Although the Financial Conduct Authority's recent censure of Catalyst Investment Group Limited seems to be an open-and-shut case of mis-selling, there is more to the final notice than meets the eye, perhaps because of bad drafting.

Although the Financial
Conduct Authority's recent censure of Catalyst Investment Group
Limited seems to be an open-and-shut case of mis-selling, there is
more to the final notice than meets the eye, perhaps because of bad
drafting. Catalyst's case, which it made to the FCA, was that it was
driven out of business solely by regulatory action. The FCA's
argument against this seems tenuous in places where it ought not to
be.

The FCA's reasons for
censuring the British company are twofold: the first is to set the
scene for a full-scale banning and fining of the principals, namely
Timothy Roberts, the chief executive, and Andrew Wilkins, a former
director; the second is because Catalyst's monetary problems preclude
it from imposing a fine. Catalyst, according to para 4.26 of the
final notice, is in deep financial trouble: “The position of
investors in unclear: the pending investors...risk losing some or all
of their investment, pending a decision on legal ownership of the
funds. None of the investors is currently receiving interest.”

Bonds in Luxembourg,
investors in the UK

Catalyst was the
primary UK distributor of the ARM Capital Growth Bond – issued by
ARM, a securitisation company, in Luxembourg – and the ARM Assured
Income Plan. The bonds were listed on the Irish Stock Exchange until
November 2010. These products are a form of ‘traded life policy
investment’ based on life insurance policies purchased in the
United States. Securitisation firms typically purchase these policies
from policyholders for a lump sum and take on the burden of paying
them their regular premium. When an original policy holder dies, the
firm receives the insurance payment.

All was going well at
ARM until its internal compliance department 'formed a legal opinion'
on 19 November 2007 that it had been issuing bonds in a non-compliant
way. The FCA, at para 2.3, states this in the vaguest (and least
grammatical) way possible, commenting that ARM thought that it needed
a licence from the CSSF, Luxembourg's regulator, to continue to issue
its bonds “as inter alia it [whatever 'it' is] fell within the
CSSF's interpretation
of 'issuing on a continuous basis.' With these mysterious words
hanging in the air, the FCA mentions that Catalyst knew of this
opinion at the time ARM formed it and then turns to ARM's application
for a licence in July 2009.

The
FCA takes up the subject of 'continuous issuance' again at para 4.15.
Luxembourg law, it says, provides that securitisation undertakings
which issue securities to the public on a continuous basis must be
licensed by the Luxembourg financial regulator, the CSSF. Another
piece of the jigsaw pops out at para 4.16 with ARM's opinion, formed
on 19 November 2007, that it thought it needed a licence because it
because it issued bonds more than three times a year – one wonders,
but one is never told, whether this might have made it an 'issuer on
a continuous basis' – and that this might make it a 'securitisation
undertaking' in the eyes of the CSSF, with the implication that the
CSSF's opinion on this was important in some way.

In the footnotes there
are more tantalysing clues about the relationship between the CSSF
and the law. Here, in a message to the FCA, (Annex B 1.1d) Catalyst
states that, in its own eyes, “the position under Luxembourg law is
unresolved as to whether ARM actually required a licence – if so
this was only because the CSSF had changed the way it chose to
interpret the 2004 Securitisation Law.” This throws up more
questions than it answers. Why would anyone care what the CSSF
thinks? (According to the FCA, it is not even ARM's regulator – at
4.8 it states baldly: “ARM is not regulated.”) Does it regulate
securities firms at all, or does it merely grant them licences for
various things? What powers does the CSSF have to interpret statutes?
Is this not the job of a Luxembourg judge? Does the CSSF have any
powers over bond-issuers other than the power to distribute licences?
What are the Luxembourg courts' view of that doubtless important but
unexplained phrase, 'issuing on a continuous basis'? The document
does not bother to answer even one of these questions.

Openness about the
regulatory situation

The FCA states that
every firm in Catalyst's position is obliged under APER principles 1
and 7 (conducting business with integrity and meeting the information
needs of clients) to point out anything that might be bad or
unfavourable to investors about the bond-issuer's regulatory
position. In this case the 'regulatory position' – a phrase it
repeats over and over – was
that
ARM did not have a licence from the CSSF, but considered that it
required one.
We can extrapolate from this that, in the FCA's eyes, if any firm in
the supply chain believes that regulatory trouble might affect
business, the firm that deals with the high-net-worth investors is
obliged to tell them that.

Dicing with death: the
Luxembourg licence application process

The FCA makes a
disconcerting observation about the CSSF licence-issuing process at
para 2.4: “One consequence of the refusal of a licence under
Luxembourg law is that the issuer of the bonds must be liquidated.”
In other words, any Luxembourg securities firm that wants to issue
bonds is taking its life in its hands
every time it asks the CSSF for permission to do so – a very
serious deterrent to business of this kind. CM
asked the CSSF to comment on this, but had received no reply 24 hours
later.

Catalyst
clearly transgressed against APER principle 1 (“a firm must conduct
its business with integrity”) by failing to point out the fact that
ARM thought that it was staring liquidation in the
face, something that ARM told it as soon as it had formed the opinion
itself on 19 November 2007. Much later, on 20 November 2009, Catalyst
knew that ARM would not issue any more bonds, at least until it had a
licence, but also said nothing. Because of this and its secrecy about
the aforementioned opinion it transgressed against principle 7
(paying due regard to the information needs of clients and passing
information to them in a clear, fair and not misleading way)
throughout the period of the censure.

Catalyst sent letters
to independent financial advisers in December 2009 and to investors
in March 2010. These were, indeed, misleading about ARM's
predicament. They intimated that the Luxembourg firm's application
for a licence was voluntary and steered clear of any mention of
liquidation.

The Irish escape-hatch that never opened

There were also plans
afoot from early 2010 for ARM to relocate to Ireland. Here it would
not need clearance from the regulator to operate, although regulatory
approval would have been necessary for the prospectus and other odds
and ends. A shell company was set up for this purpose but the
crossover from Luxembourg never happened. In the letter to investors
of March 2010 (para 4.31) Catalyst told investors that a move to
Ireland would be 'advantageous' if it could not be 'regulated in
Luxembourg.' The FCA thought that this was a disingenuous
understatement.

In
making its representation to the FCA, Catalyst wrote: “Catalyst
reasonably believed at all times that either the CSSF licence would
be granted or the re-domicile to Ireland would succeed, but believed
that knowledge of those difficulties could cause a run on the bonds
by consumers.” This may have been so – the FCA paper is unclear
about what happened to the Irish escape plan and never states that it
was not viable. It does not even state that ARM was right to believe
that it needed a licence from the Luxembourg regulator.

Causing
undue alarm to future victims

Catalyst's
proposition that its decision to keep information away from the
investors was legitimate, however, does seem far-fetched as
principles 1 and 7 make it obvious that investors must be put in full
possession of all the material facts. In another representation in
Annex B 1.5a, the FCA remembers that Catalyst made the rather rum
suggestion that a disclosure about the CSSF application was best
avoided because it might cause “undue alarm to...pending
investors,” a phrase that sounds remarkably close to an admission
of mis-selling.

It
also, however, refused to do so to avoid causing alarm to existing
investors and causing a run on the ARM bonds. Here it was on firmer
ground. The FCA itself states at Annex B 1.9b: “Catalyst was never
required by the Authority (and ARM was never required by the CSSF) to
write to investors regarding CSSF authorisation of ARM. This was
clearly because nothing positive would have been achieved by doing so
and there was a serious risk of precipitating a run on the bonds if
that explicit message had been given.” Nonetheless, it is a
different story when the FCA evaluates Catalyst's decision to keep
quiet to the investors at 1.10b by saying “...the Supervisory
Notice is not relevant to the case against Catalyst. Further, the
prospect of a run on the bonds would not have been a legitimate
reason to issue misleading promotions.”

Other
holes exist in the document. For one thing, at paragraph 2.10 the FCA
states that “any loss is currently unknown.” In other words, the
FCA has not tracked down even one loss. Despite the general soundness
of its conclusion, the tricky puzzles and blind
alleyways that the Catalyst censure document presents to the reader
are noticeable.

The
FCA's interpretation of recklessness

In
previous final notices the FCA and its predecessor-body have
struggled with the definition of 'recklessness', a word that often
justifies a fine. In the final notice the regulator often states that
Catalyst's continuing promotion of bonds throughout the long crisis
showed “a
reckless disregard for the interests of investors.” Its decision
whether a firm acts recklessly (Annex A 3.8) rests on “giving
consideration to factors such as whether the person has given no
apparent consideration to the consequences of the behaviour that
constitutes the breach.” Expressing itself differently, it states
at Annex B 1.6b: “Catalyst acted recklessly in closing its mind to
the risks to investors when sending the letter.” It imposes even
heavier penalties if it thinks that the behaviour it is punishing was
deliberate.

A
generous penalty...in principle

The
award of penalties, in view of Catalyst's inability to pay, are
largely academic. The FCA does, however, say that since most of the
conduct it is censuring occurred before the new and
more stringent penalty regime began operating on 5 March 2010, it
would only have charged Catalyst a fine of £450,000 in accordance
with the old regime. This might have repercussions for other persons
whose misdeeds straddle the two periods and who are able to pay.