ABS Financial Planning Ltd & Ors, R (on the application of) v Financial Services Authority & Anor

The claimants in this application for judicial review are 217 companies and partnerships involved in financial and investment business. They challenge the decision of the defendant, Financial Services Compensation Scheme Ltd, on 29 March 2010 to impose an interim levy of some £32 million on them in relation to compensation payable in respect of claims accepted by the defendant concerning the business of a company in default, Keydata Investment Services Ltd (hereafter “Keydata”). As well as the claims that have been accepted by the defendant, at the date of the hearing there were claims of about £8 million relating to Keydata still in the pipeline. The claimants’ case is that the defendant erred in law or acted irrationally in concluding that the interim levy should be imposed on them as “investment intermediaries”. They claim it should have been imposed on firms that are “fund managers”. They also claim the defendant failed properly to consult them before imposing the levy. These proceedings were launched on 30 April 2010 and permission was granted on the papers on 26 June.

The defendant was established by the Financial Services Authority (hereafter “FSA”) and authorised to administer the compensation system established pursuant to section 213 of the Financial Services and Markets Act 2000. The overall annual limit for compensation under the scheme administered by the defendant is £4.03 billion. The defendant and the compensation system are funded by levies made by it on authorised financial services firms. The defendant has no power to fund or pay compensation without imposing a levy. Broadly speaking, initially only firms whose activities fall within the same sub-class of business as the activity of the failed business which has given rise to the claims are liable to make contributions.

Keydata was placed in administration on 8 June 2009 on the application of the FSA. It was confirmed to be in default on 13 November 2009. After Keydata was determined to be in default the defendant (in accordance with its practice, see Mr Derbyshire’s first statement, paragraph 14) investigated whether those who had invested with Keydata were likely to have valid compensation claims. It considered the investments promoted by Keydata, bonds issued by SLS Capital SA (“SLS”) and Lifemark SA (“Lifemark”), two Luxembourg special purpose companies, and whether Keydata’s marketing literature complied with the law and the regulations applicable to financial promotions. It concluded that the marketing brochures contained a number of misrepresentations. In particular they represented that the products would qualify for ISA status when they did not because the bonds were not listed on a suitable securities exchange.

There are five classes of business activity for the purpose of levies; deposits (class A), life insurance (Class B), life and pensions (Class C), investment (Class D), and home finance (Class E). All but class A are split into two sub-classes: providing the business, and intermediation. The sub-classes of the investment class are D1, fund management and D2, investment intermediation, each of which consists of a list of regulated activities: for those relevant in these proceedings, see [17]. At the hearing I was informed that there are some 5,000 authorised persons in the D2 sub-class.

The defendant concluded that Keydata’s activities which gave rise to the claims fell within the “investment intermediation” sub-class of investment business and it imposed the interim levy on authorised persons classified as members of this sub-class. As a result of the activities in which they engage the claimants are so classified. It is common ground that the claimants fall and Keydata fell within the “investment” business class. The dispute concerns whether Keydata’s activities giving rise to the claims fell within the D1 or the D2 sub-classes.

The evidence before me consists of three statements on behalf of the claimant by Gareth Fatchett, a partner of Regulatory Legal LLP, the claimant’s solicitors. They are respectively dated 28 April, 10 May and 23 August 2010. The third statement is concerned with an application for disclosure which was in the event settled. The evidence on behalf of the defendant consists of three statements of James Darbyshire, the defendant’s “head of legal”. These statements are respectively dated 29 July, 21 September and 8 October 2010.

Section 19 of the Financial Services and Markets Act 2000 (hereafter “the 2000 Act”) requires firms to be authorised to carry on regulated activities. The classes of activity and categories of investment are defined by the 2000 Act and the Financial Services and Markets Act (Regulated Activities) Order 2001 SI 2001 No. 544 (“the 2001 Order”).

Section 22(1) of the 2000 Act provides that “an activity is a regulated activity for the purposes of this Act if it is an activity of a specified kind which is carried on by way of business” and “(a) relates to an investment of a specified kind” or “(b) in the case of an activity of a kind which is also specified for the purposes of this paragraph, is carried on in relation to property of any kind”. By section 22(4), “‘investment’ includes any asset, right or interest”. Schedule 2 to the Act makes provisions supplementing section 22 but (see section 22(3)) nothing in Schedule 2 “limits the powers conferred by subsection (1)” of section 22. One of the supplementary provisions specifying an activity is paragraph 6 of Schedule 2.Under the heading “managing investments”, it states this to be: “Managing, or offering or agreeing to manage, assets belonging to another person where – (a) the assets consist of or include investments; or (b) the arrangements for their management are such that the assets may consist of or include investments at the discretion of the person managing or offering or agreeing to manage them”.

The 2001 Order provides that a large number of activities in relation to investments constitute “regulated activities”. These include: “dealing in investments as agent” (Article 21) and “managing investments” (Article 37). By virtue of Article 77 of the 2001 Order a bond issued by a Luxembourg company is an investment whether or not it is listed.

Article 21 provides that “[b]uying, selling, subscribing for or underwriting securities or contractually based investments …as agent is a specified kind of activity”. (Footnote: ¹) An activity falls within Article 37 if the authorised person manages “assets belonging to another person, in circumstances involving the exercise of discretion” and the assets consist of “any investment which is a security or a contractually based investment” or the arrangements for management are such that the assets may include such investments: and see the definition in the Glossary in the FSA’s Handbook, referred to at [67]. Article 40 provides that the activity of “safeguarding and the administration of assets” consists “of both (a) the safeguarding of assets belonging to another, and (b) the administration of those assets”.

Under the heading, “financial promotion”, section 21 of the 2000 Act prohibits a person from communicating an invitation or inducement to engage in investment activity unless he is an authorised person or an authorised person approves the content of the communication. A marketing brochure issued by an authorised person is such an invitation or inducement. Marketing is not a regulated activity in the present context. However, a financial promotion issued by an authorised person is an activity ancillary to the regulated activity which the authorised person is thereby offering to undertake. The contents of such a brochure are regulated by conduct of business rules made by the FSA under section 145. The conduct of business rules apply to authorised firms.

The provisions for compensation are in Part XV of the 2000 Act. Section 213(1) requires the FSA by rules to establish a “scheme for compensating persons in cases where relevant persons are unable, or are likely to be unable to satisfy claims against them”. Section 212(1) requires it to establish a “scheme manager” to exercise functions conferred on it by or under Part XV. The defendant is “the scheme manager”.

I have referred to the requirement in the 2000 Act that the compensation scheme be funded through levies on authorised persons. Section 213(3)(a) requires the rules to provide that the scheme manager is able to assess and pay claims made in connection with “regulated activities carried on (whether or not with permission) by” authorised persons. Section 213(b) requires the rules to give the scheme manager power to impose levies “on authorised persons or any class of authorised person” for the purpose of meeting expenses incurred or anticipated in paying compensation.

The Act also requires that, as far as is practicable, levies should be made on the class of authorised person in respect of whom claims are or are likely to be made. Section 213(5) requires the FSA to “take account of the desirability of ensuring that the amount of the levies imposed on a particular class of authorised person reflects, so far as practicable, the amount of the claims made, or likely to be made, in respect of that class of person”. Section 214(1) provides that the compensation scheme may make provision: “(b) for the establishment of different funds for meeting different kinds of claim”; “(c) for the imposition of different levies in different cases”; and “(i) for the making of interim payments before a claim is finally determined”.

The FSA’s Handbook contains the scheme in the “COMP Rules” provisions in the “redress” section. The COMP Rules set out inter alia, who is an eligible claimant, what type of business is protected and how claims may be quantified and paid by the defendant. By COMP 3.2, an eligible claimant is a person who has made a claim for compensation “in respect of a protected claim” against “a relevant person who is in default”. COMP 5.2(3) provides that a “protected claim” is a claim “in connection with protected investment business” COMP .5.5 defines such business as inter alia “designated investment business carried on by the relevant person with, or for the benefit of, the claimant (so long as that claimant has a claim), or as agent on the claimant’s behalf”, provided it was carried on from an establishment of the relevant person in the United Kingdom..

The rules for funding the compensation scheme administered by the defendant are contained in the FEES 6 chapter of the FSA’s Handbook. The material provisions are:-

The relevant classes of activities are set out in Annex 3 of FEES 6. Class D is “Investment”. I have referred to its two sub-classes; D1 “Fund Management”, and D2 “Investment Intermediation”. A number of activities are listed in each. Of those listed under D1, only “managing investments” is of relevance. Of those listed under D2, “dealing in investments as agent for the customer”; “safeguarding and administering of assets”; “arranging safeguarding and administering of assets”; and “agreeing to carry on a regulated activity which is within any of the above” are of relevance.

Keydata was authorised for a number of purposes by the FSA. These included; advising on investments, agreeing to carry out a regulated activity, safeguarding and administration of assets (and arranging for this), dealing with investments as agent, and managing investments. It was involved in the design of a number of structured investment products known as the “Secure Income Bond Issues 1-3” (“the SLS Plans”) and, between July and December 2005, marketed them to retail investors in the United Kingdom. Between January 2006 and 8 June 2009, when it was put into administration, Keydata also marketed a number of other structured investment products. These included other issues of the Secure Income Bond (“the SIB”), three issues of an “Income Plan” and ten issues of a “Defined Income Plan” (also known as the “Lifemark Plans”).

The structured products Keydata was marketing were a beneficial interest in bonds issued by SLS and Lifemark, the Luxembourg SPVs. The underlying assets were United States life insurance policies which SLS and Lifemark purchased with sums received on the sale of the bonds. By an agreement dated 14 March 2005 between SLS and Life Settlement Solutions (“LSS”), a Delaware corporation, LSS took responsibility for the choice and management of SLS’s portfolio of assets. There are similar agreements, dated 21 December 2007, between Lifemark and Montage Financial Services LLC and Meditron Asset Management LLC.

Keydata expected to receive charges and commissions as a result of the transactions with retail investors but the basis upon which it was to be remunerated is not clear from either the brochures or the terms and conditions. The brochure’s “key features” section contains a heading “how will charges and expenses affect my investment?”. Under that it is stated “there are no explicit charges other than a fee of £150 +VAT for transfer … or early surrender … plus an additional 5% in year one, 3% in year two, and 1% in year 3”. It is also stated “Keydata will receive a fee for administration and distribution. This will not affect the return. There are no other explicit charges.” Clause 15 of the terms and conditions refers to these charges, and to a benefit from the rounding of interest. The clause also contains a reservation by Keydata of the right to introduce an additional charge to cover additional expenses incurred as a result of significant regulatory change.

The plans were marketed to investors by way of brochures and often through investors’ independent financial advisers. The parties agreed that the brochure and terms and conditions in respect of Secure Income Bond Issue 1 could be regarded as typical for the purposes of these proceedings. The front page of the brochure states that the bond is “fixed-income with no stock market exposure”, “7.5%” and “five years”. Keydata describes itself as “one of the fastest-growing and highest-regarded investment boutiques in the UK”, and states that it provides “a wide range of investments through structured products, VCTs and limited partnerships”. Page 2 also states that Keydata provides “investment administration for some of the leading asset managers in the world”.

The features of the bond are described at page 3. It is stated that the assets the Secure Income Bond “invests in, cash and insurance contracts, are not linked in any way to the stock market and are issued by insurance companies that are rated ‘A’ or better by leading rating agencies. This makes it lower risk than many traditional stock market linked income investments”. The benefits are stated to be tax savings through ISA and self-invested personal pensions, and availability for ISA and PEP transfers. As to income, a choice is given between a 7.5% fixed annual income, a 1.875% quarterly income, or a payment of 43.5% at the end of the five-year period, in the case of SIB Issue 1, on 7 October 2010.

The brochure also states that investors should be reassured that the insurance contracts within the bond are issued by financial institutions with a minimum credit rating of “A” and that the current portfolio has over 90% invested in contracts issued by companies rated “AA” or better including AIG, GE Life and Prudential. The brochure has a heading “Strong Management”. Under this it is stated “in order to provide sufficient checks and balances the Secure Income Bond has been structured as an institutional investment ensuring your investment delivers the value you expect”. This section also refers to the fact that the trading of the insurance contracts is overseen by HSBC, and that one of the “big four” accountancy firms, KPMG, constructed the financial models used to structure the bond and checks the credit ratings of the insurance companies issuing the contracts and monitors the credit rating of the portfolio of investments.

On page 8 of the brochure it is stated “Keydata Investment Services Ltd does not offer investment advice or make recommendations in relation to the bond. This investment is not suitable for everyone. If you have any doubt whether it is suitable for you, you should obtain expert advice from your Independent Financial Adviser”. Clause 26 of the terms and conditions provides that “[n]o warranty is given by us as to the performance or profitability of the Bond” and that investors must be aware that “the price of securities can go down as well as up and that there is a degree of risk attached to your capital”.

These are set out at pages 14-15 of the brochure. In clause 1, the definitions provide that Keydata is the “account manager”, and “Securities” are “Bonds listed on the Luxembourg stock exchange”. It was because the Bonds were not so listed that they were not eligible for ISA status. Clause 2(ii) provides that the Account Manager “may accept” an application but “reserves the right to reject” it for any reason. By clause 18 Keydata “may appoint another company to be the Manager of [the investor’s] SIB”. Clause 3, “Cancellation Rights”, provides that the investor cannot claim full reimbursement if “the price at which your securities were purchased has fallen when we sell them following your exercising your right to cancel…”. Clause 5, “Permitted Investments”, provides:-

Clause 6 provides that “cash will be held in a pooled Keydata ISA designated Client Account with a bank”. It also provides that, within an ISA or PEP, “cash can only be held pending an investment and if held in cash over a prolonged period there is a risk that HM Revenue & Customs may void your ISA or PEP”.

By clause 7, all cash “will be applied to purchase Securities in permitted Investments” on or before “the effective date”, 30 September 2005. The Account Manager is to “be responsible for all purchases and sales of investments for your SIB” and “may aggregate any transaction for an Investor with one or more transactions for other Investors, even though this may result in a less favourable price”. Clause 8 provides that the investor chooses one of the three different types of return (see [22] above) by ticking the appropriate box on the application form. It was accepted by the claimants (grounds, paragraph 23) that “as a matter of fact, there was no exercise of discretion by Keydata once it had received the funds from the applicant”.

Clause 9 provides that “all assets within your SIB will be, and must at all times remain, in your beneficial ownership and must not be used as security for a loan … lent to or deposited by way of collateral with any third party.” It also provides that “We”, i.e. Keydata, “may not lend any of your assets to a third party, nor may we borrow against their security” and “[s]ecurities will be registered in the name of our nominee company, Keydata Investment Product Nominees Ltd., or such nominee approved by us”.

Clause 13 makes provision for termination. The Account Manager is empowered to terminate the SIB by giving three months written notice or immediately if, in its opinion, “it is impossible to administer the SIB in accordance with the [Individual Savings Account Regulations 1998 and/or the Personal Equity Plan Regulations 1989 as amended] or you are in breach of the Regulations”. The Investor is given power to terminate at any time by giving written notice and to stipulate when he or she wishes the proceeds to be realised. The Account Manager “will then sell [the] investments at the next practicable dealing date”.

This authorised Keydata to hold the applicant’s “cash subscriptions, Direct Investments, ISA Investments, interest … dividends and other rights in respect of those investments and any cash or other proceeds”. It also authorised Keydata to make “any claims to relief from tax in respect of ISA Investments” on behalf of the applicant. The form also states that “The Account Manager may, at their (sic) discretion, extend the closing dates period beyond that advertised…”.

There were quarterly “liaison” meetings between senior representatives of the defendant and senior representatives of the Association of Independent Financial Advisers (hereafter “AIFA”), and the Association of Private Client Investment Managers and Stockbrokers (hereafter “APCIMS”) and ad hoc meetings on specific issues. Mr Darbyshire’s evidence (first statement, paragraphs 45 - 46) is that the defendant, while not accepting that it is under a duty to consult about the allocation of levies, tries “to maintain an ongoing dialogue with … industry representatives and other interested parties about matters that will affect them or the groups they represent”. In relation to the D class of levy payers the liaison and ad hoc meetings with AIFA and APCIMS are part of that dialogue.

In April 2009 the defendant imposed a levy on investment intermediaries in the 2009/2010 financial year in respect of the failure of two companies, Pacific Continental Securities (UK) Ltd and Square Mile Securities Ltd. The December 2009 issue of Outlook, the defendant’s newsletter, stated (page 5) that the majority of claims concerning insurance intermediaries received “this year so far” related to those two companies. The introduction by David Hall, the defendant’s chairman, stated (page 1) that additional funding would be required because of the default of Keydata, which was not anticipated when it made its “initial levy assumptions”.

Under the heading “Investment Intermediation” the newsletter stated (page 5) that the defendant was “expecting Keydata to generate a large number of new claims for the second part of the year” and that claims were likely to fall into two categories. The first was where there was evidence to suggest that the underlying assets held may have been misappropriated. It was anticipated that the total cost of this category of claim could be “in the range of £25m to £50m”. The second likely category of claim was stated to arise because a number of the investments were sold as ISAs but the investments did not meet the necessary requirements to qualify as ISA investments. It is stated that the defendant was “considering the best approach for dealing with this second category of claims” and also that it was too early to provide an indication of the potential costs. The concluding paragraph stated the defendant appreciated that the increasing volume of claims in this sector “will potentially put a substantial burden on the investment intermediary sub-class”.

The “levy update” section of the newsletter also stated (page 9) that the defendant “has considered carefully to which funding class the compensation costs arising from, or expected to arise from, claims for compensation in respect of Keydata should properly be allocated”. The defendant’s view at that time was that, in relation to the products that are likely to give rise to valid claims for compensation, “Keydata acted as agent for its customers in purchasing the relevant underlying bond”. It considered that the customer’s interest in the bond was registered in the name of Keydata’s nominee company and held by Keydata through that company as nominee for the retail customer. It stated that, in the brochures issued to customers, Keydata was offering a specific investment “and had no discretion to choose which bond it should purchase once it received funds from an applicant”. This, the newsletter stated, “is an activity which in [the defendant’s] view would fall within the (D2) Investment Intermediation sub-class as defined in FEES 6”. The claimants rely, in particular, on this to show that by December 2009 the defendant had taken a decision as to the class of authorised persons upon whom the levy would be imposed.

After the publication of the newsletter, on 15 December, Ian Cornwall, APCIMS’s Director of UK Regulation, e-mailed Sarah McShane, who was employed by the defendant. He stated that “it would be very helpful if a detailed and full legal explanation was made available to the trade associations explaining why the Keydata compensation hits D2”. Ms McShane replied in an email dated 18 December substantially repeating what had been said in the newsletter about the defendant’s view that Keydata acted as agents for its customers in purchasing the underlying bond. She stated that Keydata was offering “a specific investment as described in the relevant brochures” and “had no discretion to choose which bond it should purchase once it received funds from an applicant” so that “it cannot be said that Keydata was managing investments”. Mr Cornwall reverted in an e-mail on the same day stating that the explanation did not enable him “to fully articulate the position” to his members, asking for “a much more detailed explanation as to why the claims fall on D2”, and in effect (although not in terms) challenging the defendant’s position.

Ms McShane replied on 7 January 2010. She referred to the provisions of COMP 5.2 and 5.5 and stated the defendant considered that the likely claims that would arise as a result of the marketing materials produced by Keydata fell into four of the categories of activity within the D2 investment intermediation sub-class. These were “dealing in investments as agent for the customer”, “safeguarding and administering of assets”, “arranging safeguarding and administering of assets”, and “agreeing to carry on those regulated activities”. Mr Cornwall thanked her for the response and stated he would “gently break the news” to his Board.

On 1 February there was a meeting between representatives of the defendant and of AIFA, including Chris Cummings, AIFA’s Director-General. This was (see Mr Darbyshire’s first statement, paragraph 50) part of the programme of regular “liaison” meetings with senior representatives of AIFA and APCIMS. Mr Darbyshire stated that the allocation of the Keydata compensation costs levy was discussed at the meeting on 1 February. AIFA was informed that the cost was likely to fall to the D2 sub-class and provided with background as to the likely claims for compensation that the defendant expected to receive in relation to Keydata. The rough notes of the meeting record that it concerned “D2 news”. The notes include “+ £43, Keydata, need funds to 1/7 .•. £70 D2 interim → probable interim of £70m + poss £20m”.

Mr Darbyshire also stated (first statement, paragraph 51) that on 2 February there was a meeting between senior representatives of the defendant and senior representatives of APCIMS including Mr Cornwall and David Bennett, APCIMS’s chief executive. The meeting was arranged to discuss the allocation of the Keydata compensation costs levy to the D2 sub-class. APCIMS was given the same information as was given to AIFA.

On 12 February 2010 the defendant published its Plan and Budget for 2010/11. This dealt with investment claims for the remainder of 2009/10 and for 2010/11. It stated (pages 7 and 20) that the costs of major investment failures in 2009/10 and the increasing volume of claims it received would mean that it expected to issue an interim levy of at least £70 million to firms in the investment intermediation sub-class in March 2010. The document also set out the defendant’s updated position in relation to Keydata. It stated (page 11) in relation to Keydata that “we appreciate that the increasing volume of these claims will potentially generate substantial costs for the investment intermediation sub-class (SDO2)”, and (page 20) that the cost drivers for the indicative levy on sub-class SDO2 are “claims relating to investment mis-selling and property claims, including Keydata”.

The document also stated (page 7) “we are likely to have to issue an interim levy of £70m to firms in the investment intermediation sub-class” and (at page 20) refers to “a prospective interim 2009/10 levy of £70.0m” on the sub-class. The accompanying press statement referred to “the interim levy of at least £70 million [the defendant] expects to issue in March”, and “the potential interim levies”, and that “the costs will fall to investment intermediaries”. It also stated that the defendant would confirm the position “before determining and announcing the levy decisions in March”.

In a letter dated 18 February the claimants’ solicitors wrote to Ms Minghella, then the defendant’s Chief Executive asking the defendant to disclose its policy in relation to consultation before making a decision of this sort. They also asked for a detailed explanation of why the interim levy should fall on investment intermediaries and indicated that consideration was being given to judicial review proceedings. Mr Derbyshire sent a holding letter on 23 February stating the defendant would prepare a substantive response within a few days.

The next material document was published on 26 February 2010. Its title is “Keydata: FSCS’s Position Statement in respect of the 2010/2011 Indicative levy for the Investment Intermediation Sub-Class”. The document first summarises the background to the compensation scheme, how it is funded, and the power to impose a compensation costs levy. Under the heading “Application of FEES to the compensation costs arising from Keydata”, it sets out the reason for imposing the costs upon the investment intermediary sub-class. It states:-

Between 1 and 5 March there were a number of exchanges about the allocation of the Keydata levy between the defendant and the claimants’ solicitors, and between AIFA and the defendant. For present purposes it is only necessary to summarise some of these. On 1 March Mr Derbyshire emailed a copy of the position statement to Mr Cornwall at APCIMS and Mr Cummings at AIFA. He stated he hoped it would be useful in discussions with members about “the indicative compensation costs arising out of Keydata”. That day he also responded to the claimants’ solicitors’ letter dated 18 February, enclosing a copy of the position statement. The letter first responded to the claimants’ solicitors’ points. It stated the rationale for imposing the costs arising from Keydata on the investment intermediation sub-class was set out in the position paper. It also stated that the defendant had discussed the issue with the relevant trade bodies and that the allocation of the compensation costs levy did not depend upon the exercise of discretion, but upon the interpretation and application of the definition of “regulated activities” to the facts of particular claims. The letter then stated “we should make clear that no decision had yet been taken … to issue an interim levy upon the Investment Intermediation sub-class, although we hope to do so by the middle of March” and invited a response within 14 days so that the defendant could take any representations into account.

In an e-mail dated 2 March to Mr Fatchett, Mr Darbyshire reiterated the defendant’s position that it had discussed relevant issues with all the trade bodies including those in the investment sector, such as AIFA. The email also stated that the reason for publishing the Plan and Budget was as part of its dialogue with the industry, and to keep authorised firms aware of any developments relating to the compensation scheme. The claimants’ response to this is also dated 2 March. They stated that both the Budget Plan and the Press Release clearly stated that the decision to impose a levy had already been made. Mr Darbyshire replied, again stating that the defendant’s current view and expectation as set out in the documents referred to was that a compensation costs levy in respect of Keydata would fall to the investment intermediation sub-class but stating that the defendant had not actually issued the levy at that stage.

In a letter dated 2 March to the defendant’s chairman, AIFA’s chairman, the Rt. Hon John Gummer, expressed concerns about what he referred to as the defendant’s “planned levy of the investment intermediation sub-class for the Keydata default”. He asked Mr Hall personally to review the decision and to “share the information” that enabled the defendant to make its decision. In a letter dated 5 March Mr Cummings stated that the decision to impose the cost on the D2 sub-class was a “matter of considerable concern” to members of AIFA. He referred to two matters which he believed cast new light on the matter. As to the first, he asked whether the defendant was aware that Keydata had been regulated by IMRO under the previous regulatory regime. The second was that Keydata had “played a key and critical role in the construction and targeting of the bonds”. He also asked the defendant to review the situation in the light of these points, and stated that the defendant had taken too narrow a view of the market affected and that the firms to be levied should include those in the investment management community.

The claimant’s legal representatives made further representations in a document dated 15 March, but which only reached the defendant as an attachment to an email dated 19 March. They stated that the claimants did not agree that Keydata acted as the agent of its customers in purchasing the bonds. Their view was that:

The solicitors also asked for access to the Keydata authorisation file held by the FSA in order to understand why Keydata had been placed in the investment intermediation sub-class. They stated that the fact that, under the previous regulatory scheme, Keydata was a member of IMRO was “a strong indicator” that the defendant’s classification of it was incorrect.

On 19 March Mr Darbyshire and the defendant’s then Interim Chief Executive met representatives of AIFA for further discussions about the proposed Keydata levy. Following that meeting AIFA submitted written representations for consideration by the defendant’s board. AIFA stated:

The defendant’s Board met on 23 March. The minutes (extracts of which were disclosed shortly before the hearing) state the Board “noted and discussed the representations made by AIFA and Regulatory Legal LLP (a firm representing unidentified IFAs)”. Notwithstanding those representations, the Board approved the proposed interim levy for the D2 sub-class in respect of costs relating to inter alia Keydata. It extended the delegated authority previously given to the Chairman, executive directors and two others to finalise arrangements for both the 2009/10 interim levy and the 2010/11 levy.

On 29 March Mr Darbyshire wrote informing the claimants’ solicitors of the Board’s decision. The letter responded inter alia to the representations based on Keydata’s regulatory permissions and its previous membership of IMRO. He stated those matters did not affect the determination of the activity which had given rise to the claim for compensation. He also enclosed an updated version of the position statement which was to be published on the defendant’s website, and observed that the solicitors had not rejected the analysis set out in the earlier version of the position statement or sought to explain why it was incorrect.

It is suggested in the claimants’ skeleton argument, paragraph 42(h) and (i), that AIFA’s representations were not received until after the meeting and that the letter dated 29 March and the position statement “contain no indication of … consideration of the points which had been raised in the representations received from [AIFA]”. The material recorded in paragraphs [49] and [50] show that these suggestions are unfounded and the points were not pursued at the hearing.

The revised position paper is substantially to the same effect as the earlier version, but with additions and refinements. I set out only the paragraphs with material additions and new paragraphs. Under the heading “Application of the FEES Rules to the compensation costs arising from Keydata” the revised version of the second of the paragraphs from the earlier version paragraph set out at [42] states:

The paper has two new headings; “The claims for compensation to FSCS”, and “Conclusion”. Under the first of these it is stated: (a) the defendant had at that stage issued decisions in respect of 3,358 claims worth approximately £32 million brought by investors of Keydata, (b) the claims have been determined on the basis that the investors relied on misrepresentations in Keydata’s brochures, and (c) the defendant considers these claims to be made in connection with “protected investment business”. It is also stated that the defendant has concluded that the claims have arisen as a result of the marketing material produced by Keydata, which was issued in connection with Keydata’s “designated investment business” under one or more of the four categories set out in the earlier position paper (see [42]). The next paragraph states:

The “Conclusion” states inter alia:

On 31 March at one of its “liaison” meetings with representatives of APCIMS, the defendant confirmed its allocation of the Keydata levy to the D2 sub-class.

I deal first with the substantive grounds of challenge. Two of these, that the defendant erred in determining (a) rules 6.5.2 and 6.4.6 required it to allocate the costs to the levy sub-class that contained the regulated activity in respect of which the claims resulting in those costs arose or were expected to arise, and (b) in order to carry out the regulated activity of “managing investments” an entity had to exercise discretion in relation to the management of the relevant investments, were not pursued.

As to the remaining two substantive grounds, Mr Speaight QC submitted that the defendant erred in law or acted irrationally in determining that:-

The costs of the Keydata claims arose or could be expected to arise in respect of one or more of the four D2 regulated activities referred to in the defendant’s position papers and set out at [42]; and

The costs did not arise and could not be expected to arise in respect of the D1 regulated activity of “managing investments”.

The Claimants’ case on (a) is that, while Keydata did engage in activities properly described as within the D2 sub-class, the Keydata claims presented to the defendant do not arise out of D2 regulated activities but out of Keydata’s marketing of its plans. Their submissions on this are:-

“Dealing in investments as agent”: The claims arose because of misrepresentations in Keydata’s marketing brochures. The Glossary to the FSA Handbook states “dealing in investments as agent” means the regulated activity specified in Article 21 of the 2001 Order. That in turn refers to: “[b]uying, selling, subscribing for or underwriting securities or contractually based investments …as agent”. Keydata did not “deal in investments as agent” in this sense when it published the brochure and marketed the bonds because, in marketing the bonds, it either acted for itself or for the Luxembourg issuer of the bonds: Skeleton Argument, paragraph 46 (ii) – (iii).

“Safeguarding and administering investments”: The Glossary to the FSA Handbook states that the phrase means the regulated activity specified in Article 40 of the 2001 Order. That specifies an activity “consisting of both (a) the safeguarding of assets belonging to another, and (b) the administration of those assets”. However, while one of Keydata’s roles may have been to hold and administer the bonds which investors had bought, “that role is quite distinct from its role in marketing the bonds”: Skeleton Argument, paragraph 46 (v) and (vi)

“Arranging safeguarding and administering investments”: The Glossary defines the expression as meaning arranging for others to safeguard and administer the investments. Keydata’s arranging for its nominee to hold the bonds does not involve it arranging for the nominee to administer the investments. Alternatively, if it does, “the role of making such an arrangement is….quite distinct from, and carried [out] at a different time from, the marketing activity”: Skeleton Argument, paragraph 46 (viii) and (ix).

“Agreeing to carry on a regulated activity which is within any of the above”: In purchasing the bonds from the issuer, Keydata may have “dealt in investments as agent”. But its role in buying the bonds “was quite distinct from [its] earlier activity in marketing products to potential investors”: Skeleton Argument, paragraph 46 (iii) and (xi).

On (b), whether Keydata was “managing investments”, Mr Speaight realistically accepted that for an activity to constitute “managing investments” an element of discretion is required. But he submitted that Keydata exercised sufficient discretion for the activity that gave rise to the claims to be so regarded. His written submissions (paragraphs 53 and 54) state that Keydata exercised discretion in the design and creation of the products and, “taking a broad view” that activity could not be divorced from the activity it carried out when it published the brochures. The written submissions also rely on the discretion required in the six-month review to ensure the balance of investments remains on target to meet the Bond’s objectives. Although it is not stated that it was Keydata that would undertake this review, it was submitted it should be inferred that it would, as “Account Manager” (see [25]), do so.

Mr Speaight also relied on elements of discretion in the application form and the terms and conditions. These included whether to accept an application (clause 2), the time the bond would be purchased (clause 7) and when it would be sold on cancellation (clause 3) or termination (clause 13) and, as to the issuer. On the last he pointed to the fact that the terms only require the investment to have the specified characteristics, but do not (e.g. in clause 5) identify the issuer by name.

In approaching the submission that the defendant erred in law in its approach to the classification of the activity by Keydata which gave rise to the claims, I bear in mind that, as was recognised by the claimants, the analysis and determination involved, in AIFA’s words, “a complex company managing a range of products and instruments employing on and off-shore entities and using a variety of tax wrappers”. Although, in the exercise of their private law jurisdiction, courts are used to determining whether a person acts as an agent or a principal, here the legislature and the statutory regulator have entrusted the primary decision as to the characterisation of the activity in question to an independent and specialised body, subject only to the judicial review jurisdiction. The test here is (see [65]) not whether the claims arise “for” the activity of acting as an agent but the broader regulatory concept of whether they arose “in respect of” the activity of acting as an agent.

The question entrusted to the defendant in this case involves a number of complex financial and transactional issues that depend on the application and interrelationship of a number of criteria of a technical and regulatory nature. The caution of a judicial review court when dealing with complex economic issues is well known. It is because such issues are often both technical and open-textured and because the primary decision-maker is likely to have developed an expertise on those issues. In such cases, even where the question at issue is a jurisdictional question, “if the criteria are so imprecise that different decision-makers issues, each acting rationally, might reach different conclusions when applying it to the facts of a given case”, it has been said that the court “is entitled to substitute its own opinion for that of the person to whom the decision has been entrusted only if the decision is so aberrant that it cannot be classed as rational: see R v Monopolies and Mergers Commission, ex parte South Yorkshire Transport[1993] 1 WLR 23 at 32, per Lord Mustill, with whom the other members of the Appellate Committee agreed. The case involved an unsuccessful challenge to the Commission’s conclusion that the South Yorkshire area, some 1.65% of the total area of the United Kingdom was “a substantial part of the United Kingdom”.

I have concluded that, even disregarding the approach in ex parte South Yorkshire Transport, Mr Speaight’s submissions about the D2 regulated activities must be rejected. This is because, in relation to those activities, his approach depends on separating the different activities undertaken and the different times they were undertaken in a wholly artificial manner. It is also inconsistent with his approach to the question whether Keydata was “managing investments”. In that context he submitted that Keydata’s activity in designing and creating the products could not be divorced from that carried out when it published the brochures.

It was the misrepresentations in the brochures that induced investors to enter into transactions with Keydata and to agree with it that it would carry out the relevant regulated activities including buying and subsequently safeguarding the bonds for the investors. The terms of that agreement are (see [25]) set out in the brochures. Although the basis upon which Keydata was to be paid is not clear, clause 5 expressly states that Keydata “will be acting as [the investor’s] agent in arranging for the purchase” of the bond. There is no inconsistency between Keydata issuing the brochure on its own behalf and inviting investors to enter into an agreement under which it would act on behalf of the investors in buying the bonds.

That the parsing approach contended for on behalf of the claimants is not what the regulatory scheme envisages is also seen from paragraph 6.5.2 of the FEES 6 Chapter of the FSA Handbook. That provision requires the defendant to allocate the costs of compensation in proportion to the costs of claims “in respect of” the activities, and not claims “for” the activity. So, in the present case, it is the claims “in respect of the … activities” of Keydata in buying the bonds, not claims “for” buying the bonds which is the basis upon which the compensation costs are to be allocated. The financial promotion, here in the brochure, was an activity by Keydata in the course of business carrying out regulated activity, and the brochure was ancillary to at least one of Keydata’s principal regulated activities within the D2 sub-class. This is because, even if the absence of arrangements for its nominee to administer the bonds meant that publishing the brochure was not ancillary to “arranging safeguarding and administering investments”, doing so was ancillary to Keydata’s activity of buying the bonds as agent for its investors.

In relation to the submission that the defendant erred in law or acted irrationally in concluding that the claims were not “in respect of” Keydata’s “managing investments” or partly in respect of this, I have also concluded that Mr Speaight’s submissions must be rejected. The fact that Keydata designed the products, and had discretion to choose not to accept an application were relied on by the claimants but manifestly fall outside any concept of “managing investments”. Product design and deciding whether or not to accept an application are at most preparatory steps by a firm to put it into a position in which it may do business with the product. The question is whether in this case the business activity was managing investments.

The line between a discretionary activity and a ministerial administrative one can be fine, but I do not consider that the other choices left to Keydata under the terms and conditions meant it was managing the investments, or that the defendant’s conclusion that it was not was Wednesbury unreasonable. The Glossary in the FSA’s Handbook defines “managing investments” as “the regulated activity specified in Article 37 of the 2001 Order”, and adds that this “is in summary: managing assets belonging to another person in circumstances which involve the exercise of discretion”. Keydata had discretion as to when to apply funds received in purchasing a bond in the sense that investment was to “be made on or before the effective date”. I do not consider that meant that it was managing the investment, as that term is ordinarily understood. I also do not consider the provision that, after termination, the sale of the bonds is to be at “the next practicable dealing date, normally at the end of the month” and in any case within 30 days from notification of termination, giving a limitation as to timing or the provision about selling the bond on cancellation, meant that Keydata was managing the investment.

It is particularly significant that Keydata had no input into the composition of the portfolio of assets within the bonds. The contractual arrangements made by the issuers (see [19]) provided that LSS, Montage and Meditron should take responsibility for the acquisition and servicing of the portfolio. The brochure contemplated the purchase of a bond to be held for five years producing one of the three types of return and not one that was to be traded. Moreover, there was no evidence that more than one bond was in fact available in respect of a particular brochure and category of application.

The HM Treasury’s commentary in the second consultation document to the draft of what became the 2001 Order and the FSA’s view as expressed in a quite different part the FSA’s Handbook, the PERG Chapter, also suggest that for the purposes of the regulatory system, something more than a limited choice as to the timing of the purchase and sale of the bond is required to constitute “managing” the asset. In the former, paragraph 5.25 under the heading “Managing”, stated “the exercise of discretion must relate to the management and not to some other function carried on by an investment manager, such as proxy voting”. The PERG Chapter is not concerned with allocating compensation costs and is therefore of limited relevance in the context of these proceedings, but it is noteworthy that PERG 2.7.8 states “Non-discretionary portfolio management (where a manager buys and sells, as principal or agent, on the instructions of some other person) is not caught by this activity”, that is the activity of “managing investments” and “the discretion must be exercised in relation to the composition under management and not in relation to some other function (such as proxy voting) carried on by an investment manager”.

The claimants’ case on consultation is that, although the 2000 Act, the 2001 Order and the FSA’s Rules did not expressly impose a duty on the defendant to consult prior to imposing a levy, one arises as a result of three features of this case. The first is the inherent importance of the decision by the defendant, a statutory body, to impose a large levy on the members of the D2 sub-class. Reliance is placed on R (Sporting Options plc) v Horserace Betting Levy Board [2003] EWHC 1943 (Admin) at [148]. The second is the strong concerns expressed by trade bodies which, given the complex interaction of the facts and the law, had relevant expertise. The third is that, even if there was initially no duty to consult, the defendant subjected itself to a duty to consult properly because of its decision to conduct what appeared to be a consultation exercise. Reliance is placed on R (British Waterways Board) v First Secretary of State [2006] EWHC 1019 (Admin) at [23].

It was submitted by Mr Speaight that, whatever the basis of the duty to consult, the steps taken by the defendant in this case did not constitute adequate consultation in accordance with the principles identified by Hodgson J in R v Brent LBC, ex parte Gunning(1986) 84 LGR 168, when accepting the submissions of Mr Sedley QC, as he then was. Those principles were referred to as “the Sedley requirements” in R v Barnet LBC, ex p B [1994] ELR 357, 372. They were summarised in R v North and East Devon HA, ex parte Coughlan [2001] QB 213, at [108] where it was stated:

There are two limbs to Mr Speaight’s submission. The first is that such consultation as there was came after the decision was made. The decision was announced in the issue of Outlook published in December 2009 (see [32] – [34]), reported to the trade in that month and early 2010 (see [35] - [38]), and (see [39] – [40]) announced in a press release on 12 February 2010. It was submitted that as these all pre-dated the consultation, it was accordingly not, in the language of ex parte Gunning, undertaken when the proposals were at a formative stage. The second limb is that the defendant did not give conscientious consideration to the points raised by the claimants’ solicitors and the trade bodies.

Three factors suggest that there was in this case no duty to consult all members of the relevant class or sub-class of authorised persons before imposing a levy on them, as opposed to a duty to take into account representations received. It has, however, not been necessary for me to decide this question. I have concluded that, even if there is a duty to consult, what occurred in fact constituted adequate consultation.

Since there was full argument on the duty to consult point, I summarise the factors that lead me to doubt there is a full-blown duty to consult all members of the relevant class or sub-class of authorised persons. The first is that the liability of a class or sub-class to be subjected to a levy is one imposed by the rules made by the FSA. The second (in a sense a different way of stating the first) is that the defendant has no relevant discretion in the way it allocates compensation costs to the class or sub-class of persons subject to the levy. It is under a duty to do so in accordance with the rules in the 2001 Order and the FSA’s Handbook. There was consultation pursuant to section 155 of the 2000 Act before the rules in the Handbook were promulgated. These two factors distinguish this case from the Sporting Options plc case which concerned a policy choice to impose a tax and involved a close assessment of the business of the claimant in that case. Here the close assessment was not of the claimants’ positions but that of Keydata. These factors also distinguish this case from the British Waterways Board case. It concerned a consultation about a proposed new non-domestic rating system that did not refer to a proposed change which would substantially affect the claimant, and thus excluded the claimant from the material part of the consultation.

The third factor suggesting there is no duty to consult all members is that the decision is to impose a levy on a class of person rather than one concerned with the position of individuals, and moreover, depends not on the position of the persons in the class, but that of a third party. There was no suggestion that the claimants had any particular knowledge of Keydata or its affairs and how they related to the claims made or to be made to the defendant. The application for disclosure may indeed be an indication that they did not have such knowledge.

Moreover, the decision is a general one that applies to the approximately 5,000 members of the D2 sub-class. A duty to consult all individuals affected would impose a significant burden on the defendant. Would there also be a duty to consult the members of the D1 sub-class, upon whom the levy would fall or who would share in the costs if the D2 sub-class persuaded the defendant that the activities giving rise to claims involved or also involved fund management? These practical considerations are similar to those which are one of the reasons there is, absent express legislative provision, normally no general duty to consult before exercising a legislative function. In the case of a general decision of this sort, a requirement to give notice of an intended decision and to provide an opportunity for comment and representations (such as that in section 4 of the United States’ Administrative Procedure Act 1946, 5 USC § 553) would impose a lesser burden. The defendant submitted that this was in practice what was done in this case, albeit not as a matter of duty.

The submissionthat the defendant did not give conscientious consideration to the points raised by the claimants’ solicitors and the trade bodies is not supported by the evidence. The suggestion that the Board made its decision before receiving AIFA’s March representations was not pursued. The defendant’s communications (see e.g. Ms McShane’s email on 18 December and Mr Darbyshire’s letter dated 1 March) engaged with the points raised and to which they were responding, and alterations were made to the position paper. Mr Derbyshire’s evidence is that he reflected on the points made in the solicitors’ letter received on 19 March (see [46]) and (first statement, paragraph 60) that there were “extensive efforts by FSCS to engage with industry bodies and the Claimants’ solicitors prior to finalising a decision in respect of the allocation of the compensation costs levy”. He stated that “there was a lengthy dialogue … to ensure they were able to make their views fully known and understood FSCS’s position”, and that “representations made by ACPIMS, AIFA and the Claimants’ solicitors were given due consideration before a decision was reached”. This evidence by him was not challenged.

The more difficult aspect of this part of the challenge is that the consultation occurred after the matter had progressed beyond what the first “Sedley requirement” describes as the formative stage. The contents of the December 2009 issue of Outlook on this matter do not purport to be an invitation to comment on a proposal upon which a decision will be made in the future. There are some pointers in it suggesting that a decision has been made, including in particular the defendant’s statement (see [34]) that it “has considered carefully” to which funding class the costs should be allocated. But that issue of Outlook was published less than a month after Keydata was confirmed to be in default and it also contains language that is not that of a concluded decision. I refer to the use (see [33]) of “potentially putting a substantial burden on the D2 sub-class and, that the defendant is “considering the best approach for dealing with [the] second category of claims”.

While the language of the December issue of Outlook is not that of consultation, it also has to be remembered that the second of the “Sedley requirements” is that, to be proper, consultation “must include sufficient reasons for particular proposals to allow those consulted to give intelligent consideration and an intelligent response”. That required the defendant to do more than to say there would have to be a compensation levy as a result of Keydata’s failure and it was considering imposing it on the D2 sub-class. Outlook does this and the subsequent documents show that the defendant’s position was refined in the light of its further consideration of the matter and the representations received.

It is also to be remembered that, as Fordham observes, Judicial Review Handbook, 60.2:

By the time of the publication of the Plan and Budget for 2010/11 in mid-February (see [39]) the defendant had made it clear that no decision had been made. It referred to the “indicative levy” and the 12 February press release stated the defendant would confirm the position “before determining and announcing the levy decisions in March”.

On 1 March the defendant confirmed that no decision had been made and invited representations within 14 days: see [43]. In circumstances in which those invited to make representations had already been corresponding with the defendant, this gave adequate time for the representations. The representations made by the claimants’ solicitors were made after the confirmation that the decision had not been made. For the reasons I have given (see [77]), the defendant considered the points raised on behalf of the claimants and by AIFA before making its decision.

For these reasons this claim must fail.