Risk Of Fraud In Sending Money To P2P Lending Websites

Thanks to David and UK Bond Network for letting us pinch this educational article from their own blog. It was originally entitled “Pooled accounts and Ponzi schemes – the risk of client money”.

On the 20th December 2008, the sons of Bernard Lawrence Madoff contacted US authorities. Their father had told them that the asset management business of Madoff Securities was “one big lie”.

When any investor, individual or institutional, lodges funds with a given counterparty a key question is how well protected these funds are. Federal investigators suspect the firm’s wrongdoing had begun as far back as the 1970s. Prosecutors estimated the fraud to be $64.8 billion – larger than the entire market capitalisation of National Grid.

The importance of client money protections

Madoff’s scheme was able to continue for so long because the firm was misappropriating the funds of new investors to pay the returns of existing investors. The stories of investors who invested in Madoff Securities are harrowing.

There have been many scandals in financial services over the years. For investors, the ones of most note are those that have involved client money. It is because of this reason the FCA takes an extremely stringent approach to the use of client money by all firms involved in money management. Being regulated by the FCA does not in itself, however, necessarily translate to good practice in the protection of client assets.

An important issue for the FCA

In June of 2014, the FCA finalised changes to the client money and custody assets rules, and published a 400-page document outlining new provisions, particularly pertaining to the speed of return of client assets following insolvency, as well as reducing the market impact of insolvency.

David Lawton, Director of Markets, said of the changes “The protection of client assets is central to… consumers’ rights and the trust they place with firms. These changes will improve the protection offered to client assets and should speed up the recovery of client assets on a failure of a firm.”

The danger of pooled assets

Pooled assets present a danger from an investor’s perspective: they make it easier for funds to be misappropriated. This can take two forms – a firm taking funds from pooled client assets (a little from every client can translate to a lot) or, as was the case for Madoff Securities, the misappropriation of funds from one client to another.

Professional custodians provide specialist custody services to financial intermediaries. Generally, all investments are held in a separate nominee company, and although cash is deposited with Approved Banks in designated pooled accounts, importantly, all requests to transfer client cash and investments are subject to robust controls. For investors, this creates a second layer of protection against misappropriation.

The strengths of independent custodians

Madoff Securities, for one, acted as its own custodian. The strength of having an independent custodian is that even if the manager did want to misappropriate funds, they would almost certainly be unable to – the custodian would not credit any client funds to the intermediaries account without good explanation from the manager, and approval from the client.

UK Bond Network uses Jarvis Investment Management as its custodian, a subsidiary of Jarvis Securities Plc. As UK Bond Network operates via a ‘tripartite’ agreement, with the client having a direct relationship with Jarvis as well as UK Bond Network, Jarvis has a direct responsibility to the client to ensure the protection of their assets, which overrides our relationship with them. Whilst this relationship increases our overheads, we believe this is a crucial investment to give clients confidence in the security of the funds they invest with us.

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