There is a big issue in the financial planning sector. That problem is phoenixing.
This involves businesses and individuals deliberately seeking to avoid their liabilities to consumers or hide their poor conduct by closing down firms or resigning senior positions only to re-emerge in a different legal entity.
In April 2019, the Financial Conduct Authority (FCA) set up a task force to establish a coordinated approach with the Financial Ombudsman Service, the Insolvency Service and the Financial Services Compensation Scheme (FSCS).
On the back of an FCA update on phoenixing, International Adviser spoke to a handful of firms to discuss how big of an issue it is in the financial advice industry.
Problem
The practice can have a devastating impact on individual consumers and a knock-on effect on the wider economy.
Jane Hodges, managing director at Money Honey Financial Planning, said it “ruins” the reputation of advisers, while Martin Bamford, director of client education at Informed Choice, said that “phoenixing is a scourge on the financial planning sector”.
Keith Richards, chief executive of the Personal Finance Society, said: “The most controversial use of the levy is, of course, the reckless deliberate ‘phoenixing’ conducted by a minority intent on maximising commercial opportunity, despite knowing that they could place their firm into administration when things go wrong, leaving others to pick up the consequences, and the costs.”
Why does it hurt honest firms?
Phoenixing puts up levies and regulatory costs for legitimate firms and puts a lot of those out of business, while some “earn extortionate amounts from unethical practices and then carry on ‘business as usual’”, said Alex Norwood, director of N2 Asset Management.
N2 AM is a newly established firm, so Norwood has had to deal with compliance requirements and incurred additional costs in setting up shop.
He said firms that “genuinely want to enter the market” are left with a combination of:
- Limited professional indemnity (PI) insurance options – as PI insurers fear issues such as defined benefit (DB) claims; and
- Higher costs which they either “bear or put up fees for clients”.
“In the end it puts unnecessary pressures on firms doing the right thing by their clients, yet they are the ones who are punished”, Norwood added.
Anthony Morrow, chief executive of OpenMoney, said it’s “potentially very harmful to consumers” if firms are closing down and new ones are opened to “escape their responsibilities over unsuitable advice they know they’ve given in the past”.
This is because consumers “either have no redress over the bad advice or have to turn to the FSCS for compensation, which in turn places a greater burden on the good advice firms out there through the increasing levies they pay”.
“As we’ve seen with financial scandals in the past, the dealings of a few dodgy firms can totally undermine consumers’ trust in advisers, making them less likely to turn to us for help when they need it.”
FCA crackdown
The watchdog has been slow to act, but finally it might be starting to get somewhere.
FSCS said in January 2020 that 136 potential cases of phoenixing had been referred to the FCA since April 2019.
The FCA said on 20 December 2019 that, over a 12-month period, it had prevented phoenixing via two notices that were issued, warning firms that their applications would be refused because of concerns.
In five other cases, one financial adviser and four financial advice firms withdrew their applications once the FCA raised phoenixing concerns with them.
PFS’ Richards said: “It’s good to see the FCA and FSCS combine forces to tackle this issue, but I believe the opportunity to fix it has long passed.”
Morrow added: “It’s quite difficult because the barriers for taking enforcement action, and preventing someone from carrying out their trade, are rightly high for the FCA.
“It’s easy to think that the FCA would act quicker and take action sooner but there are ‘checks and balances’ in place for a reason and it wouldn’t necessarily be a good thing to have an overreaching regulator acting outside due process.”
Slipping through the cracks
If the FCA has checks and balances, surely phoenixing should be easily spotted.
So, how do firms keep getting away with it?
“There are too many legal loopholes to get through and it is difficult without banning those individuals from any form of regulated position in the industry; either indefinitely or for a set period of time,” said N2 AM’s Norwood.
Morrow added: “Shutting down an old firm and opening another in a new name isn’t illegal, which makes it harder for action to be taken unless the FCA can prove that the firm is trying to escape their liabilities.”
Another issue is that, despite the rightly-so negative rhetoric, phoenixing can be used in a genuine and legitimate way.
“Not all phoenixing is deliberate or ill intended,” Richards added. “There have been genuine instances where firms have been unexpectantly impacted, in some instances by a lack of professional indemnity insurance through unspoiled exclusions of high excesses, or other genuine financial reasons.”
This can also be when a consolidator buys a business from a retiring IFA.
Bamford said, in that situation, “one simple solution would be for the FCA to insist that firms sell both liabilities and assets to consolidators, instead of dumping liabilities before moving assets and goodwill across to the new business”.
Future
In a bid to sort the good from the bad, the FCA needs to up its game, even more than the watchdog is already doing.
So, what does the industry want from the regulator?
“I think greater use of product data and for that to drive greater supervisory work by FCA,” said Morrow. “Ultimately, there are only so many people at the FCA looking after a pretty vast market in terms of the actual number of firms.
“More supervisors and data analysts will need to be paid for and that would probably come from FCA costs.”
Craig Stokes, head of advice at Pension Advice Specialists, said that there needs to be “far greater analysis and interrogation of advisers setting up new firms when they have existing licences in place”.
“We need to look at why firms fail and what’s driving that, what products are sold and the whole chain of fee income relating to products and advice.”
Informed Choice’s Bamford added: “Where senior people leave liabilities behind in liquidated firms, the FCA should take tougher measures to ensure they are not permitted to repeat their past behaviour.
“Obtaining authorisation from the FCA is rightly a testing process. Where a regulated individual leaves one firm behind and attempts to open another, the FCA should double down in their scrutiny, to ensure everything is above board.”
