3. Read the case below.

In 2001 an FSA (now called FCA) regulated firm called Key data started trading. A few years later it started selling policies/products offered by two unregulated special purpose vehicles (SPV) companies in Luxembourg, one called SLS and the other called Lifemark. The productThe investment product was called a secure income bond. These were high-income paying investment bonds, some of the bonds promised a high 7.5% return with low risk. The money was put into USA investments known as "life settlements" or death" bonds. the product attracted nearly 30,000 UK public investors mostly close to or in retirement. The buying and selling of second-hand life insurance policies does not exist in the UK, so is unregulated business, but is known in the USA as the "life settlements" market. These investments were based on packages of second-hand life insurance policies bought from elderly citizens in the USA. The idea is that the policies will generate a stream of income as the people originally insured under them die, and the insurance companies then pay up. The second-hand US life insurance policies were purchased and owned by the companies SLS and Life mark in Luxembourg.

Unregulated collective investment schemes Unregulated collective investment schemes (UCIS) can be based outside the UK and dedicate money to a range of different enterprises, including less common investment products and activities like film production, forest plantations and foreign property.These schemes cant be promoted to the general public in the UK, but can be proposed to some limited types of investor, including: certified high net worth investorssophisticated investorsself-certified sophisticated investorsexisting investors in UCIS Key data was regulated by the FCA but it passed investors capital to two unregulated firms in Luxemburg. In 2009The Financial Services Authority (now the FCA), which regulated Key data, applied for Key data to be put into administration because it had failed to list its investments on an Inland Revenue recognised stock exchange triggering a tax liability that it could not pay. Key data had informed financial advisers that the products it had been selling qualified for important UK ISA wrap status and therefore income and capital gains would be tax-free. Key data was initially put into administration by the FSA after it emerged that it owed a tax bill it could not pay. Key data profits had fallen to 1,414 in 2008 from 988,000 in 2007.At first the problem with Key data seemed to be that it could not pay a tax bill to HM Revenue & Customs (HMRC). But then administrators discovered a hole in its books.Safety of productThe view of the FCA is that life settlement products are toxic and high risk. A second-hand life insurance policy has no defined redemption date, which makes it risky. The income is not secure because it first requires death of the policy holder who at the time is still a survivor. So long as the policy holder survives there is no payout. Meanwhile, the product needs to pay an income to investors and therefore this drains cash that was intended to invest in more life insurance policies. The income bonds were tranche based, so the first investors would redeem before the subsequent investors the risk to the first investors was much lower first investors in are paid first, last investors in are paid last. The later you invested, the less capital invested and the lower the return there was to pay the promised income on the bond.The company was using its funds (capital) to meet the coupons and investor redemptions, but you would expect to see the payments to be made from the underlying investments. Income and redemptions had been paid in an irregular fashion out of the companys own funds, rather than from the underlying investments. The problem here is that if the fund runs out of cash, and does not keep up the regular premiums of about $4m to $5m a month on the life policies it owns, then those policies will lapse and their value will evaporate. Hence the FCA toxic viewpoint.

The opposite perspective is that the idea of investing in death bonds is entirely sound. There are firm guarantees associated with these life insurance policies and they have never failed to pay out when someone has died. In principle, if well managed, they are guaranteed to pay out -lots of other funds of this type are paying well. It must be that the business was managed very badly.According to some of Key data's policy documents, about 30% of the cash handed over by investors was supposed to be put aside.Administrator called inIn 2009 Key data was put into administration under the control of the accountancy firm Price waterhouse Coopers (PwC). There followed a series of revelations about how customers' money was managed. Key data, was a regulated firm and provided the product to end investors but passed the customer money to SLS in an unregulated environment, Luxembourg. SLS in Luxembourg had come under the control of a fugitive and bankrupt called David Elias, who appears to have died in 2009 in Malaysia (but there is no physical evidence of this death). 103m entrusted to Elias on behalf of 5,500 Key data investors had disappeared. The underlying life assurance policies were sold in 2008, the money was realised by Elias and was gone.Turning to Life mark, with SLS now declared insolvent and being liquidated, the other firm Life mark was put in provisional administration in Luxembourg. The 350m invested by the 23,000 Key data customers in Life mark was initially thought to be safe. But PwC reported that the underlying assets could no longer sustain the promised monthly repayments to the investors and their income stopped. PwC cast some doubt on whether the investors might even get their initial investments back. PwC said "It is clear that the assets are there but it is also clear they are not maturing as quickly as intended and therefore Life mark has severe cash-flow problems". Life mark, developed liquidity problems. In part this was because regular premiums need to continue to be paid on the products until death of the named individual, when a payout is received from the insurer to the SPV.An astonishingly high level of commissions were found. Life mark had paid 59m of its investors money in commission to other firms. 59m/350m assets = 17% of capital lost through commissions. Of that, 20m went up front to Key data for promoting and selling the death bonds. That was structured as 3% commission to be passed on to independent financial advisers who sold the Key data policies to their clients, while 2.5% commission was kept by Life mark itself. A further 39m was paid to a company registered in the British Virgin Islands called LAS Global. LAS Global was a company set up by the CEO of Key data as a mechanism to collect fees. Its fees were for negotiating investment and administration contracts, to provide opportunities to sell the bonds, and to give advice on selling them. A further 50m of investors money was scheduled to be paid out from the investors' funds as repeat commission between 2006 and 2019.

These fees were never indicated anywhere in the literature presented to investors or intermediaries. In taking this level of commission out, the investors stood little chance of getting their original capital back, together with their targeted income.By 2016 the fees and commissions taken out of the fund was 72.4m.The view from one of the sellers of Key data productsThe Key data affair embarrassed one of the UK's biggest building societies, the Norwich & Peterborough. From 2005 onwards its financial advisors in its branches sold Key data polices to some 3,500 of its customers. The society has denied any liability for its customers' losses but has expressed great sympathy.It offered to make an interest free loan to 1,900 of them, amounting to 2m, to tide them over. "We are owned by our customers and some of them are clearly in a very difficult position as they need the income to meet their monthly outgoings," said Matthew Bullock, the N&P's chief executive. The N&P believed the product was a suitable investment for elderly people seeking a safe home for their pension nest eggs. They offered a high level of income which his customers wanted. "There is nothing wrong with the product; it is an unusual asset class, not related to the financial markets," said Matthew Bullock. "It was an attractive product and we carried out exhaustive due diligence. [The problem] is not to do with the product but the management.Compensation and redressThe Financial Services Compensation Scheme (FSCS)declared Key data in default, and indicated that 21,000 investors would be able to seek financial redress. During the past year (2015), the FSCS has paid out more than 300m in compensation. Norwich and Peterborough building society has been fined 1.4m for giving unsuitable advice on Key data products.So far only limited compensation has been made available to Life mark and SLS investors with large amounts invested above the compensation limit of the FSCS.4,400 customers have had their Isa-related income tax bills paid by the FSCS.The FSCS pursued 820 financial advisers, with 11 advice firms facing claims of >1m. Chase de Vere was the largest at 8.6m. Altogether the FSCS recovered 100m in Key data compensation from firms. FSCS incurs costs of 15.8m in proceeding to obtain settlement from firms. Through to 2016, the FCA had spent 875,000 fighting the Key data battle to fine the CEO and key directors.The FOS managed to recover further money from advice firms that had refused to pay compensation to theFSCS. Most firms paid-up rather than go to the FOS because of the public nature of the media stories coming from FOS investigations.

FCA Decision NoticeIn May 2015 the FCA published Decision Notices against three former senior managers of Key data Investment Services. The Decision Notices set out the FCA's decision to:-Fine former CEO Stewart Ford 75 million;-Fine former sales director Mark Owen 4 million;-Fine former compliance officer Peter Johnson 200,000;-Impose prohibition orders on all three individuals against performing any role in regulated financial services, all three having been found to have breached Principle 1 (integrity).The Decision Notice against Mr Johnson provides a view from the FCA on how far an individual in a complaince role could be expected to go in challenging others more senior than him. The FCA found as follows: The steps that Mr Johnson could have taken to ensure that the Key data board of directors committed Key data to taking these actions include: (i) refusing to sign off the financial promotions for the Life mark Products, and/or (ii) making it clear that, if the Key data board of directors did not commit Key data to taking these actions, he would have no alternative but to resign from his position and/or notify the Authority of the issues.The FCA found that the three individuals had failed to exercise sufficient due diligence before selling the products, issued misleading brochures, falsely marketed the products as being eligible for ISA investment and had misled the FCA as to the financial state of the products. Most damningly, however, the FCA found that Mr Ford had used a complex web of off-shore trusts and companies to siphon off some 72.4 million in fees and commissions from the products, with the result that the products were much less likely to provide successful returns to consumers.The 75m fine for Mr Ford is the largest ever fine for an individual decided on by the FCA. All three men have referred the matter to the Upper Tribunal.The fine imposed on Mr Ford was huge some twenty times the previous record for an individual. The vast majority of the fine was related to the 72.4 million found to have been earned from the sale of the products by Mr Ford.

In light of the case above discuss the following questions.

a)Is a portfolio of second-hand life insurance policies a suitable investment for elderly people seeking to generate a safe income home from their pension saving?(10marks)

b)How effective has the financial recovery process been? Should investors and financial advisers be left to share the risk? Are they jointly responsible?(20marks)

c)How would you design a better supervisory system to stop a scandal like Key data?(10marks)

(Total 40 marks)