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FSA: relying on IMA sectors over Cru not enough

by William Robins on Dec 17, 2012 at 16:05

FSA: relying on IMA sectors over Cru not enough

The Financial Services Authority (FSA) has launched a scathing attack on IFAs’ due diligence on the Arch Cru funds, claiming it was not enough to rely on their Investment Management Association (IMA) sector classifications.

The FSA said the majority of responses it received to its Arch Cru redress scheme, to be funded by advisers found to have mis-sold the funds, were opposed to it. The regulator added a number of responses had pointed to IMA sector classifications as justifications for selling the funds as low-risk investments.

The flagship Arch Cru fund, the Arch Cru Investment Portfolio, sat in the IMA Cautious Managed sector, now renamed the Mixed Investment 20-60% Shares sector.

The regulator said: ‘Advisers cannot rely on an IMA sector classification as an indicator of the risk of a particular fund. Advisers should, as part of their due diligence, look at the kind of assets the fund manager intends to invest in, and the investment strategy.’

Some respondents also pointed to literature accompanying the funds which portrayed them as low-risk investments. But the FSA said IFAs should have realised that:  

  • the marketing material provided was limited;
  • claims in the marketing material about the overall risk consumers were taking was low or medium were not consistent with the investment strategy and the funds’ underlying assets;
  • the funds were exposed to asset classes including unlisted debt and equity.

28 comments so far. Why not have your say?

John Burchett

Dec 17, 2012 at 16:39

Let he who is without sin cast the first stone.

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Festinalente

Dec 17, 2012 at 16:40

Well stated!

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Green Eyed Monster

Dec 17, 2012 at 16:50

So IFAs cannot rely on what product providers tell them.

Q for FSA. Where do IFAs conduct the research that will uncover the truth about "where a fund manager intends to invest"?

What does that research look like?

"IFAS should have realised" that they cannot rely on the marketing material issued by product providers".

It seems some innocent IFAs did not realise that product providers are permitted to tell porkies in their marketing material and that the Advertising Standards Authority's code of practice does not apply to financial product providers? (Legal, Decent, Honest and True).

Q for FSA. Now that you have declared the product providers marketing material to be 'misleading' at best, would you recommend IFAs who have to to compensate their clients to seek redress from the product provider who caused their loss?

Q for FSA If an IFA cannot rely on an IMA service its possible that there are other providers of services that the IFA should not rely on. Rather than asking you to list all those they should not rely on, please tell us what research service in the marketplace that an IFA can rely on, if any.

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stephen lyth

Dec 17, 2012 at 17:12

Since when has has using a Jersey "Cell" structure been deemed as low risk ? Blame on both sides of the fence here im afraid

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sol trader

Dec 17, 2012 at 17:13

Well, that answers my question on another article.

Does this mean I cannot blame the regulator for allowing my clients funds to be filled up with non existent assets in the dubious form of derivatives?

Does this mean I cannot blame the regulator for allowing fund managers to lend out my clients assets (if they actually have any) and borrow against them?

Does this mean I cannot blame the regulator if my clients think they have a fund following the FTSE 100 and it is actually backed by Swiss Cheese?

Does this mean I cannot blame the regulator if it is still not clear who is making money out of my clients funds and in what way (other than my own adviser charging which I am slowly getting to grips with in terms of suitability - not transparency.)

Does this mean I cannot blame the regulator if my clients are tempted away by "cheap" "non advised" dodgy marketing, dubiously advertised investment gems that turn out bad?

Well Boys and Girls, I think we will have a role, post rdr, sorting the wheat from the chaff. It also seems we can't really trust our friends and allies in this new world - we are on our own.

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Jeff

Dec 17, 2012 at 17:20

Roll on the end of the world!!

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Andy Jones

Dec 17, 2012 at 17:21

I'm sorry folks but the FSA is right in this instance. Arch Cru were very clear at outset about the fact that Private Venture Capital would play a big part in their funds. Basic due diligence would have picked this up and it should have sounded the biggest possible alarm bell about the potential liquidity issues that ultimately faced investors in these funds. Any advisers that didn't pick this up deserve everything they are collectively getting.

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david mann

Dec 17, 2012 at 17:25

FSA are spot on - and if you as an IFA are relying on a glossy brochure and a few choice words at a presentation, then you will have failed in your fiduciary responsibility to provide robust due diligence.

Why did so many of us file the Arch Cru stuff in the bin as soon as we read about private finance, cell companies etc?

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Festinalente

Dec 17, 2012 at 17:29

Yep - spot on is correct. Bit of a difference between names like Prudential, Fidelity, Templeton, Goldman Sacks etc. AND Arch Cru - excuse me - what was that name again - Arch Cru. Better safe than sorry.

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Martinifa

Dec 17, 2012 at 17:46

I did not use this fund that said I do take issue with what the FSA has stated.

The more you try to blame the IFA the bigger the hole you are digging to highlight your own failings.

I attended meetings with Arch Cru and they stated the fund’s investment strategy as that of cautious, the IMA rating was that of cautious, the life offices rated the fund (having done their own as they put it extensive research) as cautious. SO WHY IS it only the IFA being singled out as they should have known better, is it to push through their unjustified levy I wonder? Is it to protect Capita and HSBC who failed in their duties?

In the meeting they stated that part of the funds were to be lent under secured loans to small businesses. I asked the question “who values the security”, they replied they did, but Capita and HSBC would be closely monitoring them. What they did not state is that 60% of the fund was going to be lent to a Greek Shipping Company!

Based on this statement how do I as an IFA based in South Wales gain access to the correct research? How can I trust any rating agency? Any regulated fund? As clearly the regulator takes no responsibility for the information actually being correct!!!!!!!!

If I cannot trust a “REGULATED” fund to be truthful and honest with its literature, if I cannot actually really on the IMA rating being not even close (cautious to High Risk) what does that say about the regulator and their role, what is it they actually do?

In my opinion this has always been about the regulator deflecting their failings. As I stated we did not use the fund, that said I can understand how an adviser based on the research available at the time, brochures, Life Companies ratings and finally the so called TRUST that the regulator has agreed and has checked with the fund manager what they have printed is true.

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John Invest

Dec 17, 2012 at 17:47

Andy Jones :- If it was so clear that the funds were going to be illiquid why did the FSA approve their status as OEICS? Why did Capita support Arch Financial Products to get OEIC approval. OEIC's are daily traded funds and therefore such illiquid assets would have been incompatable with that.

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alan hughes

Dec 18, 2012 at 08:54

I saw a copy of an email (dated September 2009) yesterday in which the director of supervision of the FSA had suggested that he thought Capita PLC might be a quoted company. This is the same FTSE 100 Capita that was ACD for 231 funds and had £19.9 billion under management, Considering the CF ARCH funds were suspended in March 2009 it is somewhat surprising that senior staff in the FSA were clueless as to the standing of the ACD. Perhaps such ignorance goes some way to explain why Capita was allowed to operate with such scant regard to the regulatory regime.

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Andy Jones

Dec 18, 2012 at 10:29

John Invest - OEICs are daily traded unless the underlying assets become difficult to value. This scenario is typically seen with bricks and mortar property funds (where 6 month deferral periods were relatively common in 2008/9). Even equity funds have unit price suspensions when markets are falling rapidly. OEIC status does not prevent liquidity issues.

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Richard Hardy

Dec 18, 2012 at 10:47

When is a regulator not a regulator?

When the FSA choose to be one or not!

So what due diligence was done by the FSA before allowing release of the funds to the Public?

Surely the marketing literature had been compliance checked and approved?!

An utter shambles.

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Ned K

Dec 19, 2012 at 13:10

As one earlier blogger Festinalente commented there is a difference between Prudential, Fidelity, Templeton, Goldman Sacks and Arch Cru but when you add in the manager of the fund the ACD CAPITA and the Depositaries BoNY and HSBC they are substantial quoted companies which were paid to do a job, a job which Capita failed miserably to perform. (incidentally we do not rely on names alone - goldman sachs needed a £5.5 billion bail out in 2008). We could add to the list of big names Equitable Life, Lehman bros AIG RBS HBOS all of which got into difficulty some were bailed out.. .

As for investing in Jersey cell companies (should read Guernsey cell companies) Capita controlled the Guernsey cell companies but failed to take this into account in the management of the funds they controlled.

From due dilligence we did on the people at Arch you would never have suspected anything untoward a they all appeared to be very experienced investment managers/professionals:

Robin Farrell established ARCH in 2002 and serves as its Chief Executive. He has broad experience across alternative and traditional asset management, structured finance, risk management, trading and sales. Prior to ARCH Mr. Farrell was a consultant to Goldman Sachs International and Global Head of the Alternative Investments Group at Dresdner Kleinwort Wasserstein. Previous experience includes Head of Equity Structured Products for Societe Generale in London and Executive Director - Global Equity Derivatives at the Union Bank of Switzerland. Mr. Farrell spent the first part of his career in Quantitative Investment Management and Risk Management, including the management of c.£1 billion of pension portfolios, mutual funds and structured products for the Legal and General Group and the building of trading and risk management systems for Barings Treasury and Trading (Global Fixed Income) from 1988 to 1991. He holds a BSc. ARCS in Mathematics from the Imperial College London

Robert Addison is Chief Operating Officer for the ARCH Group. He has responsibility for the implementation of the ARCH investment funds and products. Mr Addison has eighteen years of investment experience with a particular focus on specialist funds, structured products, operations and risk management. Prior to joining ARCH in 2005, Mr. Addison managed his own structuring and derivatives consultancy where he oversaw the development and launch of a number of innovative investment funds. From 1997 to 2003 Mr. Addison served as Director of Risk Management Products at UBS Investment Bank, dealing in equities, equity derivatives and alternative investments. He worked in a similar capacity with NatWest Markets from 1990 to 1997. Mr. Addison has authored numerous articles in the trade press and several book chapters on structured products and employee share schemes. He is an Economics graduate of University College, London.

Bronwyn Curtis

(Now) Head of Global Research, HSBC

Bronwyn is Head of HSBC Global Research, where she manages the HSBC global research operations. She is also Chairman of the Society of Business Economists, a board member of the National Institute of Economic and Social Research, the Council at the London School of Economic and the Advisory Board at Imperial College Business School, as well as a member of The Times newspaper’s Shadow Monetary Policy Committee.

Michael Derks is Chief Investment Officer and Head of the Portfolio Management Group. He is a Market Strategist and Economist with 26 years' experience, gained in both Investment Management and Investment Banking. Prior to ARCH he served as Chief Global Strategist and Economist with the Commonwealth Bank of Australia (CBA), responsible for all G7 interest rate and currency market forecasts. From 1992 to 1999 Mr. Derks worked in a similar capacity at Deutsche Bank (New York, London and Sydney), with responsibility for US Treasury strategy, international and cross-market forecasts, as well as a range of fixed income and currency publications. Mr. Derks spent the first part of his career in portfolio management, based in Sydney, working for Rothschild Australia, Equitilink Australia and Schroders Australia. During this time he managed a large number of fixed income, money market and currency portfolios. Mr. Derks graduated in Economics (Honours) from the Macquarie University, Sydney in 1982.

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Green Eyed Monster

Dec 19, 2012 at 14:08

@ Ned K

good research.

Begs the question of the FSA: What would adequate due diligence look like in this case?

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Ned K

Dec 19, 2012 at 14:26

@GEM IMA sector classifications perhaps?

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Green Eyed Monster

Dec 19, 2012 at 14:56

@Ned K

No. The FSA has already stated that relying on IMA sector ratings is not good enough!

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Alan Smith

Dec 21, 2012 at 12:27

Quoted directly from the ACD’s Annual Short Report produced by CAPITA Financial Group every six months from June 2007 to June 2009 “There are no borrowings or unlisted securities of a material nature and so there is little exposure to liquidity risk” – yet the FSA and CAPITA would have the outside world believe liquidity issues caused the failure of the CF Arch Cru funds.

Quoted directly from the Prospectus produced by CAPITA Financial Group:-

“CF Arch Cru Investment Portfolio is suitable for those investors wanting to achieve consistent returns, wealth preservation and capital appreciation by investing in a broad range of collective investment schemes, transferable securities, both Corporate and Government bonds, money market instruments, cash, derivative instruments, forward transactions and other instruments that the investment manager considers to be appropriate from time to time.”

This is not a third party opinion as alleged by FSA and who are using Seymour V Ockwell as justification for the S404, rather it is a statement of fact from those legally responsible for the fund. I think the key words here are BROAD RANGE – nowhere does it say over 20% in one investment in a Greek shipping company.

Therefore there was clearly misinformation given by the ACD CAPITA Financial Managers and the ACD has legal responsibility for all affairs of the fund such as information provided by Arch Financial Products LLP and CRU Investment Management. Mr Addenbrooke of CAPITA Financial Managers Ltd stated this in 2008 in an interview with a trade paper.

Ironically just this week there has been reporting of a case that is almost identical to the CF Arch Cru debacle yet no client has had to wait for their money back (now nearly 4 years for CF Arch Cru Investors).

I refer to the Standard Life Sterling Pension fund that fell in value almost overnight by £100million in early 2009. Within a month Standard Life accepted the fund had been mis-marketed and injected £100million into the fund so no client lost money and informed every investor they had two months to get out of the fund penalty free after that date if still invested the client would be accepting they were aware of the extra risks the fund did have following production of correct marketing material.

Subsequently Standard Life went to their PI Insurers and recouped the £100million as the incompetence that had resulted in the mis-marketing which led to investors being invested in the fund was Standard Life’s incompetence and after all that is what PI is meant to cover.

Obviously Standard Life’s PI Insurers did not like this but their appeal to not pay has been unsuccessful.

Standard Life were fined (and paid) over £2million by the FSA.

Why therefore did CAPITA Financial Managers do exactly as Standard Life did – make up the investors losses immediately in 2009 and allow investors to leave if they did not like the risks when the true nature of investment operandi was provided to them.

CAPITA Financial Managers PI would have had to pay out and if subsequently the PI Insurers wanted to take the Legal Action currently being undertaken by Hugh Aldous against various parties then that would have been their prerogative. However these actions would have taken place behind closed doors and investors would not have suffered the loss for nearly 4 years.

The above behind closed door deals would have been much palatable than the sordid behind closed door deals that the FSA have obviously been undertaking with CAPITA, Guernsey Authorities and Government Ministers.

If anybody would like more information about the true goings on regarding CF Arch Cru they can request from the FSA a copy of my response to the Section 404 consultation which the FSA have to release to those requesting a copy, once having read that if they want to contact me further I will send them even more revealing information.

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Alan Smith

Dec 21, 2012 at 12:37

As stated in my post above I believe it is an absolute disgrace that investors have had to wait nearly 4 years for the FSA to put a scheme in place where investors will get their money back. Yet even after 4 years it is a scheme that is so perverse that many investors will not be covered such as those who were high risk, those who invested directly without using an adviser and those using discretionary fund managers.

Those investors that are covered will end up receiving compensation either from an IFA that they do not “blame” for the loss otherwise the investor would have just complained via FOS during the last three years or alternatively (and more likely) an IFA the investor does not even know because the claims will fall on the FSCS.

The FSA are living in cloud cuckoo land if they think only 15%-30% of investors will opt in to a redress scheme. Most investors have waited and not complained because it has been so obvious to them as to who and what caused the loss of money that they naively believed the FSA would eventually put a solution on the table where the true culprits paid out. Unfortunately this has not happened and they are faced with only one choice to complain against their adviser they will take it.

This is also true for advisory firms that have already gone into default over CF Arch Cru. The FSCS had until a few months ago received relatively few claims (around 600), this has now swelled to over 1800 as a deluge of investors thought they could wait no longer and accepted CAPITA’s compensation offer.

Once the compensation offer has been accepted the investors have basically accepted the FSA will not come up with an honourable solution.

The S404 implementation confirms to the investors of defaulted firms the FSA’s intentions and therefore the FSCS will be flooded with complaints from investors of departed firms who again have waited for the FSA to get them compensation from those they know caused the losses, however as this will now definitely not happen they are left with no choice but to go to the FSCS.

Therefore IFA’s should prepare for an FSCS bill next year of at least £100million from CF Arch Cru alone.

No doubt Connaught will also fall on the FSCS next year – another fund where CAPITA and FSA conspired on when changing operator of the fund in 2009 when they knew there was a problem but did nothing and allowed a new operator to launch further funds.

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Alan Smith

Dec 21, 2012 at 12:41

Whilst writing the last two posts I have thought of a plan so cunning you could stick a tail on it and call it a weasel – or the FSA if you prefer.

The FSA’s logic on who is responsible for CF Arch Cru compensation is so irrational if it were applied to the banking collapse then anyone who held a bank deposit and had an IFA should complain against the adviser for the loss they have suffered. After all the adviser’s should have been aware of the mis-management that was going on within the banks and their imminent collapse. All depositors have lost money but as it was not directly lost they cannot work out how much exactly!

The Government decided the banks were too big to fail just as the FSA decided CAPITA Financial Managers were too big to fail – although it is perfectly acceptable for 200 plus advisory firms to fail.

If you consider the actual bank bailouts and subsequent quantitative easing which has resulted following the bailout has cost over £1trillion pound which is more than £40,000 for each tax paying adult in the UK it is scandalous that only 1 banker – Peter Cummings – has been censured by the FSA.

But hey we are all tax payers in this together, or are we? When you consider that Mr Average on £25,000 per annum and a few thousand in the bank probably pays more tax than the likes of Sir Philip Green the notion of proportionality and responsibility are thrown out of the window.

Given the above logic here is the cunning plan.

CF Arch Cru has shown that any fund with CF in front of it will not have action taken against it for over 3 years and when there is action no fines will actually need to be paid. The FSA enforcement notice shows that CAPITA Financial Managers Ltd are ACD for 231 funds with just shy of £20 billion under management. The 231 funds are split between around 100 fund management groups.

5% of £20 billion gives £1 billion. Therefore why don’t the 100 fund managers just buy the 200 IFA firms for £1billion with no independent valuation on any of the 200 IFA firms – indeed just pay a flat £5million for each IFA firm regardless of size.

The 200 IFA firms who now have £1billion in the bank can repay investors the £100million leaving them £900million. Before buying the IFA firms the fund management groups would obviously have put an agreement in the purchase arrangement that stated that in return for not bothering to get a valuation on the business they were buying on behalf of investors then the fund managers would be entitled to a “transaction bonus” of £300million giving each management group £3million for a Christmas knees up.

Leaving £600million for the 200 IFA firms so they get £3million each to walk away into the sunset and enjoy a peaceful life without the FSA having to worry about them.

In 3 months time when the fund management groups admit there is no value in these IFA firms as all the staff are sitting on a beach in the Bahamas and Winterflood Securities the market maker says there is no secondary market, luckily the fund managers will have to report only a 5% fall in investors fund values but as this will have been within the investors capacity for loss as documented by all the advisers that recommended those 231 funds in the belief that the fund managers did not operate as Arch Financial Products did.

The above is obviously farcical, but no more farcical than the FSA’s handling of this disgraceful fiasco.

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Michael Leslie

Dec 23, 2012 at 12:49

Andy Jones and David Mann - are you serious ? You are both on another planet ! This is a massive cover up by the FSA and goes deep into the realms of absolute chaos. There is NO WAY an IFA could have done any DD that would have uncovered this mess. IFAs are simply being used as a scapegoat YET again . Your broad brush attack is beyond credibility - just look at all the publications on this debacle over the last year or so. Its a scandal - and absolute scandal !!

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Andy Jones

Dec 23, 2012 at 13:16

Michael, I am very serious. First of all I am in total agreement that Capita and others have had a big hand in the failure of Arch Cru and should be held accountable, however, this deflects from the main point of my criticism.

When Arch Cru presented their funds prior to their retail launch I, like many other IFAs who attended their presentations, were given the explanation why the performance of the existing Cru funds was not correlated with the returns of other assets classes. The answer provided?? - Private Equity!! At that point the whole thing lost all credibility (as it appears to have done with David Mann) because when I asked myself what would happen if large volumes of Private Equity left the fund, the answer was clearly that retail clients (IFA clients) would be left stuck in the funds having to pick up the pieces. The smart money would always leave first. You didn't need to read the term & conditions or understand the detailed structure of the funds - you just needed to realise the massive risk of illiquidity.

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david mann

Dec 23, 2012 at 19:42

Michael, I'm sorry but the facts are that the vast majority of IFAs did not recommend these funds to clients. I recall reading the prospectus, attending a seminar in London fronted by Jon McGuire and having no doubts that it would not be an acceptable investment for Mr and Mrs Average retail client that make up my client base.

I will however now have to contribute via the FSCS for your lack of similar foresigh and the failings of others. - at least you earned the healthy commission rates on offer.

The whole thing is a mess but to try to claim that poor old IFAs are blameless is naive in the extreme.

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Michael Leslie

Dec 24, 2012 at 09:56

David - how about I answer you with "fund switch" - absolutely NO commission taken whatsoever !! Enough said !! Andy - your response is at least constructive. Many IFA questions were "answered" thru research - on material that was LATER found to be inaccurate and basically unreliable. All IFAs are not without blame - of course not ....but there are many that were duped. One size does not fit all here - by any means .

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John Invest

Dec 24, 2012 at 10:26

Michael I am in excatly the same boat. Both the Arch Cru cases I did were fund switches and no commission taken. What is even more galling is that I did not purely rely on marketing material but DID write specifically to Arch Financial Products about the potential liquidity issues and also how the assets were valued. I received back a detailed 8 page response from them on these issues mainly extalling the virtues and high standards of Capita and Bordeaux securities who would insure that valuations would be accurate and that liquidity would be maintained. As we now know these assurances were not worth the paper they were written on. Also the fund assets held in June 2007 as per the Arch Fund Factsheets were very different to what that fund held by the time of suspension in March 2009. Certainly it was not the very high risk fund at that time that the FSA claims it was. The private equity holding for example had increased from 11% (June 2007) to 34%(March 2009) (Linda Woodall at the FSA please take note).

So for those advisers out there who are holier than thou (maybe it is the time of year making you feel more like this) please note that this is not a simple case by any means of a group of greedy advisers trying to fleece clients for the maximum commission available.It is difficult to know in prcatice at the time what other Due Diligence could have been done and the FSA as usual can offer no guidance on this.

A Haapy Christmas to you all.

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Robin Hood

Dec 31, 2012 at 15:08

Putting it simply, if you were a higher risk investor you may not be awarded compensation for the lack of supervision and administration that went on by all the parties including the FSA and the misappropriation of funds-why because high risk investors expect this while cautious investors do not.

This has to be too simple doesn't it?

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Robin Hood

Dec 31, 2012 at 15:14

I, like many others, checked the share prices of the arch cru funds on the CISX with those published in the financials, guess what- they tallied, so who was telling the porkies?

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