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Watchdog tethered

Many IFAs would be forgiven for thinking that once the Financial Ombudsman has reached its final decision, then there is nothing you can do, regardless of how arbitrary and capricious it may be.

However, this is not necessarily the case and last week an IFA successfully took a stand against the ombudsman under the guidance of Birmingham law firm, Financial Services Legal.

The only method available to IFAs to dispute a final decision of the ombudsman is to follow a legal process known as judicial review. This is a two-step process which involves obtaining permission from the court and making the application. After getting permission, the financial advisers – Garrison Investment Analysis – made its full application on August 23.

The case involved the sale of well known Scarps, structured capital at risk products, namely NDF3 and NDF5, to two investors who held an equity portfolio for many years. The investors made a complaint to the ombudsman in respect of recommendations made by the financial adviser to purchase the NDF equity products. In essence, the clients alleged that the financial adviser had failed to highlight the risks of those specific products as they had an unusual gearing. This gearing meant that if the Eurostoxx 50 index fell by 25 per cent in respect of NDF3 or 15 per cent in respect of NDF5, there would be a 2 per cent reduction in capital for every 1 per cent fall. However, this risk came with the reward of a high level of income.

After the initial adjudication, and two provisional decisions, the ombudsman made his final decision for which he was required to give reasons under the statutory scheme set out in the Financial Services and Markets Act 2000. The ombudsman upheld the clients’ complaint on NDF5 only and ordered the financial adviser to make redress to the investors.

The ombudsman determined that the appropriate level of redress was to be calculated at 1 per cent above the Bank of England base rate on the relevant capital sum which had been invested in the equity products. The decision and the calculation of the compensation formula formed the subject of a dispute over several months between the adviser and the Financial Ombudsman Service. When the adviser had exhausted all avenues of settlement available, it had no other option but to seek judicial review of the decision.

The adviser contended the ombudsman’s reasons for upholding the complaint in relation to the NDF5 product were unintelligible or inadequate. It also contended that the clients’ portfolio showed they would have invested in other equity products if they had not invested in NDF5.

Indeed, the clients went on to invest in other equity products after the final decision of the ombudsman. The adviser’s argument was that the ombudsman’s decision on redress was unreasonable and effectively gave the clients a higher return on their investment than they would have had if they had placed their monies in equities or on deposit.

In the circumstances of the case, the High Court felt it was plain why the ombudsman had reached its decision in upholding the clients’ complaints in relation to NDF5. The adviser disagrees with this stance as if the investors were aware of the risks of NDF3, the same principle applied to NDF5, notwithstanding the fact that a greater amount of capital was placed in these NDF products.

In respect of redress, the High Court found that the ombudsman had wrongly proceeded on the conclusion that the clients would not have continued to invest in equities, as opposed merely to investing in some less risky form of equity. Mr Justice Sullivan concluded that, on the evidence before the ombudsman, this decision had been irrational as there had been no logical connection between the error as found by the ombudsman and the redress awarded. Mr Justice Sullivan ordered that the issue of redress would be remitted back to the ombudsman.

The decision marks a sea-change in how the ombudsman must decide how to compensate complainants. The High Court has made it clear that the ombudsman’s policy of 1 per cent above base rate is not adequate and must take into account the real financial loss to complainants. Mr Justice Sullivan questioned the policy of awarding 1 per cent above base rate as it is not possible to achieve this level of interest today without some risk. This marks a victory for the IFA industry against the FOS and should lead to a change in the ombudsman’s policy on redress.

Mark Beesley is chairman of Financial Services Legal and Gareth Fatchett is a legal consultant


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