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Risk & Analytics|Financial, Executive and Professional Risks (FINEX)
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By John Hosie | November 24, 2020

With this article we aim to help you identify potential fraudulent investment activity by sharing key characteristics these schemes often share.

By drawing from the outcomes of recent SRA enforcement actions, this article highlights the characteristics of dubious investment schemes and explains the role that law firms have sometimes played.

COVID-19 and criminal activity

The restrictions brought on by coronavirus (COVID-19) have heavily impacted on the economy. Investors who have seen the value of their investments fall may well be attracted to high return ‘get rich quick’ investment schemes.

In August 2020 the Solicitors Regulatory Authority (SRA) produced a report which highlighted dubious investment risks and issued warnings to law firms1.

Criminals have sought to take advantage of COVID-19 through the continuing use of phishing scams, but as the crisis develops, it is anticipated that the use of dubious investment schemes will also evolve.

It is not just new schemes to look out for though, as the current economic climate could expose previous schemes. An example of this is the failure of Bernie Madoff’s $65billion Ponzi scheme in the aftermath of the 2008 Financial Crisis. As investor confidence dissipates, investors typically start to ask for their money back, new investors become harder to find and Ponzi schemes start to unravel and become exposed for what they are.

In August 2020 the Solicitors Regulatory Authority (SRA) produced a report which highlighted dubious investment risks and issued warnings to law firms1.

Where do law firms fit in?

Often, the reputation of law firms is used by fraudsters to add a ‘veneer of credibility’ to the scheme2. The professional reputation and good standing of law firms is targeted to bring respectability and confidence to schemes that might otherwise be considered too good to be true.

Criminals will often exaggerate the involvement of law firms to provide assurances that the scheme is legitimate.

Criminals will often exaggerate the involvement of law firms to provide assurances that the scheme is legitimate. Historically we have seen that they will promise that the law firm’s Professional Indemnity Insurance and/or regulation by the SRA will provide security around the investment itself, which is typically not the case.

What are the types of scheme?

Schemes and tactics used by the fraudsters will evolve and develop over time, and so it is not possible to provide a comprehensive list. However, the SRA has recognised that they do typically share common characteristics across four categories3:

Buyer-led developments or refurbishments (eg. Off-plan)
Fractional developments (eg. Rooms, spaces or units within wider schemes)
Alternative investments (eg. Precious metals, fine wines)
Complex financial products (eg. Loans, shares, bonds)

Recent SRA Actions

Recent SRA enforcement action has included:

  • Solicitors Regulatory Authority and Timothy Peter Ackrell Case No. 12009-2019 (Ackrell)4
  • Solicitors Regulatory Authority and David Hayhurst Case No. 12072-2020 (Hayhurst)5
  • Solicitors Regulatory Authority and James MawbeyShaw, Law Offices UK Limited Case No. 12037-2019 (Mawbey Shaw)6

How do these schemes operate?

The case studies below will detail some common characteristics of how these schemes operate.

Case study one: Ackrell

In Ackrell, the scheme involved the sale of large multi-occupancy apartment blocks in North West England. Investments in the scheme went to purchase other sites and investments, as well as fund the extravagant lifestyles of those who had created the scheme. Ackrell, for his part in providing day to day legal services to facilitate the schemes operation, was struck off the roll.

Scheme characteristics

The scheme itself had several characteristics: -

  • Large number of units
    Multi-occupancy apartment blocks
  • High initial deposits
    Large upfront payments of around 50% were required
  • High returns
    Guaranteed rental incomes of between 8-10% over a five year period
  • Off-plan purchases
    The purchases were made off-plan as buy-to-let investments
  • Overseas investors
    The purchases were marketed outside the UK to investors who would have been unfamiliar with the UK legal process
Warning signs

For Ackrell, the warning signs on dealing with the scheme designers included: -

  • Complicated structure
    He was paid by three different employers during the time the scheme operated
  • Newly formed company based overseas
    The owners of the companies were all based overseas, and the companies had only recently been set up. Therefore there was a limited history to verify the legitimacy of the companies involved
  • Poor track record
    The companies had a poor record of completing on such deals
  • Opaque company structures
    The structure of the companies was considered unusual or unnecessary

Key takeaway

Solicitors and law firms need to be especially vigilant to ensure that any marketing material does not make any false or misleading promises, particularly around any indication that the scheme itself is regulated simply because the solicitor or law firm is.

Case study two: Hayhurst

In Hayhurst, the SRA alleged a failure to adequately advise clients on the high risks inherent in investing in property development schemes. Hayhurst received a £10,000 fine.

Note the characteristics found here are shared with those seen in the Ackrell case: -

  • Large number or units
    The purchases were new build or redevelopment projects of residential properties, comprising a large number of individual units
  • High initial deposits
    Deposits were between 40% and 80% of the purchase price
  • Off-plan purchases
    Units were not completed at the time of purchase
  • Overseas investors
    Purchasers were usually overseas buy-to-let investors

Case study three: Mawbey-Shaw

In Mawbey-Shaw, the law firm was acting for investor clients on property development schemes and failed to advise their clients on the potential pitfalls of the scheme and the risk in using an insurance bond for security.

These characteristics also share parallels with the other cases: -

  • Large number of units
    The developments were student or hostel accommodation
  • Off-plan purchases
    The units were not completed at the time of purchase, and deposits were paid before the developments had been constructed
  • High initial deposits.
    Deposits were typically between 30% and 50% of the purchase price upon exchange of contracts

A deposit protection bond had been put in place to secure the deposit against the developer defaulting. The SRA’s case was that investors would believe complete protection of their deposit was provided by the bond in light of the representations made by, and on the advice of, Mr Mawbey-Shaw. However, limited due diligence was undertaken on the insurance company which went into liquidation in January 2015.

Due diligence of the insurance company would have evidenced that: -

  • It was not established in the UK, and was not registered with the Financial Conduct Authority
  • The company was registered in Nevis, making any enforcement action more problematic
  • Few other insurance companies offered a similar product, making it inherently risky
  • There were negative press reports about the company and its directors

Key takeaway

Both the Ackrell and Mawbey-Shaw cases illustrate the need to fully understand the scheme and undertake effective due diligence across all those involved, including overseas entities and, in the case of Mawbey-Shaw, the insurance company involved.

What should law firms do?

In the last five years, we’ve taken 48 solicitors and two firms to the tribunal, resulting in 16 strike offs, eight suspensions and £870,000 worth of fines. We have also issued guidance and published three warning notices about the key signs of dubious investments in 2013, 2016 and 2017.9

The SRA’s actions on these cases and others, as well as the warning notices and guidance published, mean that these areas are especially high risk for law firms to be involved in. Law firms that do become involved should have: -

  • Fully researched and understood the scheme
  • Undertaken appropriate due diligence on any promotor, designer or developer of any such scheme
  • Ensure that marketing material does not provide false assurances
  • Most importantly, ensure that they do not lend credibility to fraudulent schemes

As a regulator, the SRA clearly advises that should a scheme be identified as dubious, full and frank advice should be offered to the buyers, and the law firm should not act8. The regulator continues to issue stark warnings about investment schemes through its regulatory actions.

“In the last five years, we’ve taken 48 solicitors and two firms to the tribunal, resulting in 16 strike offs, eight suspensions and £870,000 worth of fines. We have also issued guidance and published three warning notices about the key signs of dubious investments in 2013, 2016 and 2017.9

Conclusion

The methodology and tactics used by fraudsters will change and alternate over time and in response to regulatory guidance and warnings. New schemes will be developed, but the key characteristics have remained constant in the recent past.

Schemes advertising high returns, quick returns, requiring large initial deposits should be viewed with suspicion, and if they are off-plan purchases aimed at overseas investors then this should raise further suspicion.

Solicitors and law firms will undoubtedly continue to be targeted, to provide the ‘veneer of credibility’ to investment schemes. It is clear that the SRA believes that it is the solicitor’s role and responsibility to look beneath the surface and undertake the required due diligence and research to understand the scheme thoroughly and verify the details. Where unable to do so, then the SRA expects law firms not to act.

Footnotes

1 https://www.sra.org.uk/sra/news/press/investment-schemes-thematicreview-warning-notice-2020/

2 https://www.sra.org.uk/sra/how-we-work/reports/investment-schemes-that-are-potentially-dubious/

3 https://www.sra.org.uk/sra/how-we-work/reports/investment-schemes-that-are-potentially-dubious/

4 https://www.solicitorstribunal.org.uk/sites/default/files-sdt/12009.2019.Ackrel.pdf

5 https://www.solicitorstribunal.org.uk/sites/default/filessdt/12072.2020.%20Hayhurst_0.pdf

6 https://www.solicitorstribunal.org.uk/sites/default/files-sdt/12037.2019.Mawbey-Shaw.Law%20Offices%20UK%20Limited_0.pdf

7 https://www.solicitorstribunal.org.uk/sites/default/files-sdt/12009.2019.Ackrel.pdf

8 https://www.sra.org.uk/sra/how-we-work/reports/investment-schemes-that-are-potentially-dubious/

9 https://www.sra.org.uk/sra/news/press/investment-schemes-thematicreview-warning-notice-2020

Author

Lead Associate - Finex PI UK Legal Services

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