Treading the fine line of SIPP due diligence

The trade press has reported widely on the issue of the Financial Services Compensation Scheme declaring three, now defunct self invested personal pension (SIPP) operators, as in default based on a failure to carry out any due diligence on underlying investments, which subsequently failed.
 
This as a headline is far too simplistic and generalised. The roles of the parties involved in a SIPP are often misunderstood. Indeed, I have seen numerous comments bemoaning the fact that by acting as a SIPP trustee, fiduciary responsibilities exist and these of course should have included the need to undertake due diligence on any investments accepted in to the SIPP.

However, in many cases, a SIPP trustee acts in a capacity as a bare trustee and has no discretion over the assets held in trust. Except in the case of bare trusts for minors, the trustee has no active duties to perform. The trustee must simply follow the lawful instructions of the scheme administrator, who carries out the beneficiaries wishes, in relation to the assets held in trust: they act as a mere nominee.

So are SIPPs off the hook?

Most certainly not, since it is not the SIPP trustee at issue here but the regulated provider of the SIPP.

Evolution of regulations

The Financial Conduct Authority (FCA) (previously the Financial Services Authority (FSA)) has regulated SIPPs since 2007 and the regulation surrounding them has continually evolved. Although re-emphasising their requirements in successive thematic reviews, the FCA have always maintained that the role of a regulated entity is to act always in the interests of their clients.
 
Since the FCA’s highly critical 'Dear CEO' letter in 2014 and for most, since the preceding thematic review, SIPP providers (and to some extent, SSAS practitioners) have all quite rightly been exerting far greater levels of due diligence over all investments both standard and non-standard.
 
The core of these due diligence requirements is to ensure that the investments are genuine and that they are both safe and secure. SIPP providers, therefore, require an in depth understanding of the proposed investment irrespective of the complex nature many of them now exhibit. SIPP providers are now employing all manner of online checks into administrators, auditors, managers of funds and even these companies’ shareholders and directors.

Scammers becoming more sophisticated

As SIPP due diligence procedures increased so too did the sophistication of the scammers devising and promoting these investments. Far from the relatively simple fractional land ownership schemes, forestry and teak plantations scattered around the world (where potentially believable, but difficult to verify, investment opportunities were promoted), later schemes included multi-tiered ownership structures where deep forensic research was and is still required.
 
We have also seen structures that appear on first impression to be “bonds” which would even be listed on overseas stock exchanges but on closer scrutiny have the power to invest inside the bond into all manner of potentially toxic investments.
 
Nevertheless, as SIPP providers become ever more savvy, so do the scammers and it has become an “arms race” to remain one-step ahead.

Increased administrative burden

These factors greatly increase the administrative burden and time it takes to review and risk manage a SIPP provider’s acceptance of non-standard investments. Coupled with the associated capital adequacy burden derived from the numbers and proportion of SIPPs holding non-standard investments, many SIPP providers have exited this market and for those remaining, selective acceptance of assets will apply.
 
One unfortunate consequence of these enhanced processes, is the  simple fact that SIPP providers have the ultimate decision over acceptance of any asset into their book and if there is any shadow of doubt, or an otherwise legitimate investment straying just the wrong side of one acceptance criteria point, it will be rejected.
 
Coupled with the capital adequacy premium attaching to such investments, it has become easier in some cases simply to turn down an investment.
 
Sophisticated investors, with complex but otherwise perfectly good investments might now find it difficult to place them, and this was one of the markets for which SIPPs were originally introduced.