In this report, Sarah Hitchins and Andrew Lee, associates in Allen & Overy LLP's Banking, Finance and Regulatory Litigation Group, consider the High Court's judgment in Financial Conduct Authority v Anderson [2014] EWHC 3630 (Ch). In this judgment, the High Court provided guidance as to how sums paid pursuant to a restitution order made under section 382(2) of the Financial Services and Markets Act 2000 should be distributed to the depositors of a Ponzi scheme.

Background

Mr Anderson and Mr Peacock each operated Ponzi schemes which were sub-schemes of a Ponzi scheme operated by Mr Pruthi.

In 2010, Lewison J held that Mr Anderson, Mr Peacock and Mr Pruthi (the Defendants) had been accepting deposits from participants in the Ponzi scheme by way of business, and so carrying on a regulated activity without being authorised by the FSA (as it then was) or exempt (see Financial Services Authority v Anderson [2010] EWHC 599 (Ch)).

Subsequently, Vos J assessed the sums that each Defendant should pay by way of restitution under section 382(2) of the Financial Services and Markets Act 2000 (FSMA) (see Financial Services Authority v Anderson [2010] EWHC 1547 (Ch)). This section provides:

"The court may order the person concerned to pay the Authority such sum as appears to the court to be just having regard- … to the profits appearing to the court to have accrued and to the extent of the loss or other adverse effect".

In the present case, the FCA applied to the Court for directions as to how the sums to be paid by the Trustee in Bankruptcy for the Defendants (which were expected to be substantially less than the sums determined by Vos J) should be distributed to the depositors of the three Ponzi schemes.

Applicable legislation

No legislation or case provides guidance in relation to FSMA section 382(3), which states simply:

"Any amount paid to the Authority in pursuance of an order under subsection (2) must be paid by it to such qualifying person or distributed by it among such qualifying persons as the court may direct."

FSMA section 382(8) defines a "qualifying person" as someone who has made a profit or suffered a loss as a result of the contravention being considered.

High Court's decision

Depositors eligible to recover money

Mr D Halpern QC (sitting as a Deputy Judge of the Chancery Division) held that only depositors who had suffered real losses (being out of pocket) should receive compensation where there was a very large shortfall between the losses incurred by depositors and the amounts recoverable for distribution. Depositors who had made less profit than they expected were much less deserving of compensation.

Ideal scheme for distribution of sums to depositors

The Court recognised that fairness was the principal factor in determining how the sums should be distributed to depositors and outlined the features of a ‘perfect' scheme:

• Each depositor should be able to claim his capital losses.
• Arguably, each depositor should be able to claim interest on the capital lost.
• Each depositor should give credit for interest actually received.
• If the total available for distribution is less than the total amount to which the depositors are then entitled, the sums distributed should be reduced pro rata.
• If any depositors fail to make claims, their sums should be divided between those who have claimed, so long as they do not receive more than the amount to which they are entitled.

Scheme for distribution in this case

The Court stated that in this case the distribution scheme had to be fair but as simple as possible. This was due to the very large difference between the losses suffered by depositors and the sums available for distribution, so a complex distribution scheme would be disproportionately expensive to design and administer. In addition, the nature of the Ponzi schemes meant that the FCA had not been able to determine the facts in relation to each depositor (when they first deposited money, how much interest they earned, and whether they withdrew their money and re-invested it).

The Court decided that the distribution scheme here should work as follows:

• Each depositor should be able to claim the capital sum recorded at the time of the FCA's intervention in the Ponzi schemes (reflecting their capital losses).

• Each depositor should give credit for all interest received (although this would not take into account depositors who had withdrawn their money with interest and then re-invested it).

• The sums distributed to the depositors should be reduced pro rata based on their capital losses less interest.

• The amounts paid by the Trustee in Bankruptcy of each Defendant should be allocated to the depositors of the relevant Defendant's Ponzi scheme, rather than being pooled and divided pro rata between all of the depositors.

• The Court granted liberty to apply to adjust the proposed scheme if it subsequently appeared unfair if circumstances changed, depositors made independent claims in the Defendants' bankruptcies, or there were errors in the FCA's calculations.

Comment

This judgment provides helpful guidance as to how the sums paid pursuant to a restitution order made under FSMA section 382 will be distributed to those who have suffered losses or otherwise been adversely affected as a result of a breach of regulatory requirements.

Although the actual directions given in this case as to how the distribution scheme should work are specific to its facts, it is clear that, when dealing with sums obtained pursuant to restitution orders, the Court and the FCA will be expected to balance the need for distribution to be fair with the need to avoid over-complicating distribution schemes.