at £10,000 per investor, and excluding liability when the regulator was not “solely or primarily responsible” for the loss. Since malefactors at regulated firms will primarily cause investor losses, the chances of that test ever being met are vanishingly rare.
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The FCA was politically unable to implement these rules in 2020 following criticism by MPs and victims of financial scandals. The proposals were therefore mothballed. However, away from the scrutiny of public consultation, the FCA published separate guidance in the form of a so-called ‘Remedies Statement’, asserting the same caps and liability limitations. The FRCC has twice found the Remedies Statement to be unlawful and the FCA eventually deleted it in 2024. However, rather than accepting the FRCC’s position, the FCA has now purported to override the FRCC, by this year publishing its mothballed 2020 rules and codifying the limitations and caps those contained. Meanwhile, Parliament has been pointing in the opposite direction, conferring an enhanced role for the FRCC in its new framework for regulatory accountability, just a few months ago, in the Financial Services Act 2023.
The current situation, where investor losses are often deemed for technical reasons to fall outside FSCS, potentially creating significant liabilities for the FCA; and the FCA then purports to shake off liability in a way that the FRCC has decided is unlawful, is unsustainable. This cannot be what Parliament intended when establishing these various mechanisms and entities. With this backdrop, the FCA will likely continue to face disgruntled investors who place their money with FCA-regulated firms if losses continue to fall outside the FSCS scheme.
The FCA has found itself in a difficult position as regards its own liability, when loopholes from the FSCS regime arose. Although the FCA’s position on its own non-liability to investors is untenable and potentially unlawful, a better resolution to these issues may lie instead in FSCS reform. Urgent policy work, clear legislation and clear communications to investors are now needed on the scope of the FSCS. There is no logical or policy-based distinction as between those areas where the FSCS applies and those where it does not. For example, the FSCS applies to investment advice (despite firms holding no customer investments) but does not apply to various sectors where investors are exposed to losing their savings, particularly payments services firms handling client money (e.g. Premier FX) and regulated firms issuing unregulated investments (e.g. LC&F). The FSCS is industry-funded. It should be considered as a policy matter whether the FSCS should be extended to cover all principal investment and client money situations where the relevant assets are placed with FCA-regulated firms. Whether the FSCS scheme should apply to non-cash-handling sectors, e.g. investment advice, or should do with such high compensation limits also needs reconsideration.
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Where risks are uncompensated, the FCA probably should not underwrite the entire balance, since it is a regulator doing its best with stretched resources and not a bad actor itself. However, the FCA should probably remain liable to investors to a limited extent, under its complaints scheme and the FRCC regime, where the regulator has been a contributory cause of uncompensated investor losses.
To date, the FCA has managed to avoid large pay-outs to uncompensated victims of financial scandals, by tapping up major banks and the taxpayer. However, deep pockets like these may not always exist or be prepared to step in. The failure of the firm Collateral involved £18m of losses. Although this is a smaller headline loss than in some other recent scandals, it has had a life-changing effect on those who lost their savings or investments. This firm appeared on the FCA’s register as if it were a regulated firm and was marketed as an FCA-regulated firm to investors, but the FCA register was in error. The FSCS did not apply, since it was not actually a regulated firm. The question now arises as to whether the FCA will be liable for its error in listing an unregulated firm on the FCA register. A suite of complaints to the FCA concerning Collateral remain undecided today. It will be interesting to see what the FCA’s decision is, and whether the decision will then be appealed to the FRCC, who has an opposite position as regards the FCA’s liability.
More broadly, it is inappropriate and may be unlawful for the FCA to purport to limit and cap its own liability through rulemaking. The FCA’s liability was established by Parliament in the Financial Services Act 2012, without including any cap nor any notion of ‘solely or primarily responsible’ as a test of causation. In making such rules, the FCA has a clear conflict of interest and acts in an opposite manner to the strict liability it imposes on firms and individuals via the consumer duty and the senior managers regime. The FCA also acts in contradiction of the findings of the independent FRCC, that Parliament did not intend for the FCA to have this power. Any residual liability of the FCA for regulatory failures which contribute to uncompensated investor losses must be properly defined by statute and overseen by the Courts and the FRCC.
