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Custom House Capital Thumbnail

Custom House Capital

Investor confidence has been badly damaged here in recent years by appalling financial advice involving a lack of diversification, high and hidden commissions, and the mis-selling of financial products.

Battered investor confidence is now being assailed by counterparty risk and the risk that your trusted financial adviser, product provider or broker could potentially misappropriate your life savings and your pension.

This risk arises due to significant conflicts of interest that many investment providers in Ireland have. This vitally important element of the Custom House Capital (CHC) scandal has yet to be reported or investigated.

As a student of US government and politics for six years, I learned about the vital importance of the separation of powers - the key governance doctrine of the United States Constitution. Under this doctrine the legislative, executive and judicial branches of the US government are kept separate to prevent the abuse of power inherent in the absolutist British government the Founding Fathers had fought to escape.

This separation of powers is also associated with a system of checks and balances to ensure that protection afforded by the separation is adhered to by the participants.

Now consider the scandal at Custom House Capital.

CHC was a company providing investments and financial advice. It acted as adviser and distributor for some higher risk investments including property syndicates.

However, it was also acting as both pensioneer trustee of clients' pensions and as custodian of these assets. This allowed it to access client funds to support property deals that were going wrong. The Central Bank inspectors appointed by the High Court to investigate this mess last summer have put an initial figure of €66 million on the missing funds. It could go higher.

The abuse of client trust was made possible only because these three separate and distinct functions were being carried out by the same business.

This is not the first time that this has happened.

Remember rogue trader Nick Leeson who brought down the venerable Barings Bank? He was able to maintain unauthorised positions in the market because he was running both the front office trading function and also the settlement of these trades.

More recently, some $600 million of MF Global client funds have been misappropriated. Regulators and bankruptcy receivers are investigating the broker-dealer for allegedly using client money to cover margin calls in the final days before the firm went out of business. The misuse of customer accounts came to light - as it did with CHC - only when a potential buyer with access to company records discovered massive discrepancies and backed away from the deal.

Financial services work best when there are clear divisions of trustee, custodian and advisory functions. Investors are put at risk when investment providers, brokers or advisers are able to combine these separate services while having direct access to their clients' funds and assets.

Investors are better protected by making sure their investments are held with an independent custodian who is legally separate from the adviser. Where advisers or brokers directly hold client money, there is always a potential risk to clients' funds.

The practice in Ireland of many pensioneer trustees who also provide investment advice (either directly or through a subsidiary company) leads to a clear and demonstrable conflict of interest.

Finally, advisers should provide appropriately diversified portfolios of uncorrelated asset classes to Irish investors.

This affords a degree of protection to their clients of avoidable risks such as concentrating their investments in a narrow range of Irish companies or in high risk products which are marketed as low risk. Those advisory firms which lack the resources to manage this function in-house should consider outsourcing their investment function to an external specialist provider of portfolio services.

One of the benefits of having an independent investment committee is that an external check can be made on the recommendations being made to clients to further safeguard their interests.

These simple principles are best practice among family offices catering to high net worth clients internationally.

They are widely accepted as the basis of a fiduciary client relationship around the world and would have protected investors in Custom House Capital. In order for investor confidence to be restored, pensioneer trustees should not be allowed to advise their clients on investments and should hold their clients' assets with an independent custodian.

Having independent trustees and custodians prevents advisers and brokers from having access to client funds.

Investors' interests would be better protected if this important division was implemented.

*Marc Westlake (CFP, TEP), is a Certified Financial Planner and Registered Trust & Estate Practitioner