The insurance giant Aviva is paying compensation to investors in its preference shares who sold up in March, based on an announcement from Aviva that the shares would be cancelled. However, it subsequently decided to not cancel the shares. The outcry raised the issue of who is responsible for investment decisions.

Caveat emptor, or ‘let the buyer beware’ used to be generally regarded as an underlying principle in investment decisions, putting the responsibility on the investor to choose the right product. However, the increase in the complexity of financial products and a series of misselling scandals have encouraged regulators to tighten the rules on investments and to step in when savers lose out.

On 8 March 2018, Aviva announced it had received legal advice that it could cancel £450m worth of irredeemable preference shares at face value – the original issue prices at which they were first bought. 

The news triggered a slump in the preference share price from 170p on 7 March, the day before the Aviva announcement, to close to their face value of 100p a couple of days later, before recovering to around 150p a share on 27 March. Around 2,000 investors, who had sold their shares based on the news, were furious. The pref share price, at the time of writing in August 2018, has dropped to 146p.

Following an outcry from investors, fund managers and politicians, and after the launch of an investigation by regulators, Aviva backed down and on 23 March shelved the plans to cancel the preference shares. In April, Aviva said it would make a “discretionary goodwill payment” to offset investors’ £14m losses.

Aviva's pref shares were originally marketed towards retail investors, who make up the majority of the shareholders. Over 580,000 of retail investors could have been affected in terms of income. 

While that may have resolved the one-off issue, the debacle has raised questions over who is responsible when people invest in individual securities – and especially more esoteric ones.
What are preference shares?Preference shares (or prefs) are stakes in a company that take preference over ordinary shares. Their dividend is paid out ahead of ordinary shares and their investors can be ahead of ordinary shareholders for a share of the company’s assets in the case of bankruptcy.

Preference shares tend to pay a fixed dividend, known as a coupon, which makes them similar to a bond. Aviva’s prefs were sold to investors with a dividend of 8% to 9%, which tended to be higher than its dividend rate, which was 5.6% in its 2017/18 financial year. But Aviva's shares would not trade at a yield of 8% to 9% anymore. As at August 2018, the yield is at 5.85%. 

What made the prefs particularly attractive was that the prospectus said the shares were “irredeemable”. Aviva’s decision was based on legal advice, which said it was entitled to redeem its shares under the Companies Act to a “return of capital” in certain circumstances.

Mark Taber, an analyst and campaigner on preference shares, says institutional investors, who made up a third of Aviva’s prefs shareholder base, were “as livid as I have ever seen them“. He says Aviva didn’t have much choice but to concede, and it was right to do so. “Aviva had to back down. The way it went about it caused such a problem.” 

Mark says no prospectus he has examined disclosed the route Aviva used to repay the shares at face value. “I have been following [pref shares] for ten years and have never heard a squeak about it and the shares have been valued as if [what Aviva did] could not happen,” he says. 

He said for investors to know the potential liability they face, they would have to understand the Companies Act, relevant case law (law set by judges in court cases) as well as some European law. “That is nonsense if you are talking about something that should be a fairly basic share that trades on a leading capital market. Markets can’t function properly if that is what is needed to understand a simple security on the market.”
Investors need adviceThe FCA is considering launching an investigation into whether Aviva breached the EU’s Market Abuse Regulation in the way it released information. Chief executive Andrew Bailey has written to the CEOs of around 20 companies that issued prefs, asking them to clarify their position. 

The FCA published a 'Dear CEO' letter on the topic. It reads: “The FCA wants to ensure investors have access to the information that they require in order to properly assess the risks and rewards attaching to such shares.”

The picture is further confused by the fact that many prefs, including Aviva’s, were issued two decades ago and have been traded on public markets ever since.
 
In a letter to Nicky Morgan MP, chair of the Commons Treasury Select Committee, Bailey said it was possible much of the investment advice around these products would not have come from the original marketing material that accompanied the first sale of the shares in 1992 or the prospectuses. “Rather, it may be that investors have been influenced by or relied on more recent advice or statements or a more general view of the rights of these types of instruments.”

While institutional investors such as banks, fund managers and insurers have the resources to comb through prospectuses and keep a track of legislation, prospectuses for shares can be extremely thick and most people never wade through them. James Daley, founder of campaign group Fairer Finance, says the Aviva affair has highlighted the need to ensure retail investors have adequate information.

“If retail investors want to buy preference shares then maybe there has to be a greater effort to ensure they are aware of any restrictions or limitations,” he says. “It is clear from Aviva that people were not aware of potential limitations.”

While UK and European legislation and media campaigns have given consumers greater muscle to seek redress against losses on financial transactions – payment protection insurance being the most high-profile example – experts believe caveat emptor still applies in some circumstances.

Danny Cox, financial planner at investment management firm Hargreaves Lansdown, which does not give advice on individual equity holdings, says if an investor buys without advice it is down to them to understand what they are buying.

However, when a broker or someone offering discretionary or advisory services is recommending any type of instrument to their clients, they need to understand the risk themselves. “They have an obligation to explain to their clients what any change in the situation means for the securities in the portfolio,” says Danny. 
The next steps The market is waiting for a decision by the FCA and for other issuers to reply to Bailey’s letter. The FCA declined to comment on whether anyone had replied.

Given the wrath Aviva faced, it is unlikely any issuer of preference shares will attempt to cancel the shares using the Companies Act. “But the risk is still there,” says Mark. “There is a big issue to be resolved here and it should not happen in an efficient market.

He said that once the storm over Aviva has died down, he would not rule out someone having another attempt at buying back prefs at face value. “Times change and issuers have become a lot more aggressive in their approach to investors. If they see something as expensive funding, they start to look for ways to get rid of it.”