The Duck that Laid the Golden Egg

Here in the States, we like to say, ‘If it walks like a duck, and talks like a duck… must be a duck!’ You Brits are sticklers for detail, so you’ll probably say there are members of the anatidae family that walk and talk much like ducks, but in fact belong to other species of bird. Who cares? They’re ducks, near as dammit.

We make this point because the brochure for a new investment scheme reached us this morning, and already it’s waddling about and quacking just like the Connaught fund that suckered investors out of about £70m. It’s called the TB Walker Crips Income From Short Term Lending Fund.

The proposition is similar: the fund will pay investors interest at 8.4 percent a year (which can be distributed or capitalised, according to preference), based on lending out the money at higher rates to residential bridging loan borrowers. There’s an Operator (called, in this case, the Authorised Corporate Director – a phrase that may resonate for anyone who lost money in the collapse of the Arch Cru funds), an Investment Manager (equivalent to Connaught’s asset manager) and not one but three Short Term Lenders (the equivalent of the Specialist Partner). The only addition is that the roles of Operator and Depositary have been split, largely because the ACD, T. Bailey Asset Management Limited, does not appear to have FCA permissions to hold client monies. Even so, I’m sure you pedantic limeys will admit that, while investors were never informed, a similar arrangement was in fact in place for part of the life of the Connaught fund, when a division of Capita continued to act as custodian for some months after the firm had run away from the Operator role, because the fall-guy replacement, Blue Gate Capital, did not initially hold the relevant permissions. Waddle, waddle!

Another intriguing similarity is revealed by the trade media coverage of the fund launch. Turns out that the new scheme is the brainchild of someone we all know: Connaught’s James Allen. Allen is not our favorite guy, not least because he continued promoting the fund as late as mid-2011, long after we believe he either knew or should have known that there were problems with it: (http://www.financialreporter.co.uk/spotlight/?ID=7062). Moreover, the Walker Crips fund shares something else with Connaught: key parties such as the ACD, Fund Manager and Short Term Lenders have balance sheets that are tiny in comparison with the £500m target fund size. Indeed, of the three Short Term Lenders, the parents of two have NAVs of less than £1m, while the third – Bridgebank Capital – was insolvent as at the last accounting date. Quack, quack!

The IM reveals some minor differences: interest will be paid monthly rather than quarterly (yay!), liquidity is quarterly rather than monthly (boo!), and the fund is described as medium to high risk, rather than low-risk, as was the case with Connaught (whatever!). But the document is, we think, almost as flawed and incomplete.

For a start, the risk warnings (page 13) omit the single biggest danger that faces investors in this fund, and that caused losses in the Connaught equivalent: fraud. Anyone thinking of investing in the Walker Crips scheme should consider whether sufficient protections are in place against the following:

• Monies being passed to or returned the Short-Term Lenders (STLs) but used to meet the running costs of that business, or its parent, or another company in the Group, or for property acquisition or development by one of those companies, the principals, or their relatives or associates;
• Monies being loaned for speculative property development, as opposed to residential bridging mortgages;
• Monies being loaned to companies, whether incorporated in the UK or in murky offshore jurisdictions, rather than individuals;
• Non-recourse loans being made to family members or other connected parties;
• The re-financing of existing, non-performing loans made by other subsidiaries of the STLs;
• The STLs retaining monies drawn down for approved loans where either the borrowers changed their minds or the STLs rejected their applications at the last minute so they could hold on to the advances;
• The STLs retaining monies returned by borrowers, leaving the charges in place on the properties so it looks as if the money is still outstanding;
• The STLs letting borrowers connected to themselves off interest or even capital repayments;
• Collusion between the STLs and borrowers, valuers, solicitors or contractors, intended to defraud the fund

All of the above could, in theory, happen without the knowledge and active involvement of the Fund Manager. But it would be very much easier to do, and would take a lot longer to spot, if the FM were in on the scam. We stress that there is, at this stage, no firm proof that James Allen, or indeed anyone else at Connaught, did anything illegal, and there is of course no suggestion that the three STLs appointed by the Walker Crips fund have any intention of doing a Tiuta, it seems to us there’s a lot of waddling and quacking going on.

We should point out that there’s one key difference between this fund and the Connaught one: the Walker Crips scheme is approved and regulated by the Financial Conduct Authority (FCA). In fact, it’s the first bridging loan fund to achieve this accolade: http://www.bridgingandcommercial.co.uk/mobile-article-desc.php?id=3248&title=first-fca-regulated-bridging-fund-to-launch#.UeP0yY2juuJ.

Potential investors may be tempted to entrust their money to this scheme because it enjoys the regulator’s stamp of approval. They should consider that every party involved with the Connaught fund, excepting Connaught itself, was also FCA registered. Tiuta was – and still is – registered, but that didn’t stop the principals from using investors’ monies for all kinds of things never envisaged in the IM, or from being insolvent. Capita Financial Managers (CFM) is registered, but that didn’t stop it from issuing a misleading IM, operating the scheme other than as described, then walking away without alerting investors (or, we strongly suspect, the FCA), when it realised the extent of the mess it had created. It remains so despite having left investors in the Arch Cru funds nursing huge losses because the division’s combined net assets and insurance cover totalled a fraction of the size needed to meet investor losses in that one scheme alone. We hear that investors are close to bringing a case against CFM, which if successful would render it insolvent. And yet it is still on the register, carrying out regulated business, with investors in the schemes it manages none the wiser about the risks to which they could be exposed. As are 13 other Capita subsidiaries, despite the fact that at least one member of the parent company’s board also knew about the problems with Connaught and participated in the cover-up. So, being FCA registered or approved is no guarantee. Waddle, waddle!

One of the most alarming features of the fall-out from the Connaught fund’s collapse is how reluctant the regulator appears to be to point the finger of blame at Capita for setting up and promoting a scheme that let the bad guys take our money, then running away and hiding for cover, rather than fessing up and trying to fix the problem, when it realized what it had done. We’ve seen mealy-mouthed correspondence to MPs talking about the asset class being ‘speculative’ and hence unsuitable to the vast majority of even qualifying investors and claiming that the regulator’s powers over Capita are ‘very limited’ in respect of an unregulated fund, despite there being no difference under the Financial Services and Markets Act 2000 (FSMA) in the responsibilities of registered firms or the regulator’s powers over them according to the regulatory stance of the funds they manage. So far, at least, FCA approval would seem to be no guarantee of redress if things go wrong. Quack, quack!

You Brits like to say it’s an ill wind that blows nobody any good. I guess you guys never saw the twisters we get in the Midwest, nor the tornados down our East coast. But you may be right. While we’re naturally concerned that the Walker Crips scheme shouldn’t turn into a repeat of the Connaught fiasco, the new fund’s approval strengthens investors’ hands. No longer can the FCA credibly argue that it specialized in a speculative asset class or that registered businesses are not liable for their errors due to the nature of the fund.

Best of all, looking at the risk warnings in the Walker Crips IM, it is abundantly clear that none of them was the cause of investors’ catastrophic losses in the Connaught equivalent. That leaves only the explanation we outlined earlier in this blog: widespread, systemic fraud. And once the FCA recognises this, which we think it soon will, we cannot believe that it will be able credibly to maintain its reluctance to make those who were and are registered, who stood by and watched, compensate the victims for the losses they sustained.

So we don’t yet know for certain whether the Walker Crips scheme will be another duck. But we hope it may just have laid a golden egg…