House of Commons - The failure of the Presbyterian Mutual Society

The failure of the Presbyterian Mutual Society - Treasury Contents

2 Roles and responsibilities

The activities of the Society

18. The annual returns filed by the PMS were prefixed by a statement of registration under the Industrial and Provident Societies (Northern Ireland) Act 1969. However, no mention was made of any regulation that applied to the Society and the activities that it carried out. The activities of PMS underwent a significant change in nature over the 5 years running up to its administration. In 2002 an information leaflet produced by PMS proclaimed that the directors did not speculate with members' funds entrusted to their care. In contrast, in a buoyant Chairman's review in 2005, Rev. Sidlow McFarland reported the purchase of 3 properties in the UK at a cost of £27 million to add to the Society's fledgling commercial portfolio.[8] Members of the PMS were informed that this course of action was necessary "in order to maintain the high level of dividend paid to members" but were reassured that the Loans Committee was always "very careful about lending your money" and there was "always ample money" to support any members that were in need.[9] A further addition was made to the property portfolio in 2006, bringing the number of commercial properties to 10, then worth £106 million.[10] The Society also continued to make mortgage advances.

Figure 1: Total assets of the Presbyterian Mutual Society

Source: PMS Annual Returns, 2000—2008

The year of administration

19. By March 2008, the picture had changed somewhat. In June 2008 the annual report for the year ended 31 March was issued for the first time not with a full set of accounts but a summary financial statement. This change of format was attributed to "the common practice of financial institutions".[11] As a reflection of the brewing subprime mortgage crisis and unrest in the financial sector the outlook appeared to be more subdued, with the Chairman's Report admitting that the "challenge" of the economic climate had "obviously gained strength".[12] It was necessary, he said, to approach the situation with "calmness, patience and confidence".[13] The value of the property portfolio had fallen and no further purchases were made. The provision for bad and doubtful debts increased, to cover the "very substantial" size of the loan book which was then valued at £175 million.[14]

Figure 2: Bad debt provision

Source: PMS Annual Returns, 2000-2008

20. At the time of its administration, the PMS's commercial property portfolio comprised thirteen office and retail units, of which twelve were in Great Britain. These were let out to a variety of banking and retail tenants. A valuation commissioned in December 2008 advised that this portfolio was valued at around £92 million, however in December 2009 it was revalued at £97 million. This still reflects a 26% decrease from the purchase cost.[15]

21. Unfortunately, the economy in Northern Ireland had begun to suffer in much the same way as in Great Britain, reeling from the cessation of a boom in property prices and supply of credit. The PMS was not the only organisation to be caught by the fall in commercial property prices, and the effect of the recession on its tenants. As a result many of the Society's commercial and residential mortgagors were unable to fulfil their obligations and fell into arrears, exacerbating the problems that the PMS began to face. The PMS also entered into a small number of "regulated mortgage contracts".[16]

The directors of PMS

22. The immediate cause of PMS's failure was lack of liquidity. The PMS itself had identified the potential loss of liquidity as a future risk. In the directors' report for 2008 it is stated that "the directors have conducted a review of the major risks to which the Society is exposed".[17] One of the risks identified was liquidity risk, and the directors' management policy was stipulated to be carried out by "ensuring sufficient liquidity is available to meet foreseeable needs."[18]

23. Sammy Wilson MP MLA, the Northern Ireland Minister for Finance told us that if the run on the Society had been avoided it was not a foregone conclusion that insolvency would have been a future problem as "the PMS had been operating since 1982 and it always had the on-call or on-demand facility available to its members and there had not been any trouble up to that particular time" and "the evidence is that for a long period there was stability there."[19]

24. The immediate cause of the Society entering administration was the run on its funds, and that run was prompted by the realisation that funds in conventional banks were safer than funds in an IPS. However, currently the Society has a deficit of £123 million.[20] The assets of the PMS were badly affected by the general financial crisis and by its non-residential lending strategy. The Administrator has submitted a confidential report on the Board's conduct to DETINI, which now has to decide whether to start disqualification proceedings. It is early to judge the degree to which the directors were culpable rather than unlucky, but nothing we say later in this Report should detract from the fact that it is the duty of directors to ensure their companies are properly run.

UK Government

25. Sammy Wilson told us that:

there is some anecdotal evidence to indicate that some of the local banks were making this [the UK Government's implicit guarantee of all bank deposits and that the monies in PMS were not protected] known to customers and indicating that money would be safer with the local banks rather than with the PMS, that started the run.[21]

It has been suggested that the actions of the UK government in creating a preferred class of financial institutions to the detriment of others[22] were blameworthy. The Government guarantee of bank deposits may have alerted members of the Presbyterian Mutual Society to the risks they faced, but it did not create those risks. Moreover, although it is theoretically possible that the Society might have survived the run and continued to prosper, it is more likely that the gap between its assets and its liabilities would have emerged in due course. Members would have been exposed to even greater losses.

Should anyone have identified the danger?

26. In the United Kingdom, as we have seen, credit unions are regulated by the FSA. Industrial and provident societies are not so regulated, but they too have to be registered. The FSA is responsible both for the registration function and the regulation function. This co-location of responsibility means that the registrar is well placed to draw the attention of the regulator to registered bodies which appear to be straying into regulated business.

27. In Northern Ireland, industrial and providential societies are registered by the Registry of Credit Unions and Industrial and Provident Societies (the Registry), which is a function retained by the Department of Enterprise, Trade and Investment (DETINI).[23] The Registrar has some regulatory functions for credit unions (which are much more restricted in what they can offer in Northern Ireland), but has none for industrial and provident societies. The function of the Registry is to hold a register of the 180 IPSs operating in Northern Ireland, and to make sure their annual returns are filed.

28. The FSA told us:

Under both I&P Acts [Industrial & Provident Societies Act 1965, the Act which applies in Great Britain and the Industrial & Provident Societies Act (Northern Ireland) 1969], the registering authority (DETI or FSA) must be satisfied that a society meets one of the specified conditions for registration set out in section 1(2) of the respective Acts and that it continues to do so throughout the period during which it is registered.[24]

The Act under which industrial and provident societies are registered in Northern Ireland provides for them either be registered as a 'bona fide co-operative' or a 'community benefit society'. The rules of the PMS indicate that it was registered as the former. The FSA told us:

The Acts do not define a 'bona fide co-operative', so it is a matter for DETI (and the FSA in Great Britain) to determine the characteristics which an applicant society must exhibit in order to qualify for registration. [...] In addition, and while there is no obligation on us to do so, we take account of the regulatory consequences of registration under the I&P Act, which include exemptions from the protections provided by FSMA. So if, for example, we consider that a society's activities would be better suited to an alternative model, such as a building society or a credit union, we would advise the applicants of this.[25]

29. The witnesses from the Northern Ireland Executive stressed the limitation of the Registrar's powers in relation to IPSs. Mr Mike Bohill, Head of Business Regulation Division, DETINI, told us:

the Registrar's function is essentially around ensuring the efficient operation of a registry, making that available to the general public and then also dealing with any complaints that might be made against, for example, an IPS by a member or a member of the public or a member of the professions. During the course of the PMS itself we received no complaints about the PMS from any member at all. It is a registration function.[26]

30. However, this limitation might not have been apparent to an ordinary member of the public before the collapse. DETINI's Corporate Plan 2002-2005 and Operating Plan 2002-2003 stated that "DETINI is responsible for regulating Credit Unions and Industrial and Provident Societies in Northern Ireland" and set out one of its priorities for community enterprise policy development as seeking to "build on this role with a view to maximising the contribution such organisations might make to the Social Economy."[27] An equality impact assessment on this policy carried out in 2003 reminded the reader that key functions of the Registry are "the exercise of prudential supervision over the affairs of credit unions and limited monitoring of other societies" and "provision of a legal framework for the proper regulation of […] industrial and provident societies to keep pace with EU and GB developments, and brief Ministers, officials, companies, societies and professional bodies on policy and legislation."[28]

31. It was the opinion of ministers at the DETINI that there was no 'gap' in the function of the Registry. Ms Arlene Foster MLA told us that "Essentially, it is up to those IPSs. If they are carrying out activities that need to be regulated by the FSA, they need to alert the FSA to that and then become regulated by the FSA."[29]

The Financial Services Authority

32. The FSA states on its website that "A[n industrial and provident] Society is responsible for considering whether any of its activities are regulated activities" and if this is the case, "the Society must […] apply for authorisation from the FSA for the conduct of such activities."[30] The system is 'opt in' rather than 'opt out'. However, the FSA also told us that it took steps to mitigate the risk that registered societies were engaging in activity which should be regulated:

Our mutuals registration team examines each society's rule book both at the time of first registration and when applications to register subsequent alterations to rules are received. This is because, as mentioned above, the FSA has to be satisfied that a society qualifies for registration; the rules under which it will operate are fundamental to this consideration. If it is evident from examination of the rules that a society wishes to carry on an activity for which authorisation under FSMA might be required, we advise it to consider whether it should apply for authorisation, although there is no statutory obligation on us in our capacity as registering authority to do so.[31]

33. In contrast, Ms Arlene Foster MLA was adamant that "it is not our [the Department of Enterprise, Trade and Investment's] function" to review the activities or even notify any industrial and provident societies that they were required to carry out such a process themselves, since if that was done for IPSs, "it would have do be done for everybody."[32]

34. Ms Foster was clear: "If the FSA decide that they may need to do more work around alerting people that they need to be regulated, that is a matter for the FSA."[33] We consider the extent to which there should be publicity about the level of regulation offered later in this Report. Here we note that there is a limit to the activities that a Regulator can undertake. If it is unreasonable to expect DETINI to alert individual bodies to the possibility they may need to be regulated by the FSA, it is still more unreasonable to expect the FSA to be able to identify and alert all bodies which may be carrying out activities which require authorisation. Companies which are carrying out activities which should be regulated by the FSA have the primary responsibility for identifying that fact, and seeking the necessary authorisation.

Filling the regulatory gap

35. Even if the Registrar's functions are limited and primary responsibility for seeking authorisation for regulated business must rest with the companies concerned, that does not mean there is no government responsibility for the regulatory framework.

36. The PMS grew rapidly in the six years prior to its administration. Between 2002 and 2007, the average yearly increase in value of the assets was 58%. A set of accounts was filed with the Registry each year. It is the Registrar's duty then to submit an annual report to DETINI. The annual report filed by the Registrar before the collapse of the PMS clearly states:

The main priorities of the Registry of Credit Unions and Industrial and Provident Societies are:

i. the effective prudential supervision of credit unions;

ii. the efficient administration and, where appropriate, enforcement of society law and codes of conduct; and

iii. the provision of an effective public search facility.

The Registry does not exercise any prudential supervisory role in relation to industrial and provident societies.[34]

37. Had DETINI been more alert it might have spotted a potential problem. When we asked whether problems might arise in relation to other IPSs we were told:

When the difficulties were apparent with the PMS we undertook a desk exercise reviewing all the business activities of the other roughly 180 industrial provident societies in Northern Ireland and none of them was offering a business model similar to the PMS.[35]

Clearly it was possible for the Department to take action to assess the risks, once the risks were apparent, whatever the legal position. It should have been possible to take such action earlier.

38. We understand that the Registrar had no regulatory functions in relation to industrial and provident societies, and could take no action. But we do not believe that the Department of Enterprise, Trade and Investment NI was so circumscribed. We note DETINI's opinion that it was not their legal responsibility to regulate the PMS or manoeuvre them into regulation. We are dismayed, however, that the Department had access to all the relevant information and yet this did not result in any preventative action or further examination being undertaken. We are surprised that DETINI did not consider whether the regulatory gap needed to be filled. This might well have entailed action in London as well as in Belfast, but as the department closest to the problem, DETINI should have taken a lead in identifying the problem, and in seeking a solution.

The role of the church

39. The Society was, as its name suggests, linked to the Presbyterian Church in Ireland although it is a separate legal entity. Its membership was limited to members of the church. Six of its directors were current or former ministers. It appears that for some members the affiliation was so close as to warrant no distinction. This association also encouraged people to become members. Mrs Smyth, a member of the PMS, told us that by nature the members of the PMS were extremely cautious, especially in the arena of financial decision making. They "took comfort, […] from the fact that the literature did say that the organisation was being run by experienced laymen and clergymen and also that it did not speculate."[36] She also told us that "at the General Assembly [of the Presbyterian Church] each year there was an endorsement, […] and there was also a pulpit call during the summer of 2008 for people to place their savings within the PMS."[37] The growth of the Society should have been accompanied by a review of its governance.

40. The Church has been described as "very effective marketing representative" for the PMS and "money was given to the Presbyterian Mutual Society because of the encouragement from the Presbyterian Church."[38] Ministers regularly gave assurances that "PMS money was as safe as the Rock of Gibraltar."[39]

41. The Presbyterian Church has also suffered from the Society's collapse. Some churches invested their money in the PMS. David Simpson MP MLA, member of the DETINI Committee, told us that "a lot of the churches were caught in the middle of building programmes […] and then everything went askew and they were left trying to go to their congregations to try and find the resources in order to finish those building programmes."[40]

42. The congregations of Presbyterian Church in Ireland have suffered as a result of the PMS collapse, both as individuals, and collectively. Legally, it appears that the Church has no liability. However, the Society was linked to the Church, its role was advertised at the General Assembly, it was the subject of pulpit calls and it enthusiastically endorsed by many of its ministers. We consider that the Church cannot evade responsibility for what happened, and should consider whether it can help in any way.

Should members of the Society have known?

43. We pressed the members of the Society as to why they had considered their investments were safe, particularly when the Society's accounts were showing such a rapid expansion and such a change in its business. Firstly, they assumed that the church would only recommend a safe investment. Secondly, having assumed their money was safe, there was little in the information produced by the Society to warn them that this was not the case. As Mr Lynn, who was not a member of the Society, but assisted their lobby group, explained:

a lot of the people who were savers were lay persons who would not have looked in any detail at the accounts, relying on the assurances they were given by various elements of the Presbyterian culture, and therefore I do not think that those accounts were examined. On none of the accounts of the last two or three years was any comment made by the auditors that there were concerns about the financial structure, whereas if one did have a trained eye on those accounts, there was evidence that the liquidity position was weakening as it moved forward.[41]

44. The marketing material produced by the Society contained assurances that investments were safe. An undated information leaflet contained the following:

Facts for Investors

Q Is my investment safe?

A The Directors give a categorical assurance that they do not under any circumstances speculate with investors' monies entrusted to their care, but use such funds specifically for the purpose of advancing loans to those shareholders who wish to borrow from the Society. Monies that are not out on loan at any given time are invested on the best terms available within the established clearing Banks in Northern Ireland.

On 12 November 2008, the Belfast News Letter reported:

…On its website the society gives an assurance that it does not speculate with its shareholders' funds.

It declares: "The directors give a categorical assurance that they do not under any circumstances speculate with investors' funds entrusted to their care, but use such funds specially for the purpose of advancing loans to those shareholders who wish to borrow from the society.

"The society uses surplus funds to purchase commercial property from which it derives a rental income and retains a percentage of the total capital in cash that is invested in established banks in Northern Ireland."[42]

45. In our view, a more accurate answer to the question "is my money safe" would have been along the following lines:

The directors use the funds deposited principally for the purpose of advancing loans to those shareholders who wish to borrow from the society.

The society uses surplus funds to purchase commercial property from which it derives a rental income and retains a percentage of the total capital in cash that is invested in established banks in Northern Ireland.

However, it is possible that not all loans will be repaid. Commercial property is a risky investment whose value may go down as well as up. The Society is a registered IPS but it is not regulated by the FSA and its members do not have access to the Financial Services Compensation Scheme.

46. After the financial crisis it is likely that members would have asked questions about an institution which was not clearly regulated by the FSA. Before the crisis, such matters were not uppermost in ordinary people's minds. Moreover, in Northern Ireland, credit unions are far more prominent than in Great Britain. They have a (voluntary) deposit protection scheme and are subject to some regulation. The Presbyterian Mutual Society would have appeared a far less unusual place to put money than it would in Great Britain. As Mr Durkan told us:

Essentially people believed that the Presbyterian Mutual Society, like other industrial and provident societies, was being regulated. In many ways many of us in the conduct of exchanges of business would have referred to officials in the Department of Enterprise, Trade and Investment as the Regulator. Of course, it was when the committee had those officials in front of us after this situation that they were clarifying that such a regulatory role as they had was merely a registration role…[43]

If the Chairman of the Northern Island Assembly Committee on Enterprise, Trade and Investment believed the PMS was regulated, it is no surprise that ordinary people made the same assumption.

47. It was clear from our evidence that many people objected to the description of members of the Society as investors, though they received annual reports showing the extent of PMS' commercial lending. The use of the term 'investors' was taken to imply that they should have been aware of the unregulated nature of the Society and have accepted that their shareholdings were at the same risk as other shares. We note that PMS shares were withdrawable on demand, and fixed in value: it is understandable that PMS members considered them as analogous to deposits in a building society.

48. In our Report on Northern Rock we noted that depositor protection schemes should be simple and well advertised. The case of the Presbyterian Mutual Society has demonstrated, once again, how little information was available to ordinary people about the organisations to which they entrusted their money. We consider that in future there has to be far clearer information given to those who make savings and investments about the way in which organisations are regulated, and the extent of any guarantee provided.

8 Chairman's Review, PMS Annual Report and Accounts for the year ended 31^st March 2005 Back

9 Ibid. Back

10 Financial Review: Property, PMS Annual Report and Accounts for the year ended 31^st March 2006 Back

11 Financial Review, PMS Annual Report & Summary Financial Statement for the year ended 31^st March 2008 Back

12 Chairman's Review, PMS Annual Report & Summary Financial Statement for the year ended 31^st March 2008 Back

13 Ibid. Back

14 Financial Review, PMS Annual Report & Summary Financial Statement for the year ended 31st March 2008 Back

15 Paragraph 6.7, Administrator's Six Monthly Progress Report, 15 December 2009 Back

16 Article 61(3), FSMA 2000 (Regulated Activities) Order 2001 Back

17 Annual Return, year ending 31 March 2008 Back

18 Ibid. Back

19 Q3 Back