The Financial Conduct Authority will commission an independent investigation into London Capital & Finance, including a review of the regulator's own supervision of the collapsed mini-bond provider.
The investigation is expected to consider whether the existing regulatory system adequately protects retail investors in mini-bonds from unacceptable levels of harm and the FCA's supervision of London Capital & Finance.
LCF entered into administration at the end of January putting the funds of more than 14,000 bondholders at risk.
Shortly before LCF's collapse the Financial Conduct Authority ordered the firm to stop marketing its fixed-rate investment bonds and Isa products and the provider had its assets frozen by the regulator.
The FCA alleged the Tunbridge Wells-based firm had signed clients up to fixed-rate Isas promising 8 per cent interest, with investors' capital then invested into mini-bonds used to issue loans to small businesses.
There were concerns the clients of the firm may not have fully understood the nature of the investment they were making due to unclear marketing material.
At present the administrators estimate bondholders would see as little as 20 per cent of their investments returned to them.
The decision to launch an independent investigation into issues raised by the failure of London Capital & Finance was made by the FCA board at a meeting on Thursday (March 28), at which it was suggested the regulator should ask the Treasury to use its powers to direct the FCA to commission this review.
FCA chairman Charles Randell wrote to John Glen MP, economic secretary to the Treasury, who agreed with the FCA board's decision.
The FCA said further information about the detailed terms of the review and identity of the independent reviewer will be published when available.
Last week the collapsed firm's administrators Smith & Williamson said they found "a number of highly suspicious transactions" among a small group of people at London Capital & Finance and would be pursuing a "small group of connected people" to recover funds and return them to investors.
They said the company did not hold any immediately realisable assets, other than cash at bank of about £3.6m, while the outstanding loans to investors amounted to £237m.
But they found several million pounds of bondholder money flowed through Cornish and Dominican property companies and ultimately into the hands of four individuals, two of whom have so far agreed to pay the money into an escrow account to be returned if the bondholders receive their money back from the assets of LCF.