Most readers will be aware of the FCA’s successful legal action in what has been widely referred to as the Avacade case, which is how we will refer to it in this article. In fact, the case was brought against a number of  defendants/appellants, namely:

AVACADE LIMITED (in liquidation) (trading as AVACADE INVESTMENT OPTIONS)
ALEXANDRA ASSOCIATES (U.K.) LIMITED (trading as AVACADE FUTURE SOLUTIONS)
CRAIG STANLEY LUMMIS
LEE EDWARD LUMMIS
RAYMOND GEORGE FOX

The Third Defendant (“CL”) and Fourth Defendant (“LL”) are father and son respectively. They were directors of the Second Defendant (“AA”), and together with the Fifth defendant, Mr Fox, directors of the First Defendant (“Avacade”). CL and RGF were formerly regulated advisers, that status having ceased in 2010.

ATEB was called as an expert witness on behalf of the FCA in this case as significant elements of the FCA’s case was based on investigative work that ATEB had undertaken in late 2016 and early 2017. We have not written about the case before but as the appeal decision is now finalised, we believe that it is relevant to do so now as there are some important principles and lessons to be taken from the actions of the various parties involved.

What was the case about?

Briefly, the case concerned the actions of the defendants as unregulated introducers of clients to a number of intermediaries, SIPP providers, and investment providers. Although the process adopted evolved during the period 2010 to 2016, it can generally be summarised as seeking individuals who could be persuaded to transfer existing pensions into SIPPs, with a view to then having some of the SIPP funds being invested in unregulated investment schemes from which the defendants would be paid a commission. Initially, clients were introduced directly  to SIPP providers with the unregulated investment then being made on an ‘execution only’ basis. Later, the introductions were made to a number of IFA firms, possibly at least in part to permit transfers from DB schemes following the pension freedoms introduced in the Pensions Act 2015. The start of the process was the cold calling of prospective clients with the offer of a ‘free pension report’, of which more later.

The FCA’s case was that the actions of Avacade amounted to advising and/or arranging investments without the necessary authorisation. That would be a breach of the general prohibition in s.19 of the Financial Services and Markets Act 2000 (“FSMA”), and a criminal offence. The FCA brought the claim against Avacade on the basis that Avacade had arranged, contrary to Article 25 of the Regulated Activities Order (RAO), and advised, contrary to Article 53 of the RAO, in relation to the transfer to the SIPPs and subsequent investments, and issued unauthorised financial promotions in breach of s.21 of FSMA.

According to the FCA, more than 2,000 individuals transferred in the region of £91.8m from their pensions into SIPPs. Approximately £68m of that amount was invested in products promoted by Avacade and approximately £905,000 was invested into a product promoted by Alexandra Associates (AA) – the Paraiba bond – relating to a Brazilian property development. This was described in the literature as a ‘Secured Fixed Rate Three Year Bond’, the word ‘secured’ referring to the investments being secured against the asset of ‘land title’. However, it is entirely possible that at least some investors could have taken it to mean ‘secure’.  From these investments Avacade and AA earned commissions in the region of £10.8m.

Unsurprisingly, many of the underlying investments have since failed or are in liquidation. So much for the promise of an investment underpinned by assets.

The Court proceedings
The FCA filed particulars of claim with the High Court of Justice, Chancery Division, dated 6 September 2017. The case was heard late January 2020. The judgment was handed down in favour of the FCA on 30 June 2020. The Court of Appeal judgment came in August 2021. The wheels of justice turn very slowly!

As stated earlier, the FCA’s case was based around Articles 25 and 53, but the defendants sought to rely on the exclusions to the general prohibition contained in Articles 27 (“Enabling parties to communicate”), 29 (“Arranging deals with or through authorised persons”) and 33 (“Introducing”) each of which provide for conditional exemption from the general prohibition on undertaking a regulated activity unless authorised.

The judgment and the subsequent appeal conclusion were well considered and lengthy and can be found online for any reader interested in the detail. A plain English (or as near as is possible with the very technical arguments that were exercised permits) summary now follows.

Article 27 defence

The defendants claimed that their actions merely enabled clients to communicate with regulated advisers. However, the guidance in PERG 2.8.6A(2) clearly undermined this defence, stating:

“Under article 27, simply providing the means by which parties to a transaction (or possible transaction) are able to communicate with each other is excluded from arrangements made with a view to persons entering into certain transactions (see PERG 2.8.6G (2)) only. This will ensure that persons such as Internet service providers or telecommunications networks are excluded if all they do is provide communication facilities (and these would otherwise be considered to be arrangements made with a view to the participants entering into transactions). If a person makes arrangements that go beyond providing the means of communication, and add value to what is provided, he will lose the benefit of this exclusion.”

The judge found that Avacade’s actions amounted to more than merely enabling communication between third parties and thus that this exclusion could not apply.

Article 29 defence

Article 29 operates as an exemption to Article 25, provided:

• the transaction is made with or through an authorised person
• the transaction is being entered into on advice provided by an authorised person
• the arranger is not receiving any pecuniary reward from any person other than the client

The flaw in this defence is therefore immediately obvious. The benefit of the exemption under Article 29 is lost if the arranging party receives a reward or pecuniary advantage, for which he does not account to the client. As Avacade received commission in respect of the underlying investments, the judge held that Article 29 could not apply.

The related defence argument that the ‘arranging’ related to the SIPP, but the commission arose from the ‘separate’ unregulated investment was also rejected. The basis for this conclusion was that the SIPP and the investment could not reasonably be considered separately as the latter could only transpire from the arrangement of the SIPP. This is entirely in line with applicable FCA rules around transfer advice and also consistent with oft repeated FCA guidance and alerts.

Article 33 defence

Article 33 provides an exemption to Article 25 which is also subject to the satisfaction of a number of conditions. The relevant PERG guidance states:

“Under article 33, making arrangements under which persons will be introduced to third parties who will provide independent services (consisting of advice or the exercise of discretion in relation to certain investments) is excluded from articles 25(2), 25A(2), 25B(2), 25C(2) and 25E(2) only. The party to whom the introduction is made must be of a specified standing (including that of an authorised person)”

Accordingly, this defence failed in two ways. First the initial model, which referred clients directly to SIPP providers did not constitute an introduction to a provider of ‘independent services’. Second, the later model, which referred clients to IFA firms fell short of the Article 33 condition that the introduction be ‘with a view to the provision of independent advice or exercise of discretion in relation to the investments’.

The evidence in relation to this aspect, much of which was based on investigative work done by ATEB, was found to show that the ‘advice’ provided could not reasonably be considered to satisfy the criteria for independent advice – instead it merely facilitated the transfer and the consequent unregulated investment from which the defendants would gain a commission payment. The judge concluded that the primary purpose of the introduction was to “bring about a situation in which the desired investments would be made and the commissions earned” and that any exercise of discretion or advice provided was an aside, and was not the primary purpose of Avacade’s introduction. For these reasons, that defendants’ reliance on Article 33 was rejected.

Other issues

The Court also pronounced on the following ‘other’ issues:

• the prohibition on financial promotions (s.21 of FSMA) – the judge held that Avacade’s website and materials were intended to promote financial activity
• misleading statements (s.89) – the judge found that Avacade’s statements that customers had to obtain independent advice to transfer their (personal) pensions into SIPPs, and that the investments recommended had proven track records and/or were low risk, were false and misleading
• ‘knowingly concerned’ (s.382) – the judge rejected defendants’ claims that they did not know what they were doing was wrong, and so could not be ‘knowingly concerned’.

The Appeal

Despite the Court’s carefully considered and detailed decision, the defendants were granted leave to appeal. The defence legal team put up a large number of grounds for allowing an appeal. All but four were rejected. The decision of the Court of Appeal was handed down on 4 August 2021 and unanimously upheld the original decision.

The ‘Pension Report’

The report that was provided to clients contained a number of hard to believe claims including that Avacade had undertaken “in-depth analysis of 10,000 pension planners throughout the UK, revealing their financial ambitions, their desires and financial performance.” Even if this claim were true, it is not clear how the ambitions, desires and financial performance (whatever that means) of pension planners is of any relevance to the people who received these reports.

The report was the culmination of Avacade obtaining information on the client’s existing pensions, and then contrasting those and the state pension unfavourably with the level of pension clients had been asked to estimate they would like.

Annuities were positioned as unattractive because of their “historically poor performance of annuity products and their restrictions to financial freedom”.

Further, the report presented past performance of ‘funds’ in a manner that was clearly intended to indicate that ‘funds’ were less likely to provide sufficient return to bridge the identified ‘pension gap’ than the alternative investments that had clearly been discussed with the client resulting in a preference for such alternatives being already built in to the client’s thought process (see below).

“From a sample of 25,208 funds, the average annual fund performance was found to be only 3.78%.”

As ‘generic information’ intended to help the client make an “informed decision” this was fundamentally flawed. The source is unstated and it is not clear over what period the statement refers to or whether it is before or after charges. And the use of the word ‘only’ implies a comparison with some alternative with a higher return – the ‘secured’ return on the Paraiba bond was stated to be 11%!

Prior to the issue of the report, Avacade had undertaken a telephone call with the client:

“As part of this report we have established with you a number of key retirement objectives including; the age at which you would like to retire, the age you wish to take your tax free cash and who you would like to leave your pension fund to when you pass away.”

Reading the ‘objectives’ in the report, it was no surprise to find that every client apparently wanted to access cash at age 55, and most would prefer to have “greater control” over investments and leave their pension fund as a legacy in the event of death. In our experience of reviewing a large number pension transfer files over the past six years, these are what we would call product led ‘objectives’, i.e. they are features of a drawdown plan and not true client specific objectives.

Crucially, the pre-report call also established whether clients would consider investing in alternative investments. The report stated that 92% of Avacade clients would consider this! It is difficult to see how lay clients would reach such a conclusion unless alternative investments had been discussed with them and further that they had been presented in a favourable light. The Paraiba bond literature stated an annual return of 11%,k which was probably a pretty favourable light!

Of course, the report went to lengths to state that it did not comprise advice and was purely factual. But its place in the process and the content and context of the prior call and intended follow-up call clearly indicated otherwise.

“Your account manager will illustrate how the above figures apply to your own pension fund and retirement objectives on your call.”

In the event, the detailed scripts of these calls were considered by the Court and contributed to the conclusion that Avacade’s actions had indeed amounted to advising and/or arranging investments without the necessary authorisation.

Lessons

Looked at from any perspective, this is a sad affair and there are lessons for anyone who cares to see them. Exploring those lessons in detail could take another whole article but a few key high-level points are probably sufficient. We have taken three perspectives:

1. Regulated individuals and firms
   If a new source of clients ready and willing to invest seems too good to be true, it probably is. Providing quality financial advice that is in the client’s best interest is not easy. If it was, clients would not need advisers. Unfortunately, the skills and knowledge required to provide quality advice are not necessarily those that are required to fully appreciate the finer nuances of the financial regulations which are, by definition, often couched in difficult to understand legal language. Make sure any major change in your business model is considered carefully, preferably in conjunction with your compliance advisers.
2. Unregulated individuals and firms
   If the prospect of easy riches from peripheral involvement in the financial services world seems too good to be true, it probably is and could lead, as here, to serious consequences rather than a quick fortune. Individuals who think that getting involved in the financial services world is a worthwhile endeavour, should get the relevant qualifications, apply for authorisation and do it properly, with the interests of the client taking precedence over what seems like an easy way to make money. The good news is that, thanks to this case and other regulatory actions, the space for unregulated firms to operate is now very much more restricted than it was even a couple of years ago.
3. Clients
   It would be easy here to trot out another ‘If it looks to good to be true’ admonishment, but that would be an all too clever and inappropriate thing to do in light of the significant losses that the clients involved in this case have suffered. Although the FCA won its case for a restitution order against the defendants, it has subsequently cautioned that this is unlikely to be sufficient. In a letter to investors, the FCA said investors were only likely to receive a small fraction of the £11m in compensation which they were owed. The letter stated: “On present information about the scale of the losses and the value of the assets of the defendants, it is likely that there will be a considerable shortfall.
   It would also be inappropriate because while it might be argued by some that the clients should have been expected to act in accordance with the principle of ‘caveat emptor’ (buyer beware), we would argue that the clients should have been expected to be able to trust individuals and firms that purported to be ‘helping’ them with their financial affairs. Most investors consult financial advisers because they do not have sufficient knowledge of financial instruments to invest without advice. Therefore, by definition, the market is asymmetric – the sellers (advisers) have significantly more knowledge than the buyers (clients). That is the whole reason why financial regulations exist and clients should be able to trust those firms and individuals from whom they seek financial advice. This is enshrined in FCA Principle 9:“A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.”None of these clients’ losses would have occurred without the actions of unregulated introducers. But none of the clients would have suffered loss had regulated firms not facilitated the process.

PS – Stable door

Blog posts to trade press articles often include criticism of the FCA for being reactive and that its actions are too little, too late. This is probably unfair in many cases. Through ATEB’s involvement, we are aware that the FCA first started to look closely at the defendants as early as 2011 but it took several years of gathering evidence from a variety of apparently unconnected investigations before it was considered that a case likely to succeed could be made. It then took over two years for the case to find a slot in the legal system.

Robbing a bank is a criminal offence but we do not criticise the police for only arresting the perpetrators AFTER the event. By definition, legal action can only follow the commission of a criminal offence, not precede it and even then, only after evidence sufficiently robust to support legal action has been painstakingly gathered. As can be seen in this case, that alone is a time and resource heavy process.

So, such criticism or the regulator is often unfair and, in this case, ill-informed.  Suffice to say that there is probably more regulatory work being done behind the scenes than sometimes appears on the surface.