Investment Adverts on Facebook: THIS IS THE HARM!

What if I told you I knew of a company which authorised and regulated by the FCA, which is offering 1-5 year fixed-rate, fixed-term bonds and ISAs and with annualised nominal returns of between 3% and 8.95%, compounded quarterly, with no fees or charges, and a 100% track record of making its interest and capital repayments? If you’re an industry professional or savvy investor, you’ll probably smell an even fatter rat than Professor Ratigan, the evil, overweight villain of Disney’s Basil the Great Mouse Detective.

But if you’re an inexperienced retail investor, fed up of a decade of low interest rates on cash ISAs and hungry for an inflation-beating return to enable you to maintain the spending power of your nest egg, it offers an opportunity – an alternative to the rubbish cash rates offered by the big banks.

This was the deal being offered by London Capital and Finance Plc (LC&F), of Tunbridge Wells, East Sussex. With professional marketing from a top agency, 11,605 investors entrusted hundreds of millions of pounds into some 14,000 the company’s products.

On January 30th 2019, LC&F went into administration, following an investigation by the FCA into its misleading, not fair, and unclear financial promotions.

What were the products?

The products were not fairly comparable to fixed-term cash deposits, despite LC&F asking investors on its website: “LOOKING FOR HIGHER RETURNS THAN THE HIGH STREET?”

The company actually issued investors with mini-bonds, which are unregulated, unlisted, highly illiquid debt securities, with no cover under the Financial Services Compensation Scheme (FSCS). Mini-bonds are generally issued by smaller companies to raise funds. However, given these high risks, they often carry attractive rates of interest.

More than just being highly illiquid, the bonds issued by LC&F were completely non-transferrable.

LC&F has stated that all the companies it lent money to had provided security for the loans.

The bonds were sold both unwrapped, and within LC&F’s own ISA wrapper. However, the FCA and HMRC have agreed that the mini-bonds are not eligible investments for an ISA because they were non-transferrable. As such, LC&F’s investors may need to pay tax on any gains within their ISA, as if the mini-bonds had been held outside the ISA. This was one of the FCA’s big problems with LC&F.

11,605 investors took out a total of 14,000 bonds, with par values totalling ￡236 million.

Once the company had possession of investors’ cash (having issued the bonds) it loaned the money to a number of other smaller UK companies across a number of different sectors. However, this pool of companies was perhaps not as broad as one might assume: one borrower was lent ￡122 million.

The company doesn’t wish to disclose who it lent money to, as to announce this publicly may negatively impact the borrowers’ businesses, and therefore their ability to repay their loans, which would ultimately be detrimental to LC&F’s bondholders. As such, I’m not going to name any in this article, but a new names have been kicking around on online forums.

What I will say is that I’m not particularly impressed with the accounts of some of these companies.

While none of the borrowers have defaulted as yet (indeed, the loans are LC&F’s biggest asset) the interest being charged by LC&F was typically between 12% and 20% APR. This provided the company with a profit margin, and enabled it to pay its own bondholders their 3%-8.95% annual fixed-rate returns.

20% APR should be all you need to know to realise that these companies are probably highly indebted with poor credit ratings, and therefore are at a higher risk of defaulting on their interest and/or capital repayments.

Even scarier than this, some of the borrowers subsequently lent out the borrowed money to other companies in order to generate a return, known as “sub-borrowers”.

The claim that the firm was “authorised and regulated by the FCA” was also misleading, because while the firm was indeed authorised and regulated to provide financial advice (not that it actually gave advice) it was not authorised and regulated to promote the bonds.

Marketing Costs

Reading this article so far, you’re probably thinking that this sounds like a simple business model. An arbitrage. LC&F borrows from investors at between 3% and 8%, and lends that cash out at between 12% and 20%, providing income to the company of between 4% and 17%.

However, one of the company’s problems and complexities was the marketing bill. It employed a professional agency called Surge PLC, paying them commission of 25% of the funds raised: circa-￡60 million.

Surge advertised everywhere, including on social media sites such as Facebook. We’ve all seen the ads, promising high returns, comparing the investments with cash deposits, and the obligatory tiny caveats and risk warnings tucked away at the bottom. This was another problem the FCA had with LC&F: the risk warnings were given very little prominence on the marketing material compared to the huge benefits of investing. This was no doubt responsible for many unwitting social media users entrusting their savings to LC&F, among other high-risk investment companies keen to capitalise on their prospective clients’ ignorance.

On top of the 25% marketing commission, a 3% fee was charged by LC&F and the custodian to the mini-bond/ISA monies prior to them being lent to the borrowers. As LC&F claimed that there were no charges or fees, this is also arguably misleading, although I admit that technically there weren’t – they were just bonds being issued.

Calculations have been done, and it appears that in order for LC&F to fully repay their bondholders (after all the commission, fees and admin costs have been taken care of), LC&F’s borrowers would’ve needed to pay LC&F significantly more than the 12%-20% interest LC&F published they were charging borrowers.

Surge has stated that it has a number of clients and its fees for LCF are in line with the industry standard. It was a supplier of services used in relation to raising investment for LCF, but did not handle client money and had no involvement in the deployment of funds to borrowing companies. 

What’s happening to the clients?

Desperate investors are posting on online forums, unsure what’s happening with their nest eggs. It’s all they can do just now, as no one is sure how much they’ll be able to recoup.

LC&F is not currently in a position to pay any interest or repay any capital to its bondholders.

The bad news is that the FSCS does not cover mini-bonds, or indeed any direct investment into corporate bonds, particularly those sold without financial advice. As such, it doesn’t look like investors are getting back their money this way.

However, if the company’s administrators are to be believed, LC&F’s borrowers are still making their payments on time and in full, and have not yet defaulted. This makes the loans valuable assets of the company.

Remember that the agreement isn’t between LC&F’s bondholders and LC&F’s borrowers. There are two agreements:

1.    Between LC&F’s bondholders and LC&F

2.    Between LC&F and LC&F’s borrowers

But, the company doesn’t appear to be worth zero. It has a net asset value. Its loans are worth something. So, it appears that investors are going to get back something. But, no one knows what this is just now.

The Administrators will have already been in touch with all LC&F’s bondholders, and there will be a claims notification process established that will be communicated to the bondholders.

My View

I’ve said for years that these ads on Facebook were misleading, comparing cash ISAs with fixed-term bonds with various underlying, high-risk investments. I’ve seen a company very similar to LC&F issue bonds backed by proposed property developments in mainland Europe. Ridiculously high-risk, yet advertised on Facebook with the same tired old message about cash ISA rates being low, so you want to invest in this all new, latest and greatest, all singing, all dancing, fixed-term bond that’s 100% safe because it’s got 400 five-star reviews on its website, no charges, and the bonds are secured.

I’m sorry, but money talks and bullshit walks. For all your talk of security and safety, you’re offering 8% nominal per annum, compounded quarterly, over 5 years, which is roughly double the dividend yield of the FTSE 100 index. So for all your comparisons with cash ISAs and talk of being “secure” and comparable to cash ISAs, the interest rate on offer tells us the risk is far, far greater. But it doesn’t tell a retail investor of the high degree of risk involved.

I have circled the part of the ad on the left which signifies “security” with a green tick. I understand what’s meant by this is that the bond is secured against the company’s assets. But to a retail investor, this says to them that the investment is a secure one. This is the message a retail investor might take from this kind of advert.

This is from their website, and I’ve green boxed the risk warnings. The FCA has argued that these were not prominent enough compared to the advertised benefits of investing: the 100% track record, the security, the positive reviews, and the no costs (although this is debatable as we’ve already discussed).

What I need to question is why these companies are advertising in this way. Why try and emphasise the security, the regulation, and the track record of payment? These are ill important, but why lead with this? You might find you get much more respect if you lead with “This is a high-risk proposition with the potential to earn strong returns”, perhaps comparing the bonds with similar high-risk debt instruments.

Investors in such bonds need to want and require high risk, potential high return investments. Don’t just caveat down the bottom – be proud that this is high risk, potential high return.

Stop advertising on social media platforms like Facebook. Your average Facebook user is not a high net worth individual with millions of pounds in the bank and a degree in economics. They’re 30 year old millennials with ￡180k worth of mortgage debt and a family to look after, with limited savings.

Advertise where and as appropriate.

However, consumers also need to take responsibility for their own investments. They have a responsibility to themselves to seek regulated financial advice where they don’t have the knowledge or skills to make their own investment decisions. I’ve purple-circled the “security” section of the website which I’m sure will have explained what was meant by “security”. Small font or not, the risks have been pointed out. And as the old adage goes, if it seems too good to be true, it probably is.

Thing is, this wasn’t too good to be true. 8% is probably about right for the risks on offer:

·      Unlisted, unregulated, but secured bonds

·      An illiquid investment that cannot be transferred/redeemed early

·      No FSCS cover

·      Ultimately backed by high-interest loans to small UK companies

If anything, 8% isn’t even that good. Not when you consider the following annualised returns from the AFI indices:

What would you rather have? Our aforementioned bonds, or liquid, multi-asset investment funds, regulated, highly diversified, covered by the FSCS, with explicit charges and the risk all laid bare for you to consider.

Always consult a qualified, regulated financial adviser before making any investment decisions.