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Why your PII costs could rocket, if the FSA has its way

by: Robbie Constance
  • 31/10/2011
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Why your PII costs could rocket, if the FSA has its way
An FSA proposal to change the law could leave mortgage brokers and lenders facing huge liabilities and PII premiums, explains Robbie Constance, senior associate at law firm Reynolds Porter Chamberlain.

The draft Financial Services Bill is currently being considered by a Joint Committee of both Houses of Parliament.

The FSA has raised for consideration the idea that regulated firms should, in effect, be strictly liable to clients for any losses they suffer, even if the losses were not caused by the firm’s rule breach or unsuitable advice.

In short, the FSA is inviting Parliament to change the law so that the Financial Conduct Authority (FCA) will, in future, be able to disregard a basic principle of law and force financial services firms to provide 100% redress to customers.

What are the FSA’s proposed changes?

As the law of “causation” stands, if a firm breaches FSA rules when providing advice, it is only liable to pay compensation if its breach caused the loss.

To impose liability on firms without reference to these causation principles, the FSA would have to secure amendment to the FSMA (Financial Services and Markets Act) 2000 to dis-apply them from the regulated sector.

The practical reality within the Financial Ombudsman Service (FOS) could be formalised in law by simple amendment to the language of s.228 FSMA.

This sets out the FOS’ jurisdiction to decide matters on the basis of what, in the opinion of the individual Ombudsman, is fair and reasonable in all the circumstances. The new Bill would simply have to add words such as: “regardless of the law of causation”.

Beyond FOS, the right to damages under s.150 FSMA would have to be amended in order to prevent firms from avoiding liability to consumers under a consumer redress scheme or similar past business review. It would, at least, need the removal of the words “as a result of the contravention, subject to the defences …”

More likely, express provisions would be required to rule out causation defences.

If such changes are implemented, it will make real the fears first expressed when the predecessor to s.150 was created in s.62 of the Financial Services Act 1986.

Then, the industry was reassured that legal defences would still be available, as the loss had to ‘result’ from the breach.

Such reassurances now start to ring hollow.

What would the effects of the changes be?

The impact of these changes is best demonstrated by considering two recent cases against regulated firms that turned on the issue of causation.

Judgment in the case of Rubenstein v HSBC, relating to the AIG Enhanced Fund, was handed down on 2 September 2011.

Although the adviser was found to have been in breach of his common law duty of care and old COB rules, the judge decided that the global economic events that caused the loss were wholly outside the contemplation of the bank or any competent financial adviser at the time the advice was provided in 2005. The judge therefore awarded only nominal damages.

However, if the wording of s.150 had been different, full compensatory damages would have been payable.

Similarly, on 4 October 2011, judgment was handed down in the case of Zeid v Credit Suisse.

Again, although the judge found Credit Suisse had made personal recommendations and that the later advice given was unsuitable, the judge concluded that the breach of the rules and negligence did not cause Mr Zeid’s losses as he would have made the investments anyway.

With nearly US$70m at stake, the case provides clear illustration of the importance of the causation defence.

Finally, on 25 October 2011, the FSA fined Credit Suisse’s UK arm £5.95m for systems and controls failings relating to the sale of more than £1bn in complex structured products to private banking clients.

Relying on the current law, Credit Suisse has only promised to compensate customers who suffered loss caused by any unsuitable sales.

One can only imagine the extent of the compensation bill, if every case of breach required full redress regardless of whether the breach caused the loss.

Future trouble?

For the mortgage industry, the proposed changes would certainly mean higher professional indemnity insurance (PII) premiums.

It might even be questioned whether the professional indemnity insurance market would be willing to insure firms exposed to such liabilities.

Furthermore, imposing near strict liability effectively makes firms guarantors of the products they sell and, possibly, the value of the property bought.

For example, if a firm breached the record keeping rules in MCOB 4.7.17 by failing to record the reasons for a personal recommendation, under the changed law, it would stand liable for any fall in value of the property.

This would encourage mortgagors to look for a loophole through which to claim compensation.

In a commoditised market more prone to systemic problems, mortgage firms are particularly vulnerable.

In the final analysis, these far-reaching changes, if implemented, would push up costs for the industry (and therefore consumers) dramatically at a time when mortgage lending is severely constrained.

With the economy faltering, further burdens on the mortgage industry is the last thing the government needs.

The FSA should be careful what it wishes for.

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