Supplementary Memorandum by Justice in
Listening to the discussions on the immunity
that it is proposed to give to the FSA, it was clear that none
of the witnesses had given the detailed consideration of the subject
that comes with preparing actual cases.
As a result, I suspect the Committee has been
misled on three very important points.
The first is the difficulty that anybody bringing
a case against the FSA will face in persuading a Court to make
a finding or award compensation against the regulator. This includes
the European Court on Human Rights which allows competent authorities
considerable latitude in carrying out their tasks. There is considerable
case law on planning applications to support this point. In practical
terms, it will be very difficult to persuade a Court to act unless
there is clear evidence that the FSA has displayed significant
recklessness or carelessness or otherwise behaved quite disproportionately
or unreasonably. Anyone who brings a case without showing this
will have to pay the FSA's costs.
This is illustrated in the case of Melton
Medes v SIB, in which case the Judge awarded indemnity
costs to SIB. (It must be said that the plaintiffs in Melton Medes
do not seem to have had the sort of case that would win general
sympathy, in contrast to the position of our founder and others
forced into confessing to crimes they had not committed.) Indemnity
costs are usually only awarded rarely, against misbehaving litigants.
In this case, the Judge appears to have been motivated by the
lack of substantial merits in the plaintiff's case.
It also lies behind Lord Denning's remarkquoted
by the chairmanthat public bodies should not have to look
over their shoulders. The Committee has, I believe, been misled
into thinking that the immunity is essential to protect a regulator
doing its job.
The second point on which the Committee has
been misled relates to confidentiality. The chairman suggested
that the immunity might not apply to actions, for instance by
somebody adversely affected by "leaks". Melton Medes
was an action following a "leak" and the Judge held
that damages were not available for breach of the statutory duty
to maintain confidence. If damages are to be available to victims
of "leaks" then there will have to be specific provision
in the FSMB making damages available.
The thirdand most importantpoint
was not raised at all. The proposed immunity will apply not just
to companies. It will also apply to consumers.
There are very real reasons for allowing consumers
to take action against the FSA. The FSA will have the power both
to award compensation itself and to delay the Ombudsman from hearing
cases whilst it considers action itself. It is unlikely that the
Ombudsman will award compensation when the FSA does not. This
opens up the real possibility that the FSA will make errors that
The FSA may also damage consumers by taking
action against their advisers and either requiring or sanctioning
a transfer of adviser that damages consumer interests. Again,
the consumer will have no redress.
These are not remote possibilities. There are
two high profile cases in which the SIB made errors that either
threatened or actually did damage consumers. There are other cases
where regulators made mistakes harmful to consumers.
SOCIETY (WBBS) AND
The SIB became involved in the dispute between
the WBBS and action groups of elderly investors whose home had
been put at risk by borrowing from the WBBS on usurious terms
to finance investments that had gone terribly wrong.
Ultimately, this case was resolved in the High
Court, with damages of around £38 million being awarded against
the WBBS. The High Court found that the WBBS had entered into
an unlawful arrangement with the investment adviser responsible
and was thus liable for losses caused.
However, at an earlier stage of the proceedings,
the SIB had "negotiated" a package with the WBBS which
it commended to the elderly investors. This package was much less
favourable than the compensation awarded by the High Court.
Plainly, investors who accepted the package
recommended by the SIB would not have obtained the compensation
due in law. These investors, elderly people with low incomes,
are universally regarded as meritorious claimants, the very people
that the SIB was meant to protect.
It seems to us very clear that an immunity would
protect the FSA from claims in the High Court should it make a
similar, massive error. (It should be noted that immunity is not
the only issuesee below.)
The Knight Williams affair started with the
SIB ignoring the advice of the regulator directly involved, FIMBRA,
and assuming that Knight Williams and Company Limited had caused
clients to suffer heavy losses. In early 1994, when the SIB became
involved, it plainly believed that these losses ran into many
millions. It now turns out, following investigation by the ICS,
that the actual losses were on a far smaller scale that SIB envisaged.
It is possible that litigation will eventually establish that
losses were below £500,000. Given the size of the Knight
Williams client base, this is not a substantial sum and is close
to compensation that the firm wanted to offer but was prevented
from offering by SIB. Even the sum paid by the ICS under heavy
political pressure from Mrs Angela Knight, a former minister,
is well within what the firm could have afforded in 1994.
However, instead of encouraging the use of the
proper complaints procedure, SIB forced the firm to establish
a special complaints handling procedure. In November 1994 Mr Jeremy
Orme, SIB's then head of enforcement, urged all unhappy investors
to make use of the procedure and have confidence in the SIB.
The result was disastrous. Nobody "who
had confidence in the SIB" received compensation until 1997.
Some have only just received compensation from the ICSover
four years after SIB urged them to trust it.
The real victims were not unhappy investors,
numbering at that point around 400. Approaching 20,000 investors
have incurred losses as a result of the SIB putting Knight Williams
and Company Limited into liquidation. These are the investors
who had no complaints but, because SIB had destroyed their firm,
had to transfer the management of their funds.
The transfer was overseen by SIB: Mr Orme was
present in person when the arrangements to transfer management
were negotiated and concluded. So there can be no doubt of the
SIB's close involvement in every step of this affair.
The 20,000 investors whose investments were
transferred suffered losses for the following reason. All these
investors had a contract with Knight Williams and Company Limited
which provided for discretionary fund management. Knight Williams
and Company Limited was able and indeed did use the discretion
to alter exposures to particular markets. The investments were
structured so that a reduction in exposure to, say, Japan and
an increase in exposure to, say, America did not require the investors
to act and did not expose them to any liability for CGT or income
Under the transfer arrangements made with the
full knowledge of SIB, the investments managed by Knight Williams
were replaced by investments managed by another firm. But those
investments which were not in a PEP were split into separate holdingsso
much in the UK, so much in America, so much in Japan, so much
in the Far East. Altering the balance of the investments required
investors to act and exposed them to CGT. Those investments in
PEPs remained in a structure that allowed adjustment of the exposures.
As a result of work done by the ICS, we know
that the investments in PEPs performed substantially better than
the portfolios which were not in PEPs. As the same fund management
firm handled both sets of investments and as the initial exposures
of the PEP and non-PEP investments were similar, the under performance
of the non-PEP element seems entirely due to investors being locked
into Japan and the Far East as a result of arrangements approved
by the SIB and only made necessary by the SIB. The losses that
have resulted by the SIB breaking up the discretionary management
arrangement would appear to be in the order of £90 millionover
£4,000 for each of 20,000 elderly investors.
There are, we believe, other cases where investors
have suffered losses as a result of regulators deciding to close
firms, but none, we think, on this scale.
FSA BE PROTECTED
The losses incurred by investors in Knight Williams
as a result of what can at best be regarded as gross incompetence
on the part of a senior employee of the SIB must give rise to
doubt as to whether the FSA should enjoy an extensive immunity
from action. The FSA will have far greater powers to intervene
than the SIB does. The risk of errors must be higher.
The Knight Williams case has been the subject
of detailed work by a QC whose opinion has been made available
to the Clerks to the Joint Committee. This opinion shows that
there are complex legal issues that need to be considered, relating
not just to the immunity but to the duties that are to be laid
on the FSA and its legal liabilities.
Although it may involve considerable further
work, we believe that the interests of consumers cannot be adequately
protected unless the FSA is made liable for the consequences of
reckless, thoughtless or incompetent actions that cause heavy
losses for consumers. We have examined advice by a QC on the scope
for consumers to form action groups and use the Courts and are
entirely convinced that, were Parliament to allow consumers to
bring actions against the FSA in circumstances in which its actions
had caused losses, then this would be a realistic remedy.
We urge the Committee to consider this problem
most carefully. As the Committee has been told, firms (and individuals)
may well be able to overturn a statutory immunity by application
to the European Court of Human Rights as it appears to contravene
Article 6 of the Convention (which states that everyone has a
right to a fair trial). However, unless the Bill is carefully
drafted to give consumers adequate rights against a blundering
FSA, they may well be unable to make an application to Strasbourg.
13 April 1999