Sunstone Holdings Ltd. and De Lec Ltd. – ex gratia payments to investors (P.90/2013) – comments.

STATES OF JERSEY

SUNSTONE HOLDINGS LTD. AND DE LEC LTD. – EX GRATIA PAYMENTS TO INVESTORS (P.90/2013) – COMMENTS

Presented to the States on 23rd September 2013 by the Council of Ministers

STATES GREFFE

2013   Price code: A  P.90 Com.

COMMENTS

1. Senator Breckon has linked his proposal that an ex gratia payment be made to investors who suffered financial losses as a result of investments made in the companies  named,  to the  precedent  set  by  payments  made  to those  who invested in Alternate Insurance Services Limited. Reference has been made to the Alternate Judgment and to the statements made by the Judge, including that for investors such as those to be left without compensation would not redound to the good reputation of Jersey and its investment community'.
2. The circumstances  of  Alternate  were  different  from  those  of  the  current proposal. It was also made clear at the time that the decision to give some compensation to the Alternate investors, many of whom were faced with great personal hardship, was not to be seen as a precedent. An important difference between Alternate and the current proposal is that Alternate was within the regulatory envelope of the Jersey Financial Services Commission (JFSC) and the latter had sought to recover funds from the investment advisers through the Court. The property investments to which the current proposal relates were not within the regulatory envelope.
3. In  the  Alternate  case,  the  problem  was  created  by  licensed  Independent Financial Advisers (IFAs) selling wholly inappropriate geared products within its own  terms  of  business  to unsophisticated  investors.  Many  of  the unsophisticated investors had a modest, or in one case no, income. Some investors  were  left  servicing  the  debt  they  had  incurred,  to purchase  the investment which was designed for high net worth and sophisticated investors that could afford to lose all or part of their investment. The JFSC plainly had responsibility for ensuring that the IFAs acted in a fit and proper manner and acted appropriately.  It obtained a restitution order from the Court against Alternate and its principals (both of which were also prevented from working in the industry after the restitution order was obtained). Alternate was placed into liquidation and the business was closed. It sought to enforce the order (including forcing a repayment plan upon one of the principals, albeit for modest sums. It targeted third parties who had lent to and insured the scheme and recovered amounts which were distributed to the investors. All available avenues of recovery were pursued by the JFSC and exhausted. A shortfall was left  and  at  that  point –  on  hardship  grounds –  the  States  decided  to compensate. The Court examined each investor's financial circumstances in detail and the full judgment, that is not publicly available, set out the hardship for each investor.
4. It has been suggested in correspondence sent to States members that the fraud was investigated belatedly by the JFSC. It acted immediately upon notice on 22nd January 2008  (in  the  form  of  a  petition  for  a  Court  Order  being published seeking redress for one of the investors) that there was a problem. It had received no prior notice of or complaint about these activities, nor could it have picked them up from its supervision of Goldridge Stone because they were being conducted separately from that entity on other contractual terms. On  1st February 2008,  the  Commission  exercised its  regulatory  powers  to demand  documents  and  explanations  from  the  principal  persons.  The Commission  devoted  considerable  resource  to undertaking  what  was  a complex  investigation  but,  by  27th June 2013,  Goldridge  Stone  had  been

closed  and  their  licence  revoked.  All  three  principal  persons  were subsequently banned from employment in the finance industry by July 2013.

5. The point has been made by some of the investors that they were persuaded to invest  in  the  US  property  development  schemes  because  the  persons marketing the scheme had been approved by the JFSC as fit and proper', albeit for different  purposes.  In  the  light  of  the  Alternate  case  and other events, the JFSC has sought to educate investors of the risks associated with different types of investment under the heading of Protect Your Money'. The protect your money' website provides the following advice "Do consider what balance of risk and return you are comfortable with. Remember the relationship between risk and reward. There is no such thing as a high return, risk-free investment".
6. It  is made  clear  by  all  regulatory  authorities  that  when  an  investment  is contemplated, particularly in high-risk areas such as off-plan foreign property purchases, investors should always seek independent advice separate from those promoting the investment scheme.
7. The proposition refers to an investor compensation scheme, the case for which remains outstanding. There are issues faced which need to be addressed: such as whether such a scheme could be limited to local residents or, if available to non-residents,  whether  it  could  be  afforded.  For  example,  the  JFSC  is currently seized of some substantial cases where UK-based retail investors have lost significant sums in overseas property development schemes where a regulated Jersey business has had some involvement.
8. What  is clear,  however,  is that  such  a  scheme  would  be  a  government responsibility and not a responsibility of the regulator, in the same way that such a distinction is drawn for depositor compensation. Indeed, Article 27 of the Financial Services (Jersey) Law 1998 explicitly makes this responsibility one for the States. An issue that this raises is how such a scheme would be funded. If the burden of funding was to be borne by investment advisers, this would present real problems for many of the smaller firms, and could force them  out  of  business  in the  absence  of  similar  schemes  in competitive jurisdictions –  the  costs  incurred  could  be  expected  to lead  to business migrating to those jurisdictions.
9. Another point that has been raised is whether, if the investors had been in the UK, they would have been able to benefit from the UK investor protection scheme. Had the circumstances of this matter been encountered in the UK, it is extremely unlikely that a claim under the UK scheme would have been upheld, because the first test is that the "investment" must have been sold to the  individual  by  an  Authorised  Firm.  This  is  defined  as  "a  company, unincorporated body, or individual permitted to carry out a regulated activity by the UK regulatory authorities".
10. The proposition calls for the funding of the compensation to come from the JFSC's funds. Reference has been made in the past to the JFSC's reserves as a source of funds for compensation but, putting aside that there is no statutory provision that would allow those funds to be accessed, it has been shown that these reserves are held to ensure that if the Commission has to take regulatory action through the Courts, it is never in a position where such action could not

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be pursued through a lack of funds. Such a position, if it was to be faced, would be particularly detrimental to the Island's reputation as an international finance centre. In the Alternate case where the States decided to compensate and where the Commission clearly had statutory duties to exercise (which it had discharged to the best of its ability), there was no suggestion of the States payment being recovered from the Commission's reserves. It seems entirely unreasonable  therefore  that  in  this  case,  where  the  Commission  has  no statutory responsibility, that this is being asserted as a course of action.

11. It  is recommended  that  any  decision  on  whether  the  taxpayer  should compensate the investors should depend on whether the circumstances of the case can be seen as sufficiently exceptional in terms of the hardship suffered, to gain widespread public support for any such action. In the light of the points made in this comment, and in particular the unknown cost that might flow from the precedent that would be set of which other investors, both resident  and  non-resident,  could  well  seek  to take  advantage,  it  is not considered that the exceptional nature of this case has been sufficiently made for the proposition to be supported. The Council of Ministers therefore asks Members to reject the proposition.