Experts say the Financial Services Compensation Scheme’s legal battle against Keydata advisers is looking increasingly desperate and question whether it may be dropped after news that the scheme could now choose uninsured firms without legal representation as lead defendants.
Lawyers warn this could see firms racking up legal bills worth hundreds of thousands of pounds, which could force them into administration. They believe the FSCS is “getting desperate” in its bid to continue with a case that appears to be unravelling.
The FSCS has settled with five of the six original lead defendants selected in its long-running battle to recoup up to £75m out of around £400m paid out in Keydata compensation. As Money Marketing went to press, it was expected that a settlement would be reached with the remaining lead defendant Chase de Vere by the end of the week.
Since January, the FSCS has been seeking new lead defendants to take the case forward and in March FSCS lawyers Herbert Smith Freehills delayed a case management conference to give it more time to devise new criteria for lead cases.
The original criteria, devised in March 2013, required lead defendants to have insurance and legal representation. Firms also had to meet a set of technical requirements based on the claims against them, including having a certain number of both Lifemark and SLS-backed product sales.
This was intended to ensure the test cases covered a wide range of sales on which judgments could be made and applied to the remainder of the defendants.
But in a letter to advice firms, seen by Money Marketing, HSF says it will invite the court to make the following orders at a case management conference this Friday: that each defendant with claims worth over £150,000 be a potential lead defendant, and to remove the requirement that lead defendants have insurance and legal representation.
The letter says: “It is the FSCS’s view that the use of lead defendants represents the most appropriate way to advance the proceedings and that, given the significant number of settlements, a larger pool of potential lead defendants will be necessary.”
Money Marketing understands there are 74 firms in the pool with claims worth more than £150,000.
DWF Fishburns partner Harriet Quiney says: “This could capture small firms which have sold just one or two products. The concern is without insurance, a firm will have to fund their own legal representation – likely to cost around £200,000 or more – or represent themselves.
“The legal bill could easily cost more than the claim against the firm and could force firms into bankruptcy.”
Regulatory Legal solicitor Gareth Fatchett says: “Any lead defendant without representation is simply not going to be able to present the legal arguments well enough. This litigation is descending into farce with the likelihood of most defendants going bust increasing substantially.”
Advisers have also raised concerns that firms pushed into default as a result of the litigation could lead to higher FSCS levies.
Apfa director general Chris Hannant says: “The FSCS has assured me it is not their intention to put any firm out of business.
“So I would be concerned if we were entering a scenario where legal costs could push firms over the edge, not least because those costs are going to fall back on the sector. It is essential whoever is chosen has the ability and the means to be able to defend themselves.”
Others argue the court will not allow any firm which cannot afford to finance its legal costs to become a lead defendant.
The witness statement due to be given by HSF partner Kirsten Massey on behalf of the FSCS at Friday’s conference, seen by Money Marketing, argues firms’ ability to afford legal costs will be the key principle on which lead defendants are chosen. Firms will also be able to present evidence arguing why they should not be chosen.
The statement says: “It is accepted some of these potential lead defendants will, in fact, not be appropriate to be a final lead defendant. However, the FSCS does not consider the mere lack of insurance or representation is sufficient reason to preclude a potential lead defendant from taking an active role in the proceedings, not least because the firm may have other sources of funding to rely on beyond insurance.
“It is the FSCS’s view that the principal (but not only) consideration will be whether or not a defendant has sufficient means (taking into account its insurance coverage, financial position or otherwise) to fund the defence costs of the proceedings.”
Beale and Company partner Damian McPhun, who is representing a number of advisers in the case, says: “The original criteria ensured the lead defendants would cover a wide range of investors and circumstances but the new proposals mean all it comes down to is whether a firm can afford to pay for a defence. That means a lot of the logic behind having test cases has gone out of the window.”
McPhun says it is also unclear how the FSCS will determine which advisers can and cannot afford to be a lead defendant.
The managing director of an advice firm in the pool of potential lead defendants, who wishes to remain anonymous, says: “No financial adviser, including national firms, can
afford this without insurance. I have no idea why the FSCS has done this other than through desperation.”
Lawyers have also suggested the judge may object to firms becoming lead defendants without legal representation.
4 Pump Court barrister Peter Hamilton says such a move would be “inappropriate” and the principal behind the recent decision to throw out an FCA fraud case because the defendants failed to get legal representation should apply in the Keydata case too. He says: “The judge’s view that the defendants would not get a fair trial in that case applies here. Individuals cannot be expected to represent themselves in complex cases and, where they do, injustices are likely to occur.
“There is an argument to say the FSCS has come to the end of the road with this litigation.”
The FSCS is so far facing total legal costs of £30m in the litigation, close to half the £75m it said last year it expects to recover in Keydata compensation. It has also settled with many firms at a significant discount.
The organisation has set aside £7.2m for Keydata recovery costs in 2014/15, on top of £7.2m in 2013/14 and £7.7m in 2012/13. A further £7.9m was spent on pursuing recoveries, including Keydata, in 2011/12.
According to Friday’s witness statement, the number of defendants has reduced from 820 at the start of the proceedings to 205 currently.
“A lot of the logic behind having test cases has gone out of the window.”
Since the last case management conference in March 2013, the FSCS has reached settlements with 368 defendants and agreed in principle to settle against a further 49 firms.
Together, this represents 67 per cent of the defendants in the proceedings at the time of the last conference.
Quiney says: “As soon as a firm is selected as a lead defendant, it has a huge incentive to settle. So there is a risk the FSCS will have to keep replacing them with smaller and smaller firms.”
Another lawyer involved in the case says: “The FSCS may be expecting every firm with claims worth more than £150,000 to panic at the prospect of huge legal bills and rush to settle.”
A spokeswoman for the FSCS says: “The FSCS is committed to pursuing recoveries where it is reasonably possible and cost-effective to do so. This delivers significant benefits for levy payers and helps to offset the costs of compensation. We are committed to pursuing defendants in the Keydata proceedings.
“To determine whether a defendant should be a lead, the court is likely to consider whether the defendant has sufficient means to fund the defence costs of the proceedings.”
When the FSCS originally chose lead defendants, its concern was that firms might get into financial difficulties and the last thing it wanted was for a firm to drop out midway through the case because it had gone bust.
But with most of the insured firms having now settled, the FSCS is getting desperate. There are lots of firms left in the litigation with just one or two claims against them and £150,000 is quite a low limit.
The concern is that without insurance, a firm will have to fund its own legal representation, which in a case of this kind would be very expensive. Legal bills could easily run to £200,000 or more and how many advice firms have that kind of money? The other alternative would be for firms to represent themselves but in a case of this complexity that would be a nightmare.
It seems firms are being sucked into something which is way over their heads. There will be a lot of struggling businesses which have been ignoring this because they do not have insurance and hoping it would go away. There is a risk that as soon as a firm is selected as a lead defendant, it has a huge incentive to settle. So the FSCS would have to go to the next set of firms and the figures will get sillier and sillier.
It would be very difficult reputationally for the FSCS to discontinue the case so it is doing the only logical thing it can to take the case forward by expanding the pool of potential lead defendants. But this is going to cause huge problems for the firms involved.
Harriet Quiney is a partner at DWF Fishburns
Keydata legal case: The story so far
October 2011: FSCS instructs law firm Herbert Smith Freehills to bring legal proceedings against Keydata advisers – in a bid to recoup up to £75m in compensation paid out to investors – on the grounds that firms breached their duty of care and made false statements about the suitability of the products.
February 2012: FSCS offers Keydata distributors with claims against them of less than £50,000 a 50 per cent early settlement discount.
September 2012: FSCS settles 103 claims it was pursuing against firms.
March 2013: Case management conference held to determine how the legal action should proceed against firms being pursued by the FSCS and the criteria for selecting six lead defendants.
June 2013: Money Marketing reveals advice firm Financial Escape secured a 99 per cent settlement discount with the FSCS over client recommendations to invest in Keydata, paying just £400 in an out-of-court settlement.
August 2013: FSCS selects six lead defendants, among them Positive Solutions and Chase de Vere.
December 2013: FSCS settles with all of the lead defendants, with the exception of Chase de Vere.
January 2014: FSCS writes to other advice firms about becoming lead defendants.
March 2014: Case management conference due to be held in March is postponed until May after HSF asked for more time to consider the selection of new lead defendants.
April 2014: FSCS writes to firms informing them of its intention to expand the criteria for replacement lead defendants.
May 2014: FSCS proposes expanded criteria for replacement lead defendants at a case management conference. It expects to serve notices to new lead defendants in July.
Ian Thomas, director, Pilot Financial Planning: “If firms have done wrong then it is right they are made to pay and my main concern is that the cost does not fall on the rest of the industry through higher FSCS costs.”
Tom Kean, director, Thameside Financial Planning: “The FSCS seems to be moving the goalposts for the firms involved, which is
unfair, and appears unconcerned about the risk of firms going bust.”