Where’s the Key Data?
Posted by robin in Financial Articles Thursday July 9, 2009 5:33 pm
There appears something of an ironic ring to the name Keydata these days…
The investment administrator was brought down by the FSA on June 8 and deemed insolvent. Some sloppy listing work meant some of its bonds were rendered non-compliant for the promised tax-exempt ISA status. The exceptional tax charge it triggered landed on the company’s plate.
Three weeks later in its update of 30 June PwC, the appointed administrator, revealed it was much worse than that. £103m in assets entrusted to Luxembourg-based SLS Capital SA had “been liquidated and may have been misappropriated”.
The case is now a fraud inquiry. The Serious Fraud Office (SFO) has been called in to what is shaping up be the largest UK investment fraud in 20 years.
PwC also revealed income payments due from SLS had dried up back in October 2008. KIS papered over this considerable crack by maintaining payments itself. Now we know what PwC meant when it spoke of ‘irregular’ payments.
Director’s innocent?
In a joint statement the three now ex-directors defended their integrity. Citywire reported on July 1:
‘The directors only became aware this week-end that the underlying assets of SLS appear to have been liquidated. As such it would now appear that, along with other distributors, Keydata has been the innocent victim of a fraud perpetrated by SLS and those connected with it.’
The fact that KIS sanctioned the afore-mentioned ‘irregular’ income payments in lieu of SLS for eight months prior, prompts some Roger Moore-style eyebrow-raising as to their plea of ‘innocence’. The FT reported on July 3 that “people close to the investigation” maintain the fund’s assets had been “missing for at least six months”.
And it turns out the SIB bonds were not the first ‘irregular’ income payment sanctioned by KIS. They had been stumping up on series of property-linked bonds when their partner in this venture, Hometrak SA, let them down. This dates back more than 16 months to February 2008 and a question mark hangs over the fund assets. PwC is seeking “confirmation as regards the status of the underlying assets” totalling some £2m.
Taken together it would appear KIS’s directors had been frantically fire fighting for some time and the tangle with HMRC finally burned the house down.
The combined drain of income payments from KIS may help explain why an ostensibly successful and growing business reported a profits slump from almost £1m in 2007 to £1,400 in 2008. KIS’s auditors, BDO Stoy Hayward presumably are fielding questions on that one.
The directors also added in their defence that they did not have any connection with the late-David Elias, a controversial businessman and “recently deceased fugitive from UK justice” in the words of the FT. He had been holed up in Singapore, controlled operations through Malaysian-based BWT Holdings from the offshore tax haven of Labuan and is reported to have controlled SLS Capital.
High income promise lures the punters…
KIS launched its first venture into structured bonds backed by US traded life insurance policies with a series of four bonds called, again now with no small tinge of irony: Secure Income Bonds.
Here, the basics of the Secure Income Bond (SIB) series:
Name Offer Closed Maturity
Secure Income Bond issue 1 Closed 16 Sept 2005 7 Oct 2010
Secure Income Bond issue 2 Closed 4 November 2005 25 Nov 2010
Secure Income Bond issue 3 Closed 23 Dec 2005 20 Jan 2011
Secure Income Bond issue 4 Closed 24 Feb 2006 17 Mar 2011
The SIB 1-4 series offered an identical deal. In a nutshell:
· A 5-year fixed term
· Income or growth options:
Income: 7.5% pa or 1.875% pq
Growth: 43.5% as bullet payment at the end of the term
· Funds invested in a mix of traded life policies (life settlements) and cash
· ISA/SIPP investment options
In an age of low interest rates, the high income was/is attractive. But despite its reassuring product name, neither capital nor income was ‘secure’.
SIB 4 was different
At this point it appears the 5,500-odd investors in SIB 1-3 may have lost their money. Those in SIB 4 have not.
How so?
This is where a trawl through the sales brochures makes for informative reading. By the time SIB 4 there were a number of subtle but distinct changes.
Crucially, in the light of subsequent events, SIB 4 switched from SLS to Lifemark SA as its Luxembourg bond securitisation agents. This may have been purely a commercial decision but may also suggest that as far back as the start of 2006, KIS and/or its Luxembourg Custodians, MeesPierson Intertrust had had their fill of SLS. According to the FT, MeesPierson appointed directors on SLS resigned the following year.
All SLS assets from Keydata together with assorted others such as Brunei -based Orion Life, Isle of Man fund Interalia Optimised Returns Fund plc and clients of UK-based IFA Marks Jacobson, are feared missing.
In contrast, Lifemark SA assets are reported safe. Of the £349m KIS invested via Lifemark SA, PwC report they have “received confirmation of the existence of the underlying assets supporting these products”. SIB 4 investors, it seems, can breathe easy.
Economical with the actualité
The unlucky SIB 1-3 investors with the presence of mind to have retained their sales brochures might be scratching their heads in wonderment, not to mention anger.
1. Who is SLS Capital SA?
In brochures 1-3 HSBC, KPMG and MeesPierson are trumpeted under a section titled “Strong Management” (the title was amended to “Parties Involved” in the SIB 4 brochure) along with their credit ratings. For most readers the names will be the most readily digestible as we enter into this complicated world of trustees, custodians, advisers, traded life policies and financial models.
In SIB 1-3 their functions are explained as:
KIS – promoter/administrator/ISA manager
MeesPierson – custodian/registrar and payment administrator
HSBC – trades and holds the life assurance contracts for the custodian
KPMG – provided the actuarial model, manage portfolio cash flow, monitor credit ratings of the life assurance companies issuing the contracts.
SLS Capital SA does not feature. Not to mention other bit part players who have since come to light such as US firm CRT Capital Investment Banking Group, which we learn advised SLS Capital.
And yet SLS apparently had the critical responsibility of making “bonds-based securitised life assurance payments”. Somehow too it may have been in a position to unlock fund assets and “misappropriate” more than £103m from KIS clients alone.
The finger of blame now points at MeesPierson Intertrust, a major provider of corporate and trust services and part of Belgian-based bank and credit crunch casualty, Fortis. As Custodians they had responsibility for holding SIB fund assets – life policies and cash.
The FT reported on 4 July staff had moved on and directors of SLS, supplied by MeesPierson, “resigned in April 2007”. And PwC’s own Luxembourg arm which had been auditing the SLS books says it quit in 2006. BDO quit in May 2009.
Did this staff turnover make it possible for to liquidate 200-odd supposedly illiquid assets (ie US life assurance policies) into a relatively niche market and abscond with the proceeds?
And what of the role of HSBC? As trustees, they were responsible for the ownership and trading of the life policies. Were these life assurance policies sold behind their backs?
The SIB 3 brochure states: “Once bought, HSBC own the contracts as Trustees for the Bond”.
So if they owned and traded these bonds, and if the portfolio was liquidated, how did they let it happen? Where does their responsibility begin and end?
KPMG’s name is used liberally in brochures SIB 1-3. They are the financial alchemists who put together the actuarial model that made the whole fund work. They also have a role in keeping an eye on credit ratings of the companies issuing the life assurance policies in the fund.
By the time the SIB 4 brochure comes out in January 2006, KPMG’s name has disappeared entirely and we read only of an “actuarial model”. HSBC’s name has gone too and becomes an anonymous “leading Investment Bank” only MeesPierson remains a named party.
2. Er, actually it’s an offshore investment…
It takes a very careful read of the entire brochure for clues that this is an offshore investment.
More than that it’s offshore on two levels as the fund assets are:
(i) Predominantly US life assurance policies
(ii) Held in Luxembourg
KIS itself was a licensed UK entity regulated by the FSA but was it made crystal clear to the average investor this was an offshore investment from the information given? Not to this writer.
The traded life policy business is an exclusively US-centric on account of the unique characteristics applying in that market. In SIB 1-3 there appears no explicit statement as to the origin of the life assurance policies.
SIB 1 makes oblique mention in the small print Foreign Exchange Risk section: “Insurance contracts in the portfolio are purchased in US $ and the ongoing premiums are paid in US $ until maturity”.
SIB 2 and 3 exclude that statement but advise under their Issuing Company Risk section: “There are 3,500 contract issuers in the US and Canada that can be included in the portfolio.”
In SIB 4 this changes. An explicit admission finally emerges and a “portfolio of insurance contracts” becomes a “portfolio of US and Canadian insurance contracts”. In addition, the line that life assurance contracts would be bought from the likes of “AIG, GE Life and Prudential” has been removed too.
The names of US life assurance companies instantly recognisable by UK investors is likely a short one and the reference of Prudential a tad disingenuous. They may be in the same line of business but the reference presumably applies to the US Prudential Financial Inc., an entirely separate organisation from the UK’s Prudential plc.
As mentioned earlier brochures refer to corporate protection policies known as “Key Man” insurance as being the kind of policies this fund will specialise in. This information seems to do little more than add further unsubstantiated jargon more likely to confuse than enlighten lay investors.
Does the brochure tell you your money will be housed in Luxembourg?
Not for me it doesn’t. Instead, the overall impression is one where, in print at least, the offshore – indeed global – nature of this investment has been systematically suppressed. If so, this is at least understandable from a commercial, if not ethical, perspective. A fair swathe of cautious investors is wary of investing offshore. Such fears, where held, look well founded in this case.
All told the impression given, at best, is one of being “economical with the actualité”. At worst, though I’m no legal mind, the word misrepresentation comes to mind.
New “asset class” not at fault
This suspected fraud exposes the twisted entrails of such complicated investments and bring into sharper focus the FSA’s initial concerns.
It launched its inquiry into KIS on fears of the “aggressive marketing” of these bonds to frequently unsophisticated investors. A fair few of whom, bought these bonds directly and without advice. As such, they likely acted on the strengths of the promotional literature alone.
It also brings the old Buffett aphorism to mind: Don’t invest in what you don’t understand…and we could add, even if you are desperate for more income than measly 300-year low interest rates will pay.
As to the promoters of traded life policies as an investment and new “asset class”, it is another unwelcome blot in their copy book. In their defence, it’s worth remembering this is “suspected” fraud and not an indictment that traded life policies don’t work as an investment. To date there is ample to suggest they can and do.
And as to the abused investors in SIB 1-3, they may have to seek redress from the Financial Services Compensation Scheme. Even this safety net may prove inadequate for larger investors as it is capped at £48,000 – 100% on the first £30,000 and 90% on the next £20,000.
If any unfortunate SIB investors who chances on reading this, I would make one suggestion. If you haven’t already, dig out all your information on this and ask yourself: were you really given the key data needed to understand what you were buying?
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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