Select Committee on Regulatory Reform Sixth Report

Letter to the Regulatory Reform Committee from Cotesworth 535 / 536 Action Group

As Chairman of the Cotesworth Action Group [CAG], I am a listed consultation respondent to the proposed LRO.

In the July 2008 response to consultation document, our proposal is outlined in section 4.40, together with the Government response in 4.41-4.46, in which reasons are put forward as to why our proposal is not necessary.

The reasoning outlines the role of the Lloyd's Ombudsman and states that where members believe that they have suffered injustice in consequence of maladministration, the Lloyd's Ombudsman has substantial powers under the Members' Ombudsman Byelaw to investigate any complaint within his jurisdiction, and to make recommendations to facilitate the satisfaction, settlement or withdrawal of any complaint— including recommendations that ex gratia payments of money be made.

However, the Government's response fails to point out that, under the Members' Ombudsman Byelaw, Lloyd's are not obliged to accept or implement the Ombudsman's recommendations and it is exactly this situation, where Lloyd's unreasonably fails to accept the recommendations of the Ombudsman, that we wish to address by way of our revised proposed amendment.

In situations where the Lloyd's Ombudsman had upheld a complaint by a member, or members, of Lloyd's against Lloyd's treatment of a Members Compensation Scheme [MCS] application, and Lloyd's decided to take no action to remedy the maladministration found by the Ombudsman, the member would have no right of appeal against Lloyd's decision, and no means of legal redress, however unreasonable, unjust or unfair Lloyd's decision.

Lloyd's sits, in effect, as judge and jury on cases where it has been found guilty of maladministration and is uniquely (for a private body) protected from suit and thus there is no appeal process available against a decision by Lloyd's, made by itself, about itself, even if Lloyd's is clearly in the wrong. In circumstances where Lloyd's disregards an Ombudsman finding of maladministration in relation to issues as serious as alleged dishonesty or fraud in the market, the Lloyd's member should have a right of suit against Lloyd's.

Our amendment is designed to prevent miscarriages of justice in relation to MCS applications. We have restricted the amendment to situations where Lloyd's fails to accept and implement the Lloyd's Ombudsman's findings in relation to a complaint about Lloyd's handling of an MCS application, since it is especially important that Lloyd's deals reasonably and fairly with MCS applications, because these applications, by definition, involve allegations that there has been dishonesty and / or fraud in the Lloyd's market.

The present situation allows Lloyd's to ignore with impunity the findings of the Ombudsman in such cases. Our proposed amendment would therefore reduce the likelihood that Lloyd's members would be deterred from investigating and presenting an MCS claim (for losses suffered as a result of dishonesty ,want of probity or fraud), by the fact that, even if the Ombudsman found that Lloyd's had treated their claim unfairly and recommended that Lloyd's compensate them or not impose a prohibitive litigation requirement, Lloyd's could, with impunity, ignore such recommendations and thereby prevent applicants receiving compensation or a finding being made that there had been dishonesty or fraud at Lloyd's.

Our amendment would introduce an additional, very limited exception to the immunity from suit under the Lloyd's Act 1982 — Lloyd's is already open to suit for libel, slander, personal injury and breaches of Human Rights legislation. The exception to immunity would only apply to any decisions taken by Lloyd's after the LRO became Law, and so would not be retrospective.

Our precise proposal is that there should be an amendment to clause 14(3)(e) of the Lloyd's Act 1982, in the form of a new (iii), providing other, very limited, exception to the immunity from suit, if "the act or omission complained of' (the wording in the Act)

"or (iii) was a failure to accept and / or implement reasonable findings and / or recommendations of the Lloyd's Ombudsman in relation to a complaint about the maladministration by Lloyd's of an application to the Lloyd's Members Compensation Scheme."

The Government raised three principal objections in relation to our original amendment:

(a)  that the amendment would have retrospective effect

(b)  that there were "non-legislative means of securing [our] objective"

(c)  that the "Society would be required to devote significant resources both in terms of cost and management time) to contesting such claims [that the Society had failed to handle MCS applications reasonably and fairly)]"

Our revised amendment is not subject to any of these objections because

(i)  it is not retrospective

(ii)  there are no non-legislative means of dealing with a failure by Lloyd's to accept and implement recommendations of the Ombudsman in relation to L1oyd's maladministration of an MCS application

(iii)  MCS applications are very rare — only two substantial applications in twenty years—so instances where the Ombudsman found that an application to the MCS had been maladministered by Lloyd's, and Lloyd's then failed to accept and implement the Ombudsman's recommendations in relation to that maladministration, should be very much rarer still. Indeed, they ought not to occur at all. The prospective waste of Lloyd's time and resources is therefore not a relevant consideration.

Furthermore, Lloyd's does not need protecting from the possibility that Lloyd's might choose to incur the costs of contesting a claim based on its failure to implement the Ombudsman's reasonable recommendations, rather than actually implementing those recommendations. Our revised amendment could not therefore be said to contravene section 3(2) (d) of the Legislative and Regulatory Reform Act 2006 [LRRA] (as the Government said our original amendment appeared to do.)

The Government also said that it is "not entirely clear how [our previous] amendment can be said to "reduce or remove a burden with the meaning of section 1(3) of the 2006 Act." Our revised amendment clearly does remove such a burden for the following reasons:

The definition of a burden in the Act includes, according to the Treasury March LRO proposal, both a 'financial cost' and an 'obstacle to efficiency, productivity or profitability.'

Applications to the MCS, and complaints to the Ombudsman about the treatment of such applications, are likely to be expensive undertakings. If Lloyd's were to disregard and/or fail to implement the findings of the Ombudsman that it had maladministered an application to the MCS, all the financial cost of applicants to the MCS would be wasted. More generally, the efficiency of any appeal process is compromised if the findings of the appeal can be ignored with legal impunity and successful appellants thereby prevented from receiving any compensation for the injustice they have been found to have suffered, or even for the costs of the appeal process.

Moreover, the absence of any available legal redress for MCS applicants in a situation where Lloyd's failed to accept a finding, or implement recommendations by the Ombudsman in relation to an application alleging that there had been dishonesty or fraud in the market, compromises the efficiency and effectiveness of regulation in the Lloyd's market, and effective regulation is a factor that contributes indirectly to the profitability of the market, because it enhances confidence in that market.

Regrettably, there is currently an apprehension among many underwriting members that Lloyd's might ignore reasonable recommendations by the Ombudsman in relation to an MCS application. This apprehension has arisen for two principal reasons.

First, Lloyd's views the existing MCS as providing discretion for them to require applicants to litigate against agency individuals as a means of proving their claims against an agent, and Lloyd's recent draft proposals for a future MCS propose that such a requirement should be the norm rather than the exception.

MCS applications are (to be) determined by a 'Panel,' The "guidance" as to what that Panel should take into consideration when deciding whether or not to make an exception to the rule of required litigation, does not include the affordability of that litigation. Prima facie, the affordability of an application is a basic and highly relevant consideration for a compensation scheme designed to provide investor protection for individual underwriting members of Lloyd's, as part of the regulatory framework.

Lloyd's have acknowledged that this was the intention of the Scheme, for in a consultation document issued in August 2007, they stated that:

"the [MCS] Scheme was implemented as a consequence of a recommendation in the 1986 report of the committee of enquiry into the regulatory arrangements at Lloyd's chaired by Sir Patrick Neill QC. The Neill report stated that:

'Names should have at least the same degree of protection as will be available to investors' in general under the SIB 's compensation scheme [the SIB was the forerunner of the FSA]'."

However, unless our amendment is incorporated, Lloyd's recent proposals could frustrate the purpose of the scheme, because a requirement to litigate would make it far more difficult for applicants to obtain redress for dishonesty or fraud or want of probity. than if the Agent had remained solvent.

By virtue of their contracts with underwriting agents, underwriting members are both required, and able, to bring claims against underwriting agents under Lloyd's Arbitration Scheme, A single individual, or a small group of individuals, can bring a claim for dishonesty or fraud provided the claim(s) do not exceed £lOOk. A single individual, or a small group of individuals, could not possibly afford to secure a Court judgment as a precursor to obtaining compensation. Unless "affordability" is regarded as a legitimate consideration in a decision about whether or not to impose a litigation requirement, individuals or small groups, could only obtain compensation for dishonesty or fraud if their agent remained solvent. But this would defeat the purpose of the MCS which is to provide a route for compensation for such claims if the agent is insolvent or otherwise unable to pay.

The situation would not be much better for larger action groups with a larger total of individual claims, because Lloyd's recent MCS proposals state that a default judgment against the agent would not be acceptable. MCS applicants would therefore be obliged to obtain a judgment against an agency individual or individuals, as a proxy for a judgment against the agent itself. In cases (like the CAG's), where it is unclear which agency individual would be held to have caused them loss from dishonesty or fraud, applicants would be obliged not only to sue a number of individuals rather than a single agent, but would also have to overcome the legal difficulties that arise in relation to suits against agency individuals (with whom applicants have no contract) and which do not arise in suits against an agent (with whom all potential applicants would have contracts.) The extra costs and risks would in most cases render litigation unaffordable even for larger groups of potential MCS applicants.

In practice, therefore, MCS applications, however strong the claims on which they are based, are extremely unlikely to be pursued unless the requirement to litigate is removed or waived.

In these circumstances, the Ombudsman might well take a different view from Lloyd's as to whether it was appropriate to exclude affordability as a consideration relevant to the crucial issue of whether or not a litigation requirement should be imposed. There is therefore considerable room for disagreement between Lloyd's and the Ombudsman as to the situations in which an exception to the litigation rule should be made.

Potential applicants would need to have confidence that in the event of such a disagreement, Lloyd's could not simply ignore the recommendations of the Ombudsman, without the applicant at least having the right of appeal to a Court. Without such a right, it is very doubtful if any application to the scheme will ever be made in the future, however strong the applicant, or applicants' case, and the intention of the scheme to provide to underwriting members "at least the same degree of protection as will be available to investors in general," will be wholly frustrated.

In this context, it should be noted that it is not just the GAG which considers that a requirement to litigate would prevent any application being made to the MCS, or being pursued once made. An article in the most recent edition of the ALM News (a bi-monthly Newsletter for independent capital providers at Lloyd's) argues that a litigation requirement would constitute

"a huge deterrent to [Lloyd's members] seeking compensation for dishonesty against a bust agent"

and that

"no claim under the MCS will ever be made by a responsible Action Group in future if a requirement to litigate against the directors [of an underwriting agency] is imposed."

What applies to an action group, obviously applies a fortiori to an individual, or a small group of individuals.

Secondly, the judgment in the 2003 Stirling Cooke Brown case gives rise to a reasonable apprehension that Lloyd's might wish to minimise the likelihood of there being a finding that there had been dishonesty or fraud at Lloyd's, for in this case, where the judge found that a Lloyd's underwriter had been dishonest, Lloyd's was criticised in the judgment for failing to comply with the Court's request to provide the Court with documents in its possession or to give any reason for that failure— the judge had to reach the finding of dishonesty without the benefit of the documents requested from Lloyd's.

A situation where Lloyd's could with legal impunity ignore a reasonable finding by the Ombudsman that Lloyd's had exercised their discretion unreasonably or unfairly to impose an onerous litigation requirement on MCS applicants constitutes a deterrent to any MCS application being made, and to the investigation of potential dishonesty or fraud or want of probity that would necessarily have to precede any MCS application.

Where investigation is less likely, transgression is more likely to occur. Efficient and effective regulation should increase, rather than decrease, the deterrence to dishonesty and fraud in the market.

The incorporation of our proposed amendment is therefore also justified under Section 2 of the LRRA in which a minister can make a Legislative Reform order "for the purpose of securing that …. . regulatory activities should be carried out in a way that is transparent, accountable, proportionate, consistent" and 'targeted only at cases in which action is needed."

Our proposed measure will achieve that very purpose, because it will provide a disincentive to Lloyd's to disregard reasonable findings and recommendations of the Ombudsman in relation to maladministration of an MCS application that seeks redress for dishonesty and fraud in the market (when that redress would not otherwise be available because the agent is unable to pay.)

As observed above, the MCS was introduced as a result of Sir Patrick Neill's review of the "regulatory arrangements at Lloyd's." Our proposed amendment would both reduce a burden on individual members who consider that they have grounds to make such an MCS application, and enhance the effectiveness of regulation in the market. As such, our proposed amendment would serve both the interests of individual members of Lloyd's and have public policy benefits, for it is in the public interest that there be the utmost confidence in the integrity and regulation of financial markets of which Lloyd's is a significant part. There are therefore no grounds for considering that our revised amendment would contravene any part of Section 3 of the LRRA.

Further, there is no good reason why our revised amendment should be regarded as "highly controversial." Lloyd's has very recently acknowledged, in its 26 August 2008 proposals for the future MCS scheme, that the MCS "helps promote overall confidence in the market." If Lloyd's were to argue that it needed to retain the right to ignore with legal impunity reasonable findings or recommendations by the Ombudsman that it had maladministered an MCS application, that would undermine confidence in the market, for a crucial ingredient in the trust and confidence in any financial market is that there will not be barriers or disincentives to the investigation of dishonesty or fraud.

I therefore hope that you will support this proposed amendment, which has been revised in the light of the Government's comments, and the very recent (26 August) Lloyd's proposals for the future of the MCS.

31 August 2008

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