Investment schemes and client account
Issued on 21 September 2016
While this document does not form part of the SRA Handbook, the SRA will have regard to it when exercising its regulatory functions.
Who is this warning notice relevant to?
This warning notice is for law firms that are involved or asked to become involved in investment schemes. Members of the public who are considering paying money into an investment scheme where a law firm or solicitor is involved might also find it helpful.
We are currently looking to highlight this risk more directly to the public and will produce additional information in the near future.
That all firms and individuals working within the legal services market and regulated by us comply with the Principles and Outcomes of the SRA Handbook 2011.
We are particularly concerned about the dangers of investment schemes where the involvement of a law firm is used to give an impression of credibility or security.
The involvement of a law firm that is acting for the promoters of the scheme, or is holding the investment money, does not mean that the scheme is definitely safe.
Some law firms are continuing to facilitate investment schemes which are dubious. Such firms improperly provide a banking service through their client account. In designing the schemes, law firms and the promoters of the scheme pay attention to red flags that we and other regulators warn about. They then deliberately create a scheme that avoids raising those red flags.
To evade rules preventing the improper movement of money, they also manufacture a process which they claim means that the firm is acting in a genuine underlying transaction. The reality is that they are simply allowing their client account to be used to commit what is very likely to be a fraud - and to launder the proceeds.
The facilitation of dubious investment schemes by law firms is not new. Over many years, we have closed down law firms and many solicitors have been disciplined as a result of their involvement in such schemes. Some have been prosecuted and imprisoned by others.
From at least 1997 onwards, we have warned about this problem and about the improper use of client account. This warning notice is being issued to:
- a. provide updated information
- b. alert the public and firms to the increasing number of these schemes and the losses being suffered
- c. warn that indemnity insurers may refuse to pay for losses
- d. warn that those who pay money into these schemes without taking extreme care might not receive any compensation
- e. remind the public and firms that fraudsters are designing schemes to avoid the red flag warnings that we and other regulators issue from time to time.
We are aware of clear consumer losses arising from these schemes. Our initial analysis of cases we are currently dealing with suggests these losses are significant - amounting to many millions of pounds.
The true figure is probably much higher than we are aware of because some cases are being dealt with by other regulators or the police. We are also aware that, in some schemes, many of the investors are from abroad and have not been in contact with us.
We first warned about high-yield investment frauds or banking instrument frauds in October 1997 and our warning card is quoted in Constantinides v Law Society. Our latest warning was issued on 10 September 2013.
We have also warned for many years about the improper use of client accounts. One of our warning cards was discussed in detail in Attorney General for Zambia v Meer Care & Desai. Our latest warning on this subject is dated 18 December 2014.
We still see crude, high-yield investment schemes where "investors" are offered extraordinary returns which are clearly unrealistic. In the case of Wood-Atkins, in which the solicitor was struck off, the returns were said to be 40 percent per month. There is reference to secret banking or monetisation transactions through which high returns can be made. They are invariably nonsensical.
Our previous warnings on high-yield investment fraud remain important. The nature of these schemes is now so well known that any solicitor who becomes involved in them may face being closed down urgently and alleged to have acted dishonestly. Members of the public who "invest" in these schemes are very unlikely to be compensated because it is so dangerous and imprudent to become involved in them.
Fraudsters have paid attention to warnings and moulded their schemes. They will now usually avoid offering ridiculous profits but will still mention returns that are very high compared to conventional investments, such as 20 percent per year. The return is only one of the red flag indicators.
Fraudsters will claim that there is a lucrative market in a new or unusual investment, and will try to mimic genuine investments. Investment schemes we have seen carried out and which have failed with investors’ money being lost include:
- a. Carbon credit trading – this was never a market that it was sensible or practicable for individuals to try to invest in.
- b. Diamond trading, fine wines, "rare earth minerals" (or metals) and graphene – products like this can of course be bought and sold but there is no special way to make substantial returns.
- c. Landbanking – buying a small strip of land which it is said will increase hugely in value if planning permission is obtained to develop it, but permission is never obtained and was never likely to be obtained.
- d. Hotel rooms – taking a lease of a hotel room. There is no obvious reason for someone wanting to invest in a hotel to take out a lease and pay for the conveyancing of one room. These arrangements may well be collective investment schemes.
- e. Overseas agricultural rights – we have seen schemes in Ukraine, Africa and elsewhere.
- f. Famous works of art being the "security" for an investment scheme.
- g. Property developments abroad – money being taken from numerous members of the public to pay for holiday homes before they are built, often in countries where verifying the development or recovering losses if things go wrong is difficult or impossible.
Unusual investments abroad are particularly problematic. They are difficult to verify. The chances of recovering money if things go wrong are very low. The legal system may be very different. For example, we have seen schemes where investors are assured that their money will be held "in trust", but the law in the country where the investment is taking place does not recognise the concept of a trust.
The involvement of a law firm or solicitor does not provide security or assurance. It may actually suggest a need for particular caution. This is because:
- a. The law firm will usually be acting for the promoters of the scheme (and not for the investors) and will not be looking after the investors’ interests, although they may not realise that – investors must get advice from their own trusted professionals
- b. The law firm may itself know very little about the scheme, particularly if it involves overseas investments
- c. An honest or safe investment scheme does not need to involve a solicitor to give it credibility
- d. There is no good reason why money being paid to an investment scheme should pass through the client account of a law firm acting for the investment company – it could and should be paid direct to the investment company
- e. investment company and the law firm manufacture a process, sometimes involving "certification" or "verification" that something has happened to give the impression that they are doing some legal work when they are not. The law firm will be instructed or pressured by the investment company to release the money as soon as possible and will often have no independent knowledge of whether what the investment company is telling them is true or not.
The promoters might use the involvement of a law firm in their direct or indirect marketing, either in brochures, on websites or by briefings to trade and other journalists. An anonymised example from a case involving losses of more than £20m is: "You enter into an escrow agreement with [X & Co] Solicitors to manage and maintain the credibility of the account process. This gives full protection for you and us."
Another brochure in the same case said: "The money is looked after by an English law firm which holds an insurance policy."
In that case, the insurance company refused to pay claims. We also see cases where perhaps £50m passes through a law firm but it only has insurance cover of £3m.
Evasion of our rules
We are particularly concerned that law firms and their clients are deliberately designing schemes to give the false impression that genuine legal services are being provided. There is no need for a law firm to be involved or for money to pass through its accounts.
We see what we consider to be spurious attempts to create a legal context. This could include supposed "verification" or "certification" which is of no real benefit or relevance. We also see "anti money laundering checks" on investors when there is no requirement for such checks in the transaction in question. Even if there were a need for them, they should be carried out by the investment company and not a law firm.
The SRA Principles
Law firms must ensure that they do not become involved in potentially-fraudulent financial schemes.
Failure to observe warnings could lead to disciplinary action or criminal prosecution. Attempts to limit your involvement, particularly by a purportedly "limited retainer" are ineffective in protecting you if you simply should not become involved.
If you are, or are considering, becoming involved in any financial arrangement, you must ensure you comply with the Principles in the SRA Handbook. While all Principles may be relevant, some require particular attention:
- a. Integrity (Principle 2)
- b. Independence (Principle 3)
- c. best interests of the client (Principle 4)
- d. behaving in a way that maintains the trust the public places in you and the provision of legal services.(Principle 6)
You must also ensure you do not take unfair advantage of investors in any way.
If you are likely to become involved in transactions involving large sums of money, individually or cumulatively, you must ensure you have sufficient indemnity insurance. Outcome (7.13) is that "you assess and purchase the level of professional indemnity insurance cover that is appropriate for your current and past practice, taking into account potential levels of claim by your clients and others and any alternative arrangements you or your client may make." Your insurers might want to aggregate claims and you find that you have insufficient cover.
What should law firms do?
- a. Do not become involved in investment schemes that you do not fully understand, or have not independently and rigorously verified
- b. Do not allow your client account – or any account you control – to be used to receive investment money that could simply be sent by an investor to an investment company
- c. Do not attempt to evade rule 14.5 of the SRA Accounts Rules 2011 by trying to manufacture a process of legal work or advice
- d. Do not attempt to evade rule 14.5 by moving money through another account – you are still facilitating the scheme and might be helping launder the proceeds of crime
- e. Do not assume that you can escape liability in law or in conduct by giving investors an obscure warning that you do not act for them
- f. Bear in mind that even if you do not act for investors you have duties not to take unfair advantage of them and to act honestly and with integrity
- g. Do not draft or facilitate the use of contracts that are unfair to the investors – promulgating a contract with unfair terms may be part of an overall case that you have taken unfair advantage, whether or not consumer protection legislation applies
- h. Do not give undertakings as "security"
- i. Do not allow your involvement to be used to promote the scheme in any way
- j. Regularly check the internet to ensure your involvement is not being used to promote the scheme in any way and take action to stop or correct this – your name might not be mentioned, but if you are acting in some way and there is reference to the involvement of a law firm, you still need to stop it
- k. Be particularly alert to any mention, directly or indirectly, of your insurance or the Compensation Fund
- l. Research the investment company and any intermediaries fully by reference to official sources such as regulators and Companies House, also paying appropriate attention to media or other commentary
- m. If you become aware that someone in your firm is involved in an investment scheme, ensure that you fully understand it and take urgent steps if necessary to cease involvement
- n. Be particularly careful about acting for an investment company, ceasing to act and then acting for the investors – that gives rise to concern the firm is still looking after the interests of the investment company (particularly if someone who acted for the investment company leaves the firm to join the company or to be associated with it)
- o. Bear in mind that in helping an investment company to carry out one of these schemes you might well be facilitating a fraud and laundering the proceeds.
Failure to comply with this warning notice is likely to lead to disciplinary action.
If you require further assistance with understanding your obligations in relation to high yield investment schemes please contact the Professional Ethics Guidance Team.
If you have evidence of one of these schemes or are concerned that you have been approached or have become involved, please contact your SRA supervisor.
If you are already involved and become concerned, urgently contact the Red Alert line.