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The real reason Keydata failed..?
Posted by robin in Financial Articles Monday June 29, 2009 2:00 pm
Satirical magazine and admirable scourge of the rich and powerful, Private Eye, invariably refers to the Financial Services Authority (FSA) derisively as the Fundamentally Supine Authority.
Post credit crunch, this perception may have passed its sell by date as the chastened UK regulator is reorganised and reinvigorated under the new leadership of Lord Turner.
The recent case of Keydata Investment Services Ltd gives cause to wonder. This regulated investment firm was forced into administration by the FSA on June 8, 2009.
A history of success
On the face of it this seems a highly successful business with a canny knack for giving consumers what they want. The 30-40 suitors vying to buy the business adds credence to this view.
So why didn’t the FSA like this business? And what went wrong?
Well, let’s start with a little history…
Keydata was started in 1997 by Stewart Ford to provide investment information to IFAs. The business really took off in 2001 when Keydata Investment Services (KIS) was established. This business for the most part created and administered structured products for retail investors. Between 75-80% was on behalf of third parties such as RBS, HSBC, Skandia, Blue Sky Asset Management and Morgan Stanley and the balance was their own products.
Structured products have been popular sellers with cautious retail investors as they offer both a return and capital security (up to a point) over a fixed term, typically 5-7 years. A backdrop of bank failures, economic upheaval, and interest rates at a three hundred year low, has prompted nervy investors to pile in. Even after many lost money following the Lehmans failure, where the investment bank acted as market counterparty for a range of structured products.
Such favourable conditions helped KIS increase turnover over 50% in the past two years to £15.7m. Staff numbers increased too to help administer it from 60 in 2006 to 95 in 2008. By the time PwC was appointed it boasted 85,000 investors and £3bn under management with the directors expressing “confidence” in the future outlook for the business.
In spite of this expansion the company had managed to pay off £2.9m long-term debt in the preceding two years. In October 2006 it paid £1.2m of a £1.85m debt to 3i Plc. The £650,000 balance was waived as an inducement to early repayment by the FTSE venture capital firm.
More recently it paid off a final £400,000 to leave the company debt free, not bad in the teeth of a severe recession and at a time when financial services businesses generally are suffering.
As at its latest accounts to 30 September, 2009, prepared by BDO Stoy Hayward, the company had £3.4m cash and current assets exceeded current liabilities by some margin.
FSA pounce on tax trouble
So how does a debt free company with cash in the bank get brought down?
Well, it turns out the FSA was conducting an ongoing investigation into the company and when it discovered it had a tax problem with HMRC, it stepped in.
What triggered their probe and how long it had been going on prior to their taking action is a mystery. It had managed to avoid the obvious banana skin of having used Lehmans as a market counterparty unlike competitors such as NDF and Arc, so was not tainted by its failure.
The tax problem was caused by KIS’s own in-house products. Some appeared to fall foul of the ISA rules reported the FT on June 9. They had not been properly listed on the Luxembourg stock exchange, a core requirement, so did not qualify as tax exempt. SLS Capital, was hired by KIS to arrange this for them. Who screwed up here is unclear but the ultimate HMRC bill lay at KIS’s door.
The total investment sum caught in the debacle has been estimated at £200m. Though Dan Schwarzmann of PwC, the appointed administrator, chose his words carefully when he told the FT Secure Income Bonds 1-3 did not qualify for ISA status, and other plans which “may be impacted” include the Defined Income Plans 1-8, and Secure Income Plan 1-12 and 14.
A Keydata source disputes the total putting it at about between £80-100m and maintains only “a couple of products weren’t listed”. In addition, the tax bill they say was a good deal less than £5m. The company had agreed a “simplified voiding”, whereby bonds are back-listed, and a tax take between £700,000-£2.5m had been agreed.
Given the strong financial position of the company, it would appear to have been able to meet this cost with room to spare. In addition, the directors had allegedly built up an external contingency fund with up to £6m available.
Not good enough said the FSA and it was declared “insolvent”.
“…a product development issue…”
If this doesn’t quite seem to add up, what else might have been the problem?
Well, a good number of KIS’s own structured products were invested in a relatively novel and not uncontroversial asset, a portfolio of American traded life policies aka life settlements. Is the FSA uneasy with these investments for structured products sold often to relatively unsophisticated investors? A comment from the CEO of one of Keydata’s client asset management companies, Blue Sky, in Money Marketing offers an insight:
‘Blue Sky chief executive Chris Taylor said: “This is not a structured products event. This is a product development issue about life settlements. Life settlements never were and aren’t a structured product even when they’re issued by a structured product provider.”’
If Mr Taylor is right, Catalyst Investment Group Ltd is likely to be reviewing their future structured product plans. They too have offered similar life settlement structured products with their Arm Assured Growth and Income Plans.
Suspect sales strategy
A further report on June 18 from Money Marketing disclosed the FSA has long been worried about structured products and that Keydata’s sales relationships with IFAs was ‘at arm’s length and not close enough’.
This was of particular concern in relation to outbound telephone sales practice on complex structured plans linked to traded life policies. The concern was whether customers would really understand what they were buying if they were not sitting down in front of someone.
KIS had evidently aware of this concern and made moves to address it by deploying regional sales staff last October.
“Fat Cat” greed..?
Another question mark surrounds the directors. Comments such as “loss of faith” and “lack of confidence” have surfaced. Although turnover had been going up profits had slumped from £2.4m in 2006 to £988,000 in 2007 and just £1,414 in 2008 and directors’ remuneration had skyrocketed. The three directors paid themselves £7.8m in the past two years, with the highest paid pocketing almost £2m. A Citywire report exploited the City fat cat image with the headline ‘Keydata director’s salary increased eight fold in three years’.
In their defence, it is worth remembering the business was growing, had paid off all its long-term debt, written down a dud £1m loan to Fundworks Ltd to nil and still had £3.4m in the bank. It had created a further 35 jobs in the past two years. Furthermore, the directors had built up this private business from nothing paying themselves much lower salaries in earlier years.
Some of the more recent and much higher remuneration is alleged to have gone into the contingency fund. Also, the running of the business appears to have been sound given a mere day after going into administration, PwC judged the business “fit and proper” to service its £3bn in assets. The assets themselves appear to be safe having been successfully ring-fenced against such an eventuality.
Not too shabby in the teeth of the worst downturn most can remember.
A further cause for eyebrow-raising may have been the fact that founder director and majority shareholder has become a Swiss resident. Stewart Ford owned 53.4% of Keydata UK Ltd, the holding company for KIS. Did the combination of rapidly inflated remuneration and tax haven residency raise hackles with the authorities?
Whether FTSE venture capitalists 3i saw these risks coming down the track we don’t know. They appear to have exited some time prior to its demise, having been repaid their money (albeit at a 35% discount) and hold no shares in the holding company, Keydata UK ltd, although they are listed on the register.
Would a discreet deal have been better?
FSA spokeswoman Abi Jones told FT Adviser on June 11: “We would not make the decision to put a regulated firm into administration if that was not to secure the best possible outcome for investors.”
Here’s hoping but it seems a lot of distress for the investors concerned.
Wouldn’t a sale on the quiet have been the best possible outcome? After all, this “insolvent” business has seen no shortage of suitors vying for its talents with the likes of Morgan Stanley expressing interest alongside smaller investment boutiques such as Premier Asset Management, Meteor Asset Management and Jubilee Financial Products. A deal is said to be imminent.
Why further disillusion investors attracted to what they believed to be “lowish risk” investments? A quiet sale engineered by the FSA could have ensured continuity and avoided further damaging public confidence in savings products, surely never at a lower point.
The real problem…
The FT’s Matthew Vincent suspects a new macho culture and reported the FSA “even use the language of The Sweeney”, a hard hitting ‘70s TV cop show, these days. The Feds nailed Al Capone on taxes and that’s what the FSA has done with Keydata, he concludes.
That may be what nailed them but the real reason for their demise looks like something else.
It looks like serious regulatory concern at a perceived mismatch: a mismatch of inadequately selling complex investment products, backed by exotic assets, to predominantly unsophisticated investors.
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