Sipps: Regulation - Tackling the threat of fraud

There have been some high profile and widely publicised cases over the past 12-18 months involving self-invested pensions and rule-breaking. Sadly, there is a danger that these isolated cases may tarnish the industry estimated to be worth some £75bn with over 300,000 plans in force. The problems at two or three providers involving only a few clients and relatively small amounts of money should not lead to the misconception that fraud is a chronic issue.

So what has actually gone wrong, what are the consequences and what can be done to prevent fraud?

There are two potential areas where problems can arise: internal and external. Internal fraud is a threat to any business. A maverick employee with access to bank accounts or other sensitive processes could steal client funds. This appears to have happened in the recently publicised cases and so robust internal procedures are essential.

Let us consider the risk of external fraud. Sipps and Ssas are very popular because of the vast array of investment options available, including unregulated funds, private equity and loans. A Sipp or Ssas can pay pension scheme money to a fund manager, company or individual as an investment. If the recipient of these funds has given false information and then makes off with the loot there is very little the pension provider can do about it.

Take the following example: an unquoted company is formed. A Sipp then buys shares in that company, and then funds are channelled back to the member before the now insolvent company is wound-up. This is commonly known as "pension busting" and is taken very seriously by the authorities and pension providers alike.

The penalties for fraud are very severe. Where the pension provider acts as scheme administrator (a formal duty registered with HM Revenue & Customs) hefty financial and other penalties are likely. The FSA can also effectively shut a provider.

To counter internal fraud a clear and unavoidable segregation of duties is required. This mainly involves the handling of client bank accounts, but covers all areas of the company's operation. No one individual should be capable of transferring or removing funds or placing investments, with client money. Any requirement to transfer money must be broken down between different responsible individuals within the organisation so that the placing of the payment request, the setting-up of the payment, the checking and the authorising are all carried out separately. The FSA is particularly concerned about the way small providers handle client bank accounts, as they tend not to have sufficient resources to segregate these duties.

IFAs should inspect a provider’s segregation of duties policy as well as details of the professional indemnity insurance as part of their thorough due diligence on recommending a provider. They must be satisfied they are not exposing their clients to potential fraud.

To counter the threat of external fraud, the provider must be satisfied that any non-FSA regulated investments are genuine, before proceeding. In the case of private equity or loans, for instance, this means carrying out suitable due diligence and record keeping. IFAs and their clients will have peace of mind from a provider that operates robust due diligence.