Since December 1999, the Financial Services Authority (FSA) has issued several warnings to consumers about what it refers to as "precipice bonds". These are high-income bonds where the income, or level of growth, is guaranteed.
However, the original investment is linked to the performance of an index/indices or a basket of stock, and there is a high risk that investors may not get back all of this capital. Indeed, in some cases, investors may not get back any of their capital.
The FSA is concerned that the complexity of these products, and the fact that investors may not understand that their capital is at substantial risk, mean there is a danger of mis-selling. Our experience tends to support this view. We are already dealing with complaints about the mis-selling of these bonds.
Firms offer high-income bonds in limited issues and the bonds are designed to be held for a specified period, typically three to five years. Income and growth are set at rates that exceed those of more traditional products. For example, some bonds offer annual income of over 10 percent for three years, or capital growth of 30 percent or more after 38 months - and these rates are guaranteed. However, the amount of capital that investors will get back usually depends on a complicated formula linked to the value of specific shares.
Typically in complaints referred to us, we find the firm has marketed the bonds as medium- to high-risk investments but sold them to customers who say they were led to believe the risk was low and their capital was secure.
In dealing with such complaints, our approach is to try to establish what the representative told the investor at the time of the sale, and what product literature and other documents the firm gave the investor.
The points we consider include whether:
The marketing literature for these bonds does sometimes contain a warning that the investor's capital is not secure. But we know that investors rely to a great extent on what the firm's representative tells them at the point of sale. And even where there is a warning in the product literature, this can be undermined by a representative's assurances to the investor that any shortfall is likely to be relatively small.
Very few investors appear to have any understanding of what "attitude to risk" and the firm's relative ranking of their own attitude to risk actually mean. So we may not always consider the sale of these products to have been appropriate, even where there is clear evidence (from the "fact find" completed by the firm at the time of the sale - or from the firm's report of recommendations to the investor) that the investor was prepared to accept a medium to high level of risk.
Mr M was 72 and living on a modest pension when he was advised to invest £5,000 in a high-income bond.
The firm's product literature for the bond warned that investors could lose a small amount of capital. The "'fact find" completed by the firm recorded that Mr M was "seeking capital growth" and was prepared to take a medium/high level of risk with his investment. However, Mr M had not signed the "fact find" and there was no record that the adviser had discussed any alternative type of investment with him.
Several years later, alerted by press reports about some of the disadvantages of high-income bonds, Mr M contacted the firm. He discovered that the value of his investment had dropped considerably. Although the level of growth he had been promised was guaranteed, he now realised that the return of his original investment was not. So he complained to the firm.
We noted that Mr M had little experience of stock market investment and had never had any medium/high risk investments before. At the time he was advised to put his money into the bond, his capital was all in a deposit account, apart from £1,000 in premium bonds and £3,200 in a low-risk personal equity plan (PEP) that included some shares.
Although, after investing in the bond, Mr M still had some funds put by for emergencies, nearly 75 percent of his capital was in equity-based investments.
We upheld this complaint on the grounds that the firm's advice had been inappropriate and had exposed Mr M to too great a degree of financial risk, in view of his circumstances. We required the firm to give Mr M a refund of the full amount he had invested, together with interest.
When they were advised to invest £50,000 in high-income bonds, Mr and Mrs C had recently retired and were aged 63 and 60 respectively. According to the "fact find" that their adviser completed, they were looking for capital growth rather than income from their investment.
After reading critical press reports about some types of high-income bond, the couple complained to the firm that their investment had not performed as well as it should have done. The firm rejected the complaint, so they came to us.
We felt that the firm's product literature understated the level of risk associated with these bonds. And although the "fact find" recorded that the couple's attitude to risk was "medium/high", it was unsigned. These factors gave us some concern, so we needed to try to establish whether the sale of the bonds had been suitable
We found that Mr and Mrs C appeared to be reasonably experienced investors. In addition to having a sizeable amount in current and savings accounts, they had invested substantial sums in with-profits funds, as well as in PEPs and equity-based investment bonds.
So although the couple's investment in high-income bonds involved a greater degree of risk than the investments they had made previously, this was balanced by the substantial sum that remained in their current and savings accounts. We were satisfied that Mr and Mrs C understood the concept of risk and knew how the stock market worked. The fact that a stock market investment has not done as well as expected is not, in itself, grounds for complaint.
We rejected their complaint.
ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.
The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.