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Arch Cru and Keydata - the continued fall out

Arch Cru

Following the fourth anniversary of their suspension, Arch Cru funds have rarely been absent from the financial press, even being compared to the funds at the centre of the mid-90s scandal involving 'rogue trader' Peter Young. Many of the 20,000 individuals who invested approximately £422m in Arch Cru feel similarly dismayed at having placed their retirement funds and life savings in what initially seemed to be relatively safe products, only to see most of their investment value wiped out.

The relevant funds were two FSA-authorised open-ended investment company funds, the Arch Cru Investment Funds and the Arch Cru Diversified Funds. Both funds invested heavily in a collection of 24 'cell' companies which were based in Guernsey and listed on the Channel Islands Stock Exchange; however, the ultimate investments were placed in questionable assets such as Greek shipping companies. This eventually led Capita Financial Managers Ltd, the authorised corporate director, to suspend the funds in March 2009 on grounds of illiquidity, despite Arch Cru's stellar performance during the financial downturn in 2008.

The FSA was widely criticised in the financial press for its apparent delay in launching an investigation into Arch Cru, particularly in light of claims by Financial Secretary to the Treasury, Mark Hoban, that it had reviewed Arch Cru's promotional materials and had even made changes.

In June 2011, the FSA announced that a £54m voluntary 'Payment Scheme' would be set up for eligible investors in the funds, to help return a substantial part of their investments to them. The Payment Scheme is funded by Capita, BNY Mellon Trust & Depositary (UK) Limited and HSBC Bank plc, who all had a role in managing the funds. Compensation from the Payment Scheme must be accepted by 31 December 2013.

In December 2012, the FSA announced that it would also be launching a Consumer Redress Scheme (CRS). The CRS is in addition to the Payment Scheme. Firms that advised customers to invest in the CF Arch funds had to contact those customers by 29 April 2013 to find out whether they wanted their investment reviewed. Customers were required to respond by 29 July 2013 and firms then have until 9 December 2013 to let customers know the outcome of the review and whether they are entitled to compensation. Where compensation is owed, the CRS will put customers in the position they would have been in if they had received suitable advice in accordance with one of three benchmarks.

This is the first time that the FSA has fully used the power granted to it under Section 404 of the Financial Services and Markets Act (FSMA) to set up a CRS. This allows the FSA (and FCA) to make rules requiring firms to review their past business and pay redress where there has been: a widespread or regular failure; the failure has caused (or may cause) consumers loss about which they could go to Court; and the FSA considers it desirable to establish a consumer redress scheme, having regard to the alternatives. When proposing the CRS the FSA argued that 90% of Arch Cru sales by value were unsuitable.

Consumers who were advised to invest in the funds when they were managed by Insinger de Beaufort are excluded from the CRS, but may still complain in the usual way.

The FCA anticipates that 15%-30% of consumers will opt into the CRS. Taking into account returns from the investments themselves and compensation from the Payment Scheme, the FCA calculates that the CRS will deliver £20m-£40m in redress. The cost to IFAs (and their Insurers) is estimated at between £0.6m and £2.7m. A substantial burden will also fall on the FSCS which is currently administering claims from 1,800 customers in relation to 60 failed firms.

Keydata

Keydata was a product provider that designed and distributed structured investment products. These were distributed both directly and indirectly via IFAs. In addition to other activities, Keydata invested customers' money in bonds issued by one of two Luxembourg based companies, SLS Capital SA and Lifemark SA, which used the money to buy portfolios of US senior life settlement policies (life insurance policies). US policies were used as UK policies cannot be traded in the same way. These bonds were then sold in their thousands by IFAs throughout the UK.

The products sold were complex investment bonds, usually designed for a five year term and which generally promised high returns at a low risk. The bonds invested into a combination of cash and life settlements.

In mid-2009 it became apparent that several Keydata products had been sold as eligible for tax free ISA investment when they did not actually qualify, producing tax liabilities for both Keydata and investors. Keydata could not meet these liabilities and, in addition, the FSA considered that it would have to meet investor tax liabilities as it had incorrectly described the bonds as ISA eligible. As a result, the business was plunged into administration and at this stage the liquidator discovered significant funds appeared to have been misappropriated.

On 13 November 2009, the FSCS confirmed that Keydata was 'in default', as it could not or was unlikely to be able to meet claims made against it, meaning that investors with claims against Keydata could now claim on the FSCS. The FSCS has since paid compensation of over £300m.

Many investors who invested sums in excess of £48,000 (which is the FSCS's compensation limit) into Keydata products have sought compensation from their financial advisers by way of complaints to FOS and privately funded actions against IFAs.

In addition, the FSCS undertook a review of the sale of Keydata products by IFAs and subsequently issued proceedings against more than 500 IFAs worth in excess of £200m. These proceedings were initially stayed while the pre-action protocol process was followed and erroneous claims were weeded out (many relating to non-advised sales). Court orders are now in place to cover the way in which the action will proceed, with provisions for the selection of lead defendants and lead cases.

The FSCS says that the costs of these proceedings are estimated to be £7.7m in 2012/13 and similar for 2013/14. It expects total recoveries from the litigation be around £75m, to be recovered over the next two to three years. It has already recovered £30m from the Norwich & Peterborough Building Society which was investigated by the FSA in relation to its sale of Keydata products.

FSCS levy increase?

In February 2013, the FSCS confirmed spending on compensation for the 2011/12 year (which ran from 1 July) at £223m. It anticipated compensation of £323m for the 2012/13 year, reducing to £266m in 2013/14. The main reduction is £52m in the 'Investment Intermediation' class due to fewer anticipated compensation payments relating to MF Global UK Limited, Worldspreads Ltd and Pritchard Stockbrokers Limited, as a result of the FSCS's work on claims relating to these firms coming to an end. This will not result in a decrease to the FSCS levy over 2012/13, as that year was originally budgeted at £265m, with an additional £45m being raised by an interim levy on the investment and general insurance intermediation classes.

    This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

    Harriet Quiney

    Partner - Team Leader – Professional Liability & Marine

    I work in the Professional Indemnity team specialising in financial services, pensions and emerging risks.