Surviving platform fraud or fiasco

Should you – do you – fully trust your platform to look after your investments?

Might they hire a budding Bernie Madoff who siphons off your assets to his own account?

Or maybe a Mr Bean, who loses track of them altogether?

Surely our world-leading regulatory oversight would prevent anything so catastrophic from happening?

And anyway, there’s always the FSCS to bail you out if anything does go wrong, right?

Well…maybe.

In the second of (what I’ve just decided will be) my investment survival series, let’s look at how platforms aim to keep your assets safe.

(In case you’ve already forgotten, part one wasSurviving system meltdowns and cyber attacks.)

Where are my assets?

Platforms typically hold client assets in omnibus nominee accounts.

That is to say, your fund, equity, and cash holdings are pooled together with everyone else’s.

The legal owner of your assets is normally a nominee company or custodian appointed by the platform.

You are the beneficial owner, entitled to enjoy the dividend payments and sales proceeds.

The number of shares you see displayed on your account is from your platform’s own records. In many cases, the fund managers, company registrars, or banks don’t know who you are and what you own.

Thus, your financial well-being is heavily dependent on the successful functioning of the platform and its custodian.

What are the safeguards?

The Client Asset (CASS) rules are quite rightly one of the most important parts of the FCA Handbook.

Investment firms must:

• Keep your assets separate from their own
• Maintain a good record of what you have
• Regularly check that it’s all still there

Every day, platforms get up-to-date statements from banks, fund managers, and security depositories. The platform then adds up all the client holdings of each asset and checks that they hold that many units (or shares or pounds) in their nominee account.

This is known as reconciliation.

If there’s any discrepancy, the platform must immediately put some of its own cash aside to cover any shortfall until the problem is resolved.

The nominee company is usually a separate legal entity from the platform. If the platform goes under, the legal owner of your assets should still be standing, and your assets should be out of reach of creditors of the platform.

The details of the appointed nominee will usually be given on the platform website, if you want to check.

The platform must appoint a senior person to be responsible for CASS compliance. This way the FCA knows who takes the rap if anything goes wrong.

Bulletproof, right?

In my experience, the platforms take CASS very seriously and have good people overseeing all this. I’ve never witnessed any behaviour that gives me any concerns.

And yet, and yet…

…the history of finance offers plenty of examples of astonishing levels of fraud and incompetence going undetected for extraordinarily long periods of time.

Ultimately, all the safeguards depend on key people being competent and honest. Whilst most of us try to think the best of people, there is a limit.

What could go wrong?

In 2020, the FCA fined Charles Schwab UK Ltd (CSUK) £9 million for failing to adequately protect client assets.

These failings included:

• Incorrect records of client assets
• Failure to reconcile client assets
• Poor organisational structure
• No resolution plan in case of insolvency

There were no client losses, but to a nervous investor, this still sounds quite damning.

I’m not sure whether to be comforted that the FCA is breathing down the neck of investment companies or worried that these problems arise in the first place.

The FCA’s summary stated:

Charles Schwab UK failed to put in place the necessary safeguards to ensure, if required, there could be an orderly return of client assets.

If a platform simply fails as a business, then you would expect segregated assets to be returned to clients in full without too much fuss.

If custody records are poor however, then the process of returning assets to clients will be harder and take longer.

But the real problems occur if that poor record keeping is covering up a genuine hole in client assets through incompetence or fraud.

What’s the worst that could happen?

In 2023, the FCA demanded that WealthTek, a wealth manager, cease operations after identifying an £80 million-plus shortfall in client assets and money.

The head of the company John Dance was later charged with allegedly diverting £64 million from client assets into his own accounts. The trial is now set for 2027.

It took over 18 months after the company went into administration for the first clients to see any of their money returned. Some had to wait more than a year longer than that.

According to the FCA, around 84% of clients got all their money back from the administrators.

Of the remaining 16%, some were covered by government compensation and some were not.

This is scary stuff.

On the plus side, Mr Dance did win the King George VI at Kempton in 2022 with one of the horses he bought with the allegedly stolen money.

Will the government bail me out?

The Financial Services Compensation Scheme (FSCS) can compensate you for up to £120,000 for the loss of cash held with a failed bank or building society, and up to £85,000 for the loss of assets held with a failed investment company.

In practice though, working out what you’ll be covered for is not always easy. If you want to know the details, there’s no better place to look than The Accumulator’s article referenced above.

But for now, his pithy summary is enough:

The FSCS investment protection scheme may come to your aid. But eligible claims have more strings attached than a puppet show.

In the case of WealthTek, the FSCS was clear that it would not cover all client losses:

The maximum amount payable to eligible WealthTek customers is £85,000 per client, inclusive of the cost contribution. We recognise that many clients may have lost more than £85,000 and will not have been fully compensated following the completion of this process.

Note the mention of costs. The costs of the administrator responsible for overseeing the wind up of the company were passed on to the clients.

For the 84% of WealthTek clients that got all their money back from the administrator, the FSCS covered their share of the administration costs.

But for the 16% who didn’t, the administration costs compounded their losses.

Should we worry?

WeakthTek was a relatively small wealth manager. It’s highly unlikely that any mainstream platform will fail. It’s even less likely that there would be any shortfall in client assets.

But it is not impossible.

If you’re still in the early stages of accumulating wealth, you probably shouldn’t worry too much. You have less at stake, and you should get everything back well before you need it.

But if you’re at the end of that journey and relying on your assets for income then the risks, however small, become more pertinent.

You won’t be able to make up any losses from earnings if you’ve stopped working. And even where there are no client losses, you can hardly get by without income for two years.

What can we do?

Most obviously, if you spread your assets across multiple investment platforms, then your losses will be lower if one fails and you will still be able to take income from elsewhere.

It would also be sensible to make sure that your chosen platforms are not owned by the same parent company. This would have implications for FSCS limits. Having all your eggs in one basket leaves you exposed to the risk of a failed company infecting others in the group.

For instance:

• Interactive Investors is owned by Aberdeen, which also owns a couple of adviser platforms.
• Lloyds Banking Group owns both the Scottish Widows platform (formerly iWeb) and Halifax/Lloyds Bank Share Dealing.

It might also be wise to stick with platforms owned by large banks or investment companies with deep pockets, risk averse operations, and a hard-earned reputation to protect. Size is no guarantee against failures, but large, well-capitalised firms might be better able to absorb losses and have stronger incentives to protect their reputation.

If a company is listed, so much the better as its accounts should be well scrutinised.

Lastly, you could keep a recent statement tucked away somewhere. The chances of all client records being permanently deleted are vanishingly small, but there might come a time when you’ll be thankful you have some evidence to show that the administrator has made a mistake.

And finally…

If you read my previous article, you may have spotted that the measures to protect yourself against cyber-attack are pretty much the same as those to protect against fraud.

But it’s good to think through all the risks to help decide how far you want to go to protect yourself.

Look out for part three of this survival series, which will address the breakdown of society. Spoiler: a PDF of your latest statement won’t help in that scenario.

Peaceful dreams!