The market turmoil caused by economic conditions over the past few years has spurred a large number of claims against independent financial advisers (IFAs). The UK’s regulatory bodies have also taken steps against IFAs who sold Keydata and Arch Cru investments, which have caught many IFAs by surprise. We look here at a number of recent developments.
FSCS’s Keydata action
The Financial Services Compensation Scheme (FSCS) began paying compensation in 2010 to individuals who lost their Keydata investments. In November 2011 and May 2012 FSCS commenced litigation to recover those payments from the IFAs who had sold the products, even though those IFAs said they had relied on Keydata’s promotional materials (as they are entitled to under Financial Services Authority (FSA) Rules).
Although the scope of an IFA’s duties is normally determined by the relevant FSA Rules, this case is somewhat unusual. FSCS has not reviewed the individual investor files, but has served generic pleadings, with the action supported by a FSA policy statement (made a few days after service) that these are high risk and “toxic” investments. This is in contrast to the FSA’s earlier file reviews which did not class these as high risk investments.
FSCS has indicated that it is willing to settle these claims for a 50 per cent payment. This broad brush approach places inordinate pressure on individual IFAs to settle, regardless of whether they believe they mis-sold the investments. Ironically, FSCS’s claim has already led one IFA to become insolvent, with the result that FSCS will now need to compensate its clients for other product claims.
What caused the losses?
Investor losses often arise from market drops or the financial collapse of other institutions, rather than as a result of their IFA’s involvement. In Rubenstein v HSBC Bank plc the lower court decided that although the IFA had failed to meet the FSA’s regulatory requirements, the loss was caused by general market turmoil after Lehman Bros collapsed. This was unforeseeable by the IFA in September 2005, and only nominal damages were awarded.
This decision caused a flurry of excitement amongst IFAs’ solicitors until it was overturned by the Court of Appeal (see Mills & Reeve’s briefing) The Court of Appeal appeared tacitly to accept, however, that in other circumstances, market turmoil could break the link between the loss and the IFA’s negligence.
The Financial Ombudsman Service (FOS) reached a similar conclusion in Mr W v an IFA. In what many found to be a surprising preliminary decision, Chief Ombudsman Tony Boorman decided that although the IFA was negligent (due to the FSA’s guidance that Keydata bonds were high risk investments), the IFA had tried to meet the investor’s needs with a balanced portfolio. Since the IFA could not have foreseen the Keydata fraud which led to the loss, he was only directed to pay nominal compensation.
We are yet to discover whether this becomes a final decision. FOS has wide discretion to decide what is “fair and reasonable in all the circumstances” and the preliminary decision is potentially inconsistent with FSCS’s litigated claim.
More recently, it appears that FSCS has become concerned that larger value defendants in its Keydata litigation have not initiated settlement discussions. It therefore asked the court to order the “top 10” IFA defendants by value to mediate. Fortunately the court refused, noting that although it could make such an order, it could not force IFA defendants to settle.
Whilst it is encouraging that the judge took a pragmatic view, the approach adopted by FSCS in this litigation will concern all IFAs and their insurers, since it appears designed to shift the costs of investigating what may be wholly unmeritorious claims onto them.
Similar issues have arisen in connection with Arch Cru compensation.
The FSA has set up a £110 million redress scheme under section 404 of the Financial Services and Markets Act 2000 which requires IFAs to review their advice and compensate Arch Cru investors where recent FSA guidelines are not met, even if the investor has not complained to their IFA.
This is in contrast with the £54 million compensation package paid by Capita Financial Managers, BNY Mellon and HSBC Bank, whom most see as responsible for the Arch Cru investments’ failure. Under these arrangements, investors who have sought compensation from Capita through FOS have had their complaints rejected, and been forced to accept the settlement, leaving a shortfall in their recoveries unless they claim against their IFAs.
The actions taken by the various regulatory bodies are therefore serving to increase the costs of insurance and the risks for both IFAs and their insurers. These are moves towards a regime of strict liability where IFAs are presumed responsible for investors’ losses, unless proven innocent.
(Henrietta Gordon is advising insurers regarding the FSA’s proposed consumer redress scheme for Arch Cru investors and in relation to Arch Cru claims brought against IFAs. Debra Kirkwood has been defending Keydata claims since shortly after Keydata was put into administration in 2009.)
Authors: Debra Kirkwood and Henrietta Gordon