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Trusting the regulators? You should not.

The recent case of Catalyst Investment Group highlights the fact that sensible investors should not rely on the financial regulators to warn them about dubious investments and those who promote them. Indeed so far as the FCA, and its predecessor the FSA, is concerned, the fact that a business is regulated by them does not necessarily mean they are trustworthy at all. All it means is that they have met the regulatory requirements at some point in the past.

The recent outrageous example of Catalyst Investment Group makes the point. This was a company that promoted bonds issued by Luxembourg based ARM to intermediaries such as IFAs in the UK, who sold them to retail investors. However the bonds concerned had never been approved by the Luxembourg financial regulator who had actually told ARM to stop issuing them.

But that did not apparently stop Catalyst selling the bonds (£17m worth, plus £37m of other ARM bonds). ARM has now been placed “under supervision” by the regulator and all payments have been suspended. Any investors in their bonds should go to this FCA web page for more information: www.fca.org.uk/news/consumers/arm-investors .

Even more alarmingly, the FSA were aware of the issue and “invited” Catalyst to stop selling them, but they did not do so. In addition this was a private communication which was not published.

Finally the FCA have taken tougher action with a £450,000 fine on former Catalyst CEO Tim Roberts (and banned him from working in the financial sector) for reckless behaviour plus lesser fines on other staff. The company itself was not fined as it has been declared “in default” by the FCA.

Similarly the FSA did not warn investors in small cap stocks (such as “US Regulation S” stocks) a few years back that some of the companies promoting them were selling them to inappropriate investors, i.e. those incapable of understanding the risks associated with them. In other words some of the firms operating in the “boiler room” style were regulated by the FSA until quite late in the day.

Likewise, if the LSE disciplines an AIM Nomad they often don’t disclose it in public. At least the FCA seems to be taking a different stance on disclosure now, but it’s well overdue for the LSE to change its ways.

However you look at it, it is down to you the investor to make sure you understand what you are buying. If you do not, you should not buy it. Even a little research on what Catalyst and ARM were promoting might have disclosed that it was complex and possibly risky. You can still see the “prospectus” for some of these bonds on the internet – all 73 pages of easy reading which explains these were bonds that securitised the pooled payments from the cash benefits of “life settlements”, i.e. life insurance policies where the insured had not long to live and the policies had been assigned for some reason.

In the USA where securitised mortgage debt was the source of a major worldwide financial crisis (again selling products that the buyers did not understand), JPMorgan have just agreed to pay $13bn in settlement and it looks like the Bank of America (BofA) will also have to pay compensation of record amounts. Pooling risks did not reduce them in this case, it just concealed them while the regulators took no notice.

So the moral is, don’t trust anyone trying to sell you an investment proposition, and don’t trust the regulators to ensure you are not mis-sold a pup. Likewise don’t rely on the regulators or AIM Nomads to ensure AIM companies behave in an responsible manner and act in the interests of shareholders.

Roger Lawson

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