Vannessa Young 13 Jun 2005

Firms that want to challenge a Financial Ombudsman Service determination face even greater obstacles following a recent High Court ruling, according to a leading City law firm.

Freshfields Bruckhaus Deringer has warned that the ruling in the case of IFG Financial Services Ltd v Financial Ombudsman Service Ltd highlights the broad scope of the ombudsman's powers and their potential to make compensation payments more costly — for bigger firms in particular.

The firm of financial advisers had sought judicial review of a determination by the FOS, Simon Orton, a partner with Freshfields Bruckhaus Deringer, explained to Complinet. IFG had acted as advisers to a Mr and Mrs Jenkins. The firm had wrongly advised the couple to put their money into medium-risk investments, which in fact turned out to be a high-risk fund that invested in currencies and derivatives.

The couple made a significant loss as a result of the investment. This loss was not as a result of the unsuitable advice, however, due to the unforeseeable dishonesty of one of the managers on the investment fund recommended. The FOS held that the claimant should pay the Jenkins the entirety of their loss resulting from their investment, including the loss due to the unforeseeable dishonesty of the fund managers.

The financial adviser argued that the FOS had failed to take into account relevant law in making its determination. It maintained that because no loss had flowed from the unsuitability of the advice but rather from the dishonesty of the fund managers, which was unforeseeable, the loss was not within the scope of their responsibilities towards the customer. The adviser had sought counsel from Michael Pooles QC, who had been instructed by Barlow Lyde & Gilbert. Pooles had concluded that, as a matter of English law, the Jenkins were not entitled to recover damages from the claimant.

Determining a complaint

Section 228(2) of the Financial Services and Markets Act 2000 is at the heart of the case, Orton said. This section requires the ombudsman when determining a complaint to have reference to what was, in his opinion, 'fair and reasonable' in all the circumstances of the case. The FOS does not have to make a decision in accordance with English law, however.

Orton said the rules of the FOS scheme require it, in considering what would be fair and reasonable, to take into account a list of factors, including relevant law; regulatory rules, guidance and standards; and, where appropriate, what was considered to have been good industry practice at the relevant time. This was a significant power, he noted, and one that was difficult to challenge as long as the "FOS gets within the rational bounds of what is fair and reasonable."

Mr Justice Stanley Burnton, who presided over the request for judicial review, agreed with the ombudsman that a lack of recovery by the Jenkins would not be fair and reasonable and that they had taken the relevant law into account. Nor did he agree with the firm's argument that because the fraud was unforeseeable they were not liable for any result of their unsuitable advice.

Departing from the law

Mr Justice Stanley Burnton noted in his judgement: "[The ombudsman] was entitled to depart from the result mandated by the law if he considered that another result provided the result that was fair and reasonable in the circumstances. He did, and it follows that his decision is binding on the claimant and does not fall to be set aside."

Orton explained that as a matter of strict law, if a public body has an obligation to take account of a factor in reaching its decision, it is sufficient that it has regard to that factor, even if it decides to give no weight to it.

Orton said "In the context of this case, therefore, it was sufficient that the FOS referred to the counsel's opinion in its letters (showing that it had considered it) even if it then went on, effectively, to ignore it. That may be right as a legal proposition, but firms have to operate against a background of legal certainty in order to assess and handle their exposure to customer complaints. If they can't rely on the FOS following what is a quite important principle of law then their ability to do so is undermined.

"It is one thing for the FOS to depart from the law where it is unclear or does not properly address a situation, but the proposition that it can simply ignore an important legal principle - and, significantly, that there is no check on it if it does so - is quite concerning."

Pooles sought permission to try again in the Court of Appeal, arguing: "There is a point of principle here. That is to say the extent to which, in circumstances such as this, where the ombudsman is clearly departing from the law which he is bound to take into account." He was granted leave to appeal.

Surprisingly, Mark Bogard, chief executive of UK IFA and actuarial operations at IFG Group, was not clamouring for reform of the ombudsman service. He told Complinet: "My experience of the last several years has been that generally the ombudsman gets it right."

The case itself was complex and probably unique, he believed. "It was our insurers that took the case to court," he added, explaining that his insurers had found it unacceptable that they should be liable for these unforeseen losses.

Bogard continued: "I am not in the group of people that thinks that there is a balance of favour at the FOS towards the consumer. If anything, there have been some pretty robust determinations in favour of the product provider/IFAs in recent months."

Judicial review

Judicial review was a very blunt instrument that was accompanied by a very high burden of proof. He did not, however, express any particular desire for an additional form of appeals mechanism to be introduced at the FOS. The Financial Services Authority's consultation paper 04/12 had sought industry comment on possible changes to the ombudsman. One of the ideas floated had been that there should be a formal right of appeal against FOS' decisions.

This was an idea that Freshfields had warmed to in its response to CP04/12. The law firm noted: "It seems to us that a process could be designed to address this issue, by allowing an opportunity for significant or 'wider implications' cases to be considered in a different, more rigorous way, while at the same time enabling the system to remain in its current form for the vast majority of complaints."

Industry feedback received in response to the consultation paper showed that the majority of respondents were against the creation of a formal appeals mechanism, however. This was largely because it was considered that the complaints procedures already involved at least two stages. The FSA and the FOS had consequently decided against recommending that the government introduced legislation to create an external appeals mechanism.

The FSA had also made clear in the feedback statement to CP04/12 for the first time something that it had been hinting at for a while, according to Orton. Namely that if a firm persistently rejects complaints that it knows the FOS would accept, it may be failing to treat its customers fairly and be in breach of its regulatory obligations. What this does is to give precedent effect to FOS decisions, through the regulatory system, he believes.

Orton said: "This brings starkly into focus the lack of an appeal and the practical shortcomings of judicial review as a check on the FOS. Even if a firm fundamentally disagrees with the FOS viewpoint, it may have to apply the FOS approach to its incoming complaints."

New procedures for investigating cases with wider implications had been introduced. The industry now needed to become used to how they operated, Orton added.

FOS speaks out

A spokeswoman for the FOS told Complinet that this was a 'unique case'. "We don't see the case as having wider implications for other companies," she said.

The new mechanism for reporting cases with wider implications was working well and had not been inundated with cases, she noted. There had been some interesting traffic through the system, however. The FSA and the FOS had promised to make this system transparent and would be publishing the outcome of this process on its web site soon.

Jonathan Goodliffe, Complinet's consulting editor, was less convinced about the case being remarkable, however.

Goodliffe said: "There is nothing novel in this decision. The ombudsman is required to have regard to the law and the rules but not to follow them slavishly. An example of this is the claims standards originally published by the ABI and now incorporated in ICOB 7. Some of those standards only apply to retail customers — but the ombudsman expects them to be followed in claims by small businesses.

"The proposition that, if a customer invests inappropriately because he is incorrectly advised by an IFA, the IFA should then bear the full consequences seems reasonable. It may be that the law should follow ombudsman practice rather than the reverse."