Capita Financial Managers wants to make advisers jointly liable for failings relating to Arch cru in a legal challenge from over 1,000 investors.
The firm is facing a legal challenge from Arch cru investors seeking compensation of around £36m who claim there were failings in its role as authorised corporate director of the funds.
But at a recent case management conference, Capita FM signalled its intention to issue “part 20” proceedings against advisers. This means if it is found to be responsible for investors’ losses, the redress will be paid both by Capita and the investors’ advisers.
Legal experts say the move conf-uses two separate issues – misselling and fund manager oversight – and has significant implications for fut-ure fund collapses as well as other Arch cru redress schemes.
Failings and redress
Capita FM acted as ACD for the Arch cru fund range between June 2006 and March 2009, when the funds were suspended.
In November 2012, the FSA censured Capita FM for “significant” failings in its role as ACD. The regulator found the firm did not have sufficient processes in place to monitor Arch Financial Products, the firm to which it delegated the investment management of the funds in July 2006.
The regulator found Capita FM failed to adequately identify and mitigate the conflicts of interest between Arch and the funds, which involved a complex network of onshore and offshore companies and private investments into assets such as Greek shipping and student accommodation.
The FSA said the breaches would ordinarily have led to a £4m fine but the firm could not fund this as well as its contribution to an investor redress scheme.
In June 2011, the regulator set out details of a £54m compensation package for Arch cru investors.
Capita FM’s parent company Capita Group contributed £32m to the scheme, with depositories HSBC and BNY Mellon paying the remainder.
The deal aimed to give investors an average of 70 per cent of the net asset value of the fund range when it was suspended, later revised down to 64 per cent. If accepted, investors could make no further claims against the three firms.
Separately, the regulator set up a consumer redress scheme requiring all advisers who advised on Arch cru to write to affected clients inviting them to opt into the scheme.
In January, the FCA said 48 per cent of customers had opted into the scheme and advisers would pay out £31m in compensation.
But the investors involved in the group litigation order against Capita are not covered by the redress scheme. Those not covered by the scheme include execution-only investors, clients of discretionary managers, those whose losses exceed £150,000 and professional trustee investors.
Pointing the finger
Clarke Willmott partner Philippa Hann, who is acting on behalf of advisers in the case, says: “Capita FM is saying: ‘If we are to blame, then the advisers who sold the funds are also to blame, and we will claim a contribution to the redress from them’.
“This is confusing two entirely separate issues: Capita FM’s responsibilities as an ACD and advisers’ responsibilities to their clients.”
The investors allege Capita FM failed to achieve a prudent spread of risk in the fund, failed to put in place adequate risk management, and failed to ensure the prospectus properly described the funds.
The case, which is due to be heard at the beginning of 2016, will see 15 investors selected as test cases. These findings will then be applied to the remaining investors.
Provided Capita FM’s part 20 claim is approved by the judge, if it is found liable to the investors, then it must also prove the advisers in the test cases were negligent.
This evidence will be used as a guide to determine whether the remaining advisers should contribute to the settlement.
It will be down to the court to decide what proportion of the costs advisers should pay.
Experts say it is not appropriate to apply a blanket decision to firms as the advice will be different in each case and bringing advisers into the litigation will lead to delays.
Harcus Sinclair partner Damon Parker, who is acting for investors in the case, says: “The investors’ claims are generic: everyone makes the same allegations. But if Capita makes a Part 20 claim, then they will have to go into the detail of the advice that every claimant received, because the advice will have been different in each case.”
Experts say the case could also impact how much redress is paid by advisers who are not involved in the case. ValidPath network development director and former IFA Centre managing director Gill Cardy, who spearheaded the litigation against Capita FM, says: “What Capita FM is seeking to do is inappropriate beyond belief. If it believes there is a valid case against advisers to share in their losses, then advisers must have a valid case against Capita FM to share in their own losses – the argument cuts both ways.”
Cardy says advisers are investigating the possibility of launching a counter claim against Capita FM.
Hann says there are “prospects” for launching a counter claim, which could see advisers who paid out under the FCA’s redress scheme seek compensation from Capita FM.
She says if advisers are made to share the blame this would also create a precedent for other investment collapses, which could see advisers held jointly accountable for fund managers’ failings.
“This is advisers’ opportunity to right the wrongs of the FCA’s redress scheme, which many felt held them unfairly responsible,” Hann says.
Parker says the majority of claimants in the case do not want their adviser to be held to account.
Ann Height chairs the Arch Cru Litigation Committee, a steering group which represents the interests of Arch cru investors. She says: “I feel very strongly that advisers should not be blamed for this. Capita is seeking to distract attention away from itself and I am concerned this distraction will lead to delays and higher costs in the case.”
When setting out its Arch cru redress scheme in December 2012, the FSA concluded the funds should only have been recommended as high risk to customers.
It said: “Based on the material that an IFA either had or should have had, a reasonably competent IFA should have concluded that the Arch cru funds were high risk investments.”
Hann says: “Advisers relied on the information in the prospectuses and many did a great deal of due diligence. In many cases this was a very small part of their clients’ portfolio, accounting for less than 5 per cent of their investments. So for Capita to simply point the finger at advisers and say that was sub-standard advice because you did not tell the client it was high risk is very unfair.
“Capita really has to ask itself if they are going to attempt to deflect criticism on to the very hand that feeds it, what message does that send to advisers?”
DWF Fishburns partner Harriet Quiney says advisers could not have known what the funds were invested in. She says: “The difficulty in this case is the funds were higher risk than anybody thought they were going to be. The question is whether the advisers could have reasonably determined the risk based on what they knew at the time. “The nature of the investments was not as stated in the prospectus in that the funds were not properly diversified and substantial proportions of the funds were invested in Guernsey. Advisers could not have known the funds were going to be invested in this way.”
Equilibrium Asset Management investment manager Mike Deverell, who advised on Arch cru, says Capita appears to be “passing the buck” and argues the appropriateness of advice must be looked at on an individual basis.
“Telling customers Arch cru was a relatively high risk, illiquid investment but would be suitable for diversification is very different to saying it was a cautious fund,” he says.
“Advisers should have asked the right questions but they were relying on the information given, largely by the ACD. Capita has not put its hands very far in its pockets for its role in this debacle.”
A spokeswoman for Capita says: “Any claims made against Capita Financial Managers will be vigor-ously defended and any such defence will be lodged through the appropriate channels at the relevant time.” The spokeswoman refused to comment further.
For those hoping the industry was finally rid of the Arch cru fiasco, it seems the battle is far from over.
Other Arch cru litigations
The FCA’s legal challenge against Arch Financial Products:
The FSA published decision notices against Arch Financial Products, Arch FP chief executive Robin Farrell and compliance officer Robert Addison in December 2012 seeking to issue a public censure against the fund manager and fine and ban Farrell and Addison. All three parties referred their case to the Upper Tribunal. The tribunal case was heard in May and a decision is still pending.
The Guernsey cells’ legal challenge against Arch Financial Products:
The board of 18 Guernsey-listed cell companies that made up the Arch cru funds brought legal action against Arch Financial and Arch FP chief executive Robin Farrell in December. The court is yet to announce its decision.
March 2009: £391m Arch cru fund range suspended
November 2012: FSA censures Capita Financial Managers in relation to its failings as authorised corporate director of the Arch cru fund range
December 2012: FSA publishes decision notices against Arch Financial Products, Arch FP chief executive Robin Farrell and compliance officer Robert Addison seeking to issue a public censure against the fund manager and fine and ban Farrell and Addison
December 2012: FSA publishes final details of its Arch cru redress scheme, which states the funds should only have been recommended to high risk investors
March 2013: IFA Centre instigates a legal case against Capita Financial Managers on behalf of Arch cru investors who are not covered by the FCA’s consumer redress scheme
April 2013: FCA launches its Arch cru consumer redress scheme
October 2013: FCA writes to a sample of advisers over concerns their opt-in rates for its consumer redress scheme are too low. Advisers were later given the all-clear
Dennis Hall, managing director, Yellowtail Financial Planning
Capita FM has been trying to shirk its responsibilities for Arch cru since it collapsed. If in its role as ACD it has been found to be negligent, then that must be dealt with first – to bring advisers into the case is to muddy the waters. If investors want to make a complaint against their adviser there are separate avenues for them to do that.
Martin Bamford, managing director, Informed Choice
The case is about alleged failings in Capita’s management of the fund and not alleged failings in the suitability of the advice, which has already been dealt with by the FCA. Arch cru is like a bad rash which refuses to go away and is continuing to damage the industry – by seeking to pass the buck, Capita is making the case drag on for longer.
Expert view: Capita can’t pin this on advisers
We have known since November 2012 of Capita Financial Managers’ failings in the management of the Arch cru funds, retail investment funds with 20,000 investors and over £400m invested.
Around 1,000 investors thought their offer of compensation was inadequate and, following the FSA’s enforcement notice, that Capita was to blame. Their High Court case, once dismissed by Capita as “posturing”, is in full swing.
Capita, in this latest development, wishes to share its liability with the advisers who did not spot its failings. In essence it is saying: “We are not guilty of the rule breaches but just in case we are, IFAs are also guilty of not spotting them.”
Remember, we are discussing fund accounts and auditing, valuation and pricing, identifying and managing conflicts of interest, ensuring a true market in the underlying investments, proper diversification in the funds, prep-aring accurate prospectuses, yearly and half-yearly fund reports and managing the legal and compliance aspects of managing a fund.
There is a regulatory document, the Responsibilities of Product Providers and Distributors, which makes clear providers have their part to play and it is not advisers’ responsibility to check everything that an authorised and regulated third party does, the bulk of which is simply not visible.
Several retail fund managers found wanting in the same areas have simply acknowledged their errors and corrected things, without investors having to resort to legal action and having to act against their advisers.
Capita manages over £20bn, a great deal of which is introduced by advisers.
When advising on funds do you query the identity and regulatory history of the ACD? Why should you or your clients or your professional indemnity insurer take the risk that if things go wrong, there will be a battle and one which blames advisers for things that could never reasonably be their fault.
Gill Cardy is network development director at ValidPath