RegulationOct 23 2018

Ashes to ashes: How to stop phoenixing

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Ashes to ashes: How to stop phoenixing

Entrepreneurs often fail. Lord Sugar, Sir Richard Branson and Henry Ford all suffered serious blows in the early days before going on to become famous names in their own right.

So, too, in financial services, a firm may go under due to lack of profits or inexperienced directors, and a few years later those directors may set up shop again, with more experience, better processes and a clear business model.

There are, of course, rules around how to do this, which have been laid out by the Insolvency Service (see Box 1). 

But there is another form of rising from the ashes that is quite different to that of a legitimate entrepreneurial story: the phoenixing adviser.

Such firms and individuals have been known to deliberately fold one company to avoid creditors, complaints and liabilities, only to set up shop again doing the same work under a similar name, and sometimes operating out of the same address.

Yet it is not illegal to do so. Derek Bradley, founder of online forum Panacea Adviser, notes that company law permits any limited liability company to close down when in hardship, only to forge a new firm with an almost identical name doing exactly the same thing.

Mr Bradley says: “[The issue is] they often keep the clients, but fail in many cases to look after clients from their previous entity who may have a complaint requiring resolution. So the question here should be in relation to the law. Should any directors of businesses that fail and leave customers in a bad place be allowed to trade again, ever?”

What’s the harm?

There are other issues that also warrant closer investigation. Aside from ensuring that all relevant debts and obligations are paid, the FCA has three main concerns when it comes to advisers causing consumer or peer detriment and then seeking rebirth under a new guise. These are:

  • Poor advice that causes consumers to invest in unsuitable high-risk products that lead to financial loss.
  • Financial advice firms’ non-payment of redress awarded by the Financial Ombudsman Service, which might also include the need for consumers to make a claim to the Financial Services Compensation Scheme.
  • Financial firms or individual advisers re-entering the financial advice sector having previously avoided liabilities to consumers.

A spokeswoman for the FCA says: “It is unacceptable for regulated firms and individuals to seek to avoid liabilities to consumers that have arisen as a result of the poor advice they have given. We have a broad programme of work under way to tackle the harm it causes to consumers.” 

What is being done?

To that end, the FCA and the Insolvency Service signed an agreement in May this year that aims to curtail the number of phoenixing companies in the UK.

The deal is not intended to prevent entrepreneurs from starting again after a business failure – otherwise the principles of a free market would be severely undermined – but rather to spot those company directors who deliberately close up and then start up again to the disadvantage of consumers.

Following this agreement, the FCA has said it is using “big data” analytics to spot when a firm might be a phoenix, enabling it to take action before any further consumer detriment is caused.

It is also cracking down earlier on firms that do not pay their levies on time, strengthening the regulator’s authorisations gateway and supervision for firms that provide advice on high-risk and complex investments, and – most notably as far as the question of phoenixing is concerned – making it harder for re-entry into the advice sector.

The FCA has arguably been asleep at the wheel regarding phoenixing. Keith Richards

The FCA has already introduced additional checks to improve its ability to intercept authorisation applications from advice firms or individual advisers who may have avoided liabilities to consumers previously, or are likely to have liabilities in the future.

But the big challenge is that there is often a time lag between the advice given and the harm crystallising on long-term investment products such as pensions, which makes it hard to spot where there is clear consumer detriment.

Additionally, because most complaints are recorded against a firm and not specific advisers, individual directors can potentially set up again under a different corporate structure to avoid culpability.

While sole traders or those in limited liability partnerships can be pursued individually, if they set up as a new limited company it can be harder for a claims management firm or individual to pursue a phoenixed director.

The FCA has therefore pledged to work on identifying individual advisers attached to a complaint, and making them accountable for the consequences of their poor advice through harsher enforcement action.

Different agents

Other bodies have recently announced their own measures aimed at eliminating malpractice. Jat Bains, finance partner for law firm Macfarlanes, points to a consultation response paper from the Department for Business, Energy and Industrial Strategy, published in August.

The BEIS intends to introduce rules giving the Insolvency Service wider powers to investigate the actions of directors of dissolved companies.

Mr Bains says: “This is a positive development as it will help to close a perceived loophole where a company is dissolved following administration, as well as situations where a company is dissolved absent a formal insolvency process.”

However, he believes the challenge here will be to ensure the Insolvency Service is properly funded to give teeth to those powers. 

He adds: “It remains unclear whether that will happen. For example, I understand only 5 per cent of directors subject to a D-report [a form used by insolvency practitioners when completing their statutory returns and reports on directors’ conduct] by a liquidator in relation to their conduct are subject to prosecution for disqualification as a director.”

Separately, in April HMRC issued a consultation on widening its powers so that those responsible for tax avoidance or evasion via a phoenix could be made liable for unpaid tax.

“It is unclear who the persons responsible would be, but it is conceivable that this will extend to a new company set-up as part of the phoenix transaction,” Mr Bains says. 

But he cautions: “This could give HMRC a significant advantage over other unpaid creditors, contrary to the intent behind the abolition of the crown preference under the Enterprise Act 2002, and have unintended consequences for ‘good’ phoenixes.”

Robin Ellison, partner at city law firm Pinsent Masons, says: “Phoenixing is a pain, but controls by the FCA are not that hard to achieve, given that individuals have to show they are fit and proper.”

Yet he agrees it is not so much the fact a company has gone bust, but how it has gone bust. So how easy is it to determine who is fit and proper, and who isn’t?

That again comes back to how to sift the ‘good’ phoenixers from the ‘bad’ – before consumer detriment is caused in the first place – without eroding free market principles.

Not enough

As a result, the latest steps are not enough for some in the industry. They note that bad phoenixers not only leave a trail of devastation for customers, but also for other advisers who have to foot the bill in terms of the FSCS levy and potentially higher professional indemnity insurance premiums.

Keith Richards, chief executive of the Personal Finance Society, says: “The FCA has arguably been asleep at the wheel regarding phoenixing. It has perhaps been complacent in the knowledge the sector will bear the cost of consumer protection regardless of the impact on firms and ultimately the wider advised consumer population, which absolutely needs to be addressed.”

As a result, some industry practitioners have called for outright bans on directors caught phoenixing to avoid liabilities or circumvent legislation.

“The severe cases should get banned as approved persons and so find phoenixing more difficult,” says Olly Laughton-Scott, partner at Imas Corporate Finance. “That said, only 283 people have been banned of more than 440,000 people who have been approved.”

What is unacceptable is the slowness of the FCA in responding to clear and obvious frauds, as in pensions liberation exercises. Robin Ellison 

It is clear many rogue companies still operate under the radar. The FCA has made some strides to bring these charlatans out into the open, through its Scam Smart campaign and its new-look search function on the FCA register of advisers, but this comes with its own complications.

By including rogues and scammers in the ‘find an adviser’ search facility on the FCA register, advisers and commentators have warned this could lead to further confusion by mixing the good with the bad, rather than achieve the intended transparency.

The regulator is also sometimes too slow to act, Mr Ellison says. “What is unacceptable is the slowness of the FCA in responding to clear and obvious frauds, as in pensions liberation exercises. It tries to clear up after the event, but it is too late by then.”

What more can be done?

The watchdog has pledged that, where appropriate, it will use its full range of powers to remove wrongdoers for good. Its initial work in this field already suggests a much tougher environment.

Yet even this has its caveats, as Mr Richards points out: “The FCA has committed to focus on deliberate phoenixing, which is long overdue, but it must apply balance to avoid the unintended consequences of stopping innocent and genuine individuals from pursuing a career, or earning a living through what can more often be a genuine business failure, and not forgetting that clients are impacted also when genuine failure occurs.”

He would like to see the regulator introduce positive measures that would prevent otherwise decent advisers from phoenixing because of high PI premiums or the fear of some unknown future complaint. 

Earlier this year, the PFS proposed a savings and investment monetary protection and education levy, collected centrally by government, paid by the financial advice industry itself.

This would reduce the over-reliance on expensive PI cover, provide a cash buffer in the event of a company’s failure, and act as reassurance to whoever might otherwise be tempted to ‘phoenix’ away from pension transfer advice as a last measure of self-preservation, due to there being no time limit on the liability for financial advice.

Mr Bradley would also like to see product regulation that would prevent rogue companies from recommending the sort of products whose attached liability such directors seek to phoenix away from. 

He explains: “Any failure is usually linked to a product used as part of the advice process. Licensing a product as fit for purpose, with that purpose clearly defined and acknowledged by the client as part of the regulatory process, is surely the best way of achieving this. I’d even go one step further to say it’s the single most effective consumer benefit a regulator could put in place.”

Whether the initiatives suggested and being implemented by the likes of the FCA, HMRC, the Insolvency Service and the BEIS will have the desired effect of pouring cold water on the ashes of suspicious phoenixers is yet to be seen.

One thing is clear: the industry has its own ideas as to what might work, and it is only right that regulatory bodies work with them to prevent rogues rising from the embers and leaving their fellow advisers, and their old clients, to get burned.

Simoney Kyriakou is deputy editor of Financial Adviser