The Bill which I am introducing today in this House does four things. First, it provides for compensation for clients of investment and insurance intermediaries, including Stock Exchange member firms and banks which provide investment services to customers. Second, it ensures that investors will be entitled to compensation equivalent to 20,000 ECU, which is worth about £15,500 at present, or 90 per cent of the amount lost, whichever is the lesser. Third, it implements the EU Investor Compensation Directive. Fourth, it provides for amendments to the Investment Intermediaries Act, 1995, the Stock Exchange Act, 1995, the Insurance Act, 1989, and the Solicitors (Amendment) Act, 1994.
The Investor Compensation Bill marks a further significant step in the development of the regulatory framework for the financial sector in this country. The past ten years have seen the emergence of a substantial body of legislation in this area. At the beginning of that period, the banks and insurance companies were effectively the only regulated entities in the financial sector. In the case of banks, in particular, the primary concern was prudential, the main objective being to ensure that the failure of one bank did not endanger the banking system as a whole. Further legislation in the late 1980s extended regulation to financial institutions such as the building societies. Again, the primary concern was prudential, although it was also necessary to comply with EU legislation in the area, designed to bring about a single market in financial services.
More recently, a modern system of regulation has been extended to the retail financial sector, notably through the Stock Exchange Act, 1995, and the Investment Intermediaries Act, 1995. The extension of regulation to the retail sector was necessitated in part by EU legislation, but also because there was a clear need to ensure that the sector was properly supervised. As a result, while the Stock Exchange and Investment Intermediaries Acts transposed the Investment Services Directive, the Investment Intermediaries Act in particular went far beyond what was required by the directive, introducing regulation to the wider retail investment sector, with the exception of insurance intermediaries.
Members of the House will no doubt be aware that the Tánaiste and Minister for Enterprise, Trade and Employment has announced that she proposes to introduce legislation which will bring insurance intermediaries into regulation under the Investment Intermediaries Act, with the Central Bank as the supervisory authority. The purpose of regulation is twofold, to protect investors and to promote confidence in the financial system. There have been a number of cases in recent years where investors have lost money, in some cases substantial amounts, through the default of intermediaries to whom they entrusted their savings. Let us be clear about one thing: no regulatory system can guarantee that a regulated entity will not fail. What we can do is put in place a system of regulation which is comparable with the best standards internationally and this is what we have done. Now it is time to look at the question of compensation for investors who lose money because an investment intermediary is unable to meet its liabilities.
Compensation is of course desirable but it comes at a cost: in addition to the cost of compensation itself, there will inevitably be administrative overheads to be paid for and there will also be the cost of verifying investors' claims for compensation. Not everyone is agreed that compensation is a good thing. Those opposed to compensation base their view on the principle of caveat emptor which suggests that investors should bear all the risks associated with investment themselves, including the risk that the intermediary will defraud them. Those who advocate that view believe that it is up to investors themselves to take the necessary precautions when picking an intermediary and entrusting their funds to that person. However, the Government takes the view that the stronger argument is that individual investors are not generally well equipped to make an informed assessment of the risk that the investment intermediary to whom he or she proposes to give money will fail. In addition, people make mistakes: it can be easy with the benefit of hindsight to criticise people for believing promises of higher than normal returns on their investments, but in many cases the motive for believing the promises is not so much greed as a lack of the knowledge required to appreciate the risks involved. A further point is that the provision of a system of investor compensation should help to reduce the systemic risk that a single failure of an investment firm will trigger a wider loss of confidence in the rest of the financial sector.
Having looked at the broad principles of investor compensation, we now come to the details of what is needed in this Bill. In the first instance, we must implement the EU Investor Compensation Directive. This is a single market directive intended to ensure that all investment firms which have the so-called "passport" to sell their services throughout the European Union will be covered by minimum compensation arrangements. This means that an investor will be able to entrust money to an investment firm located anywhere within the EU knowing that compensation arrangements are in place to safeguard the funds involved.
The minimum that we are required to do under the directive is to ensure that investor compensation arrangements are in place for the minority of investment firms which are subject to it. This could broadly be described as the bigger firms, such as stockbrokers, portfolio managers and discretionary investment intermediaries. Typically these are firms which handle or control investor funds and provide services on a broad range of investment products, such as shares, units in collective investment undertakings and certain types of derivative product. About 100 firms are potentially subject to the directive at present.
However, the directive does not cover what might loosely be called the retail end of the market. An example would be an investment firm which is a restricted activity investment product intermediary for the purposes of the Investment Intermediaries Act. This lengthy description refers to intermediaries who sell packaged investment products such as unit trusts and who are not allowed to handle client funds, apart from taking deposits where they have an appointment in writing from a credit institution to act as a deposit agent. The directive does not apply to insurance intermediaries. Therefore, the directive applies only to a minority of investment firms. However, the Government has taken the opportunity provided by the directive to put in place a comprehensive system of compensation for the entire investment intermediary sector and to extend investor compensation to insurance intermediaries.
The insurance industry continues to attract significant amounts of investment funds, particularly from private investors through single premium life insurance products. The Government felt that it would be anomalous to introduce wide-ranging investor compensation arrangements which ignored the insurance sector, particularly when many intermediaries are involved in both insurance and non-insurance investment business. The Bill also extends the compensation arrangements to any general insurance business, such as car and home insurance placed with an insurance agent or broker. The Investor Compensation Bill will, therefore, cover both the life and non-life activities of insurance intermediaries as well as the business of what I might call "pure" investment intermediaries. The existing protections for insurance clients under the Insurance Acts will remain in place. For example, the provisions ensuring that a client is covered for insurance where the insurance company has invited renewal of a premium or accepted an order once the client has paid the premium to the agent or broker.
Under the investor compensation directive, clients of investment firms are entitled to minimum compensation of the lesser of 20,000 ECU, that is about £15,500 or 90 per cent of the amount lost, where an investment firm is unable to return funds or securities belonging to those clients. The Government has decided that this is an appropriate level at which to set the entitlement to investor compensation generally under this legislation. This provides a reasonable amount of compensation while at the same time giving some recognition to the caveat emptor principle.
The directive also allows member states to limit entitlement to compensation to private investors and smaller companies. In this context smaller companies are those which meet two of the following three criteria: a balance sheet total of less than 2.5 million ECU (about £2 million); net turnover below 5 million ECU (about £4 million pounds) and less than 50 employees. The Government takes the view that this is a reasonable approach since the purpose of the directive and this legislation is to protect the small investor. It has decided to limit compensation generally under this legislation to private investors and small companies only.
I now turn to how investor compensation arrangements will be established. The Central Bank will be the supervisory authority for investor compensation. The bank is already the supervisory authority for stockbrokers, credit institutions and investment business firms and is the proposed supervisory authority for insurance intermediaries under legislation being drafted by the Tánaiste and Minister for Enterprise, Trade and Employment.
The Bill provides for the establishment of a company called the Investor Compensation Company. The company will oversee compensation arrangements for the majority of investment firms, including insurance intermediaries, with the exception of one group. Accountants who provide investment services only as an incidental part of their professional activities as accountants can be regulated by their professional body under the Investment Intermediaries Act, 1995, under the overall supervision of the Central Bank. Building on this, the Investor Compensation Bill allows the accountancy bodies to run compensation schemes for their members. The compensation schemes for accountants will have to provide compensation cover to the standard required under the Bill and will have to be approved by the Central Bank. This approach is appropriate because the accountants who will be covered by such schemes will not be fully fledged investment firms.
The Investor Compensation Company will be established by the Central Bank. It will be a company limited by guarantee and the members of the company will be prescribed by the Minister for Finance, with the agreement of the Minister for Enterprise, Trade and Employment. The company will have equal numbers of directors representing the financial services sector and representing consumer interests. The Minister for Finance will be responsible for the appointment of the directors representing industry and consumer interests, again with the agreement of the Minister for Enterprise, Trade and Employment. The Governor of the Central Bank will appoint the chairperson and deputy chairperson of the board. The company will oversee investor compensation arrangements generally, and it will be responsible for paying compensation. It will decide whether it should maintain a single compensation fund for all investment firms or whether there should be separate compensation funds for different categories of investment firm. It will also decide on the level of contributions to be paid by investment firms.
That is the broad outline of how investor compensation will be structured. I now turn to the proposals included in the Bill for the actual payment of compensation. Compensation will be payable where a client of an investment firm is unable to obtain the return of money or investment instruments from the investment firm. The Central Bank will first make a determination that an investment firm is unable to repay money or investment instruments. The company will then invite applications for compensation from clients of the investment firm and will place advertisements in the newspapers inviting applications. Claims will have to be verified and this will be done by the liquidator where one has been appointed by the courts. Otherwise, the bank can appoint an administrator to establish what is owed to clients of the firm. Once an investor's claim has been verified, the company must pay compensation within three months. This period can be extended to six months where the bank agrees. In the case of non-life insurance, compensation will, within the limits provided for in the Bill, cover the premium paid or the loss suffered by an investor where a claim under an insurance policy arises. Existing protection for insurance consumers, for example, where an insurance company has invited renewal of an insurance premium, will be maintained.
Investor compensation will be met by the Investor Compensation Company in the first instance from the contributions paid by investment firms. I emphasise that the Exchequer will not be involved in funding investor compensation. In the case of compensation claims involving restricted activity investment product intermediaries and insurance intermediaries, the product producers involved will be responsible for some of the funding. The product producers — in other words, banks, building societies, collective investment undertakings, insurance companies, etc., who give such intermediaries written appointments to sell their products — will be required to reimburse the company for compensation payable to clients of such intermediaries where the clients have given money to the intermediary for transmission to an identifiable product producer from whom the intermediary held a written appointment.
This is the broad outline of what is proposed in relation to investor compensation. There are, of course, other provisions in the Act designed to flesh out the detail, to transpose specific requirements of the Investor Compensation Directive and so on. I might mention in particular the provision in the Act relating to solicitors.
Solicitors are exempt from regulation under the Investment Intermediaries Act, 1995, if they provide only investment services which are incidental to their professional activities. The Law Society compensation fund covers clients of a solicitor in respect of legal services, including financial services. However, there was a doubt whether the society's compensation fund would cover financial services which did not arise from the provision of legal services. Accordingly, the Solicitors (Amendment) Act, 1994, is being amended to make it clear that the Law Society compensation fund will provide cover for investment and insurance services provided by solicitors where the solicitor is not covered for such services by compensation arrangements under the Investment Compensation Bill or, in other words, if the solicitor is not contributing to a fund maintained by the Investor Compensation Company. These provisions can be found in sections 45 to 47 of the Bill. I should also add that section 2 of the Bill contains a provision exempting certain investment business firms in the International Financial Services Centre from the obligation to participate in investor compensation. The exemption will only apply to entities which are not subject to the Investor Compensation Directive and which do not provide investment services to domestic investors.
I am also proposing a substantial number of amendments to the Investment Intermediaries Act, 1995. Senators will recall that the Dáil Select Committee on Enterprise and Economic Strategy compiled a report on the regulation of investment intermediaries following the collapse of the Taylor group of investment companies in August 1996. The committee's report recommended a number of amendments to the Investment Intermediaries Act, 1995, and many of those recommendations form the basis for the amendments which I am proposing today.
I will turn now to a description of the provisions of the Bill. I should, of course, emphasise that I do not propose to comment on each section but rather to highlight for Senators the main features of the Bill and the purpose underlying certain provisions.
The Bill is divided into five Parts. The first Part deals with general matters. Part II establishes the Investor Compensation Company Limited which will have an important role in investor compensation, as I will outline shortly, and provides that the accountancy bodies will be able to establish their own compensation arrangements. Part III provides for the payment of compensation to clients of investment firms. Part IV contains miscellaneous provisions, including the provision of information to clients of investment firms about compensation and technical sections arising from the terms of the Investment Compensation Directive as well as a number of provisions relating to solicitors. Part V contains amendments to the Insurance Act, 1989, the Investment Intermediaries Act, 1995, and the Stock Exchange Act, 1995.
Section 1 provides for the commencement for the provisions of the Act. The Minister for Finance will commence provisions of the Act by regulation. Section 2 sets out the definitions used in the Bill. As I mentioned earlier, the Bill covers the activities of investment business firms, Stock Exchange member firms, credit institutions and insurance intermediaries. These are collectively referred to as investment firms. Section 2 also includes an obligation on solicitors who are restricted activity investment product intermediaries to inform the Central Bank and the Investment Compensation Company Limited of their existence. The reason for this is that while solicitors are exempt from regulation under the Investment Intermediaries Act, 1995, if they only provide investment services which are incidental to their professional activities, a solicitor who was providing investment services which were not connected with legal services is required to be a contributor to a compensation fund operated by the Investor Compensation Company Limited.
Section 7 provides for the repeal of certain provisions in the Insurance Act, 1989, the Investment Intermediaries Act, 1995, and the Stock Exchange Act, 1995, because they will be redundant once the provisions of this legislation are in place. These include the bonding provisions in section 47 of the Insurance Act, 1989, and section 51 of the Investment Intermediaries Act, 1995, as well as section 28, subsection (4), of the Investment Intermediaries Act. Section 8 designates the bank as the supervisory authority for investor compensation schemes and as the competent authority for the purposes of the EU Investor Compensation Directive.
Part II of the Bill deals with the administration of investor compensation arrangements, the establishment of the Investor Compensation Company Limited and the approval of compensation schemes for certified persons, which in practice means accountants who provide investment services only as an incidental part of their professional activities.
Sections 10 to 20 provide for the establishment by the bank of the Investor Compensation Company Limited. The company will establish funds out of which clients of investment firms will be paid compensation under this legislation and will set the amount of the contributions to be paid by investment firms to those funds. I have already dealt with how the company will be organised in my opening remarks so I do not need to go into the details again.
Section 21 requires investment firms to make contributions to the compensation funds maintained by the company. An investment firm which does not pay its contribution in full on time will be subject to interest payments on the amount not paid. This section also provides that the company may, when setting the rates of contribution, take account of investment business done by investment firms before the legislation was commenced, in cases where the investment firm is subject to the investor compensation directive.
The reason for this particular provision is that compensation under the terms of the directive will be retrospective, in the sense that it will cover money and investment instruments given to the investment firm before the commencement of this Act. A retrospective provision such as this would not normally be acceptable in Irish law; however, our legal advice is that the directive is retrospective in this way. We are providing accordingly for the payment of compensation on a retrospective basis to the extent that this is required by the directive, in Part III of the Act. The section also allows the bank to impose conditions and requirements on investment firms.
Section 22 deals with the maintenance of funds by the company. The section specifies that the company will be responsible for deciding on the contributions to be paid by investment firms and on the amount of the reserves to be maintained in a fund. The company must consult the bank before deciding on the contributions to be paid, since the bank will be the supervisory authority and will have first hand knowledge of the sector. It is proposed that funding of investor compensation will be prospective — in other words, that the company will build up reserves in order to meet claims for compensation — rather than collect contributions to pay claims as they arise. The company will be required to ensure that it is in a position to pay reasonably foreseeable claims for compensation and must take account of the funding capacity of investment firms when deciding the level of contributions and reserves.
Section 24 requires the company to have procedures in place to investigate complaints against it. Section 25 provides for the approval by the bank of investor compensation schemes for certified persons under the Investment Intermediaries Act, 1995. In practice, this means accountants who provide investment services which are incidental to their professional activity and whose professional body is approved by the Central Bank to oversee the investment activities of its members. Section 26 allows the bank to apply to the High Court to revoke the approval of a compensation scheme for certified persons.
Section 27 provides for the issue of directions by the bank to investment firms which do not comply with their obligations under the Act. Those obligations primarily relate to contributions, but could also include providing information needed to work out what contribution to compensation the firm should pay. The bank is empowered to impose restrictions on the investment services provided by an investment firm which does not comply with those obligations. The Second Schedule contains supplementary provisions in relation to a direction by the bank under this section and provides for appeals to the High Court against such a direction.
Section 28 allows the bank to apply to the High Court, following consultation with the company, to have a direction given by it to an investment firm confirmed under section 27. If an investment firm continues to fail to comply with its obligations under the Act the bank can move to revoke the authorisation of the investment firm to provide investment services or in the case of an insurance intermediary ensure the intermediary is unable to act as an insurance intermediary on behalf of insurance companies. It will be an offence for a product producer to do business with an investment firm where the product producer has been informed that the firm has not complied with its obligations under the Act.
Part III deals with the payment of compensation to clients of investment and insurance intermediaries. Compensation will be payable in defined circumstances. There are two possible triggers, one being a court ruling which effectively prevents investors from recovering their funds from an intermediary for the time being. An example would be where the courts appoint a liquidator to an investment firm. The second trigger is where the Central Bank forms the view that an intermediary is unable to return client funds or investment instruments. In that case the bank will make a determination that a firm is unable to meet its obligation.
Section 32 provides that where the bank has made a determination or a court has made a ruling, the company or compensation scheme must inform clients of the investment firm that they have a right to apply for compensation. Clients must be given at least five months within which to apply for compensation. However, this period may be extended in individual cases where the bank believes the client is unable for good reason to lodge a claim within the time allowed.
Section 33 deals with establishing investors' entitlement to compensation. Obviously, each claim for compensation will have to be clearly established: the mere existence of a receipt showing that a client entrusted funds to an intermediary does not, for example, show that the money was not subsequently returned. A liquidator appointed to an investment firm by the courts will be required to establish what is owed to investors by the firm as a priority. If a liquidator has not been appointed, the bank will appoint an administrator to establish what is owed to investors who are claiming compensation.
Section 34 is a key section in the Bill. It provides for the payment of compensation to the client once the claim has been established. The compensation will be paid by the investor compensation company or, in the case of a certified person, which in practice means an accountant, by the compensation scheme of which the accountant is a member.
Section 35 covers the details of compensation payments. Compensation must be paid as soon as practical and at latest within three months of the date when the amount lost by a client was established. This period may be extended for a further period not greater than three months with the agreement of the bank. The compensation scheme will be subrogated to the client of an investment firm in respect of the debt owed by the firm to the client and in respect of any payments from a bond or professional indemnity insurance held by the investment firm. This means that if there is still money in the investment firm after a client has been compensated by the investor compensation company or compensation scheme, the client will not be entitled to any of it until the company or compensation scheme has recovered what it paid out in compensation. In a sense, compensation can be seen as a down payment on the money owed by the investment firm to the client.
Part IV contains miscellaneous provisions relating to investor compensation, including technical provisions arising from the investor compensation directive. Section 41 provides that the bank may require investment firms to hold professional indemnity insurance in respect of investment services they provide. This will provide additional investor protection where an investment firm, for instance, loses client money through negligence.
Section 42 provides exemption from liability in damages for the bank, its employees, officers and authorised officers, and the company, its board, officers and employees in carrying out their functions under the Act unless it is shown that an error or omission was in bad faith, and for a disclaimer of warranty in respect of compensation funds and schemes and investment firms arising from their supervision by the bank. Neither the State, the company nor the bank will be liable arising out of the insolvency or default of performance of a compensation fund or compensation scheme.
Section 43 sets out the penalties for offences created under the Act. The maximum penalty will be a fine of £1 million and, in the case of an individual, imprisonment for up to ten years, or both, on conviction on indictment. On summary conviction, a maximum fine of £1,500 may be imposed and an individual may be sentenced to prison for up to one year. Sections 44 to 47 deal with the provision of investment and insurance services by solicitors, an aspect of the Bill with which I have already dealt.
Part V contains a number of amendments to the Insurance Act, 1989, the Investment Intermediaries Act, 1995, and the Stock Exchange Act, 1995. I do not propose to go into every section in detail. Senators will find all sections are dealt with in the explanatory memorandum accompanying the draft Bill. I will instead attempt to draw attention to the thinking behind some of the more significant amendments.
Section 51 inserts a number of amendments in section 2, subsection (1) of the Investment Intermediaries Act, 1995, the definitions section. The definitions of "investment advice", "investment business firm" and "investment instruments" are being amended in the light of experience gained in the implementation of the Act. Section 54 amends section 14 of the Investment Intermediaries Act, 1995, to provide that the supervisory authority may impose conditions and requirements on investment business firms which are deemed to be authorised under section 26 of the Act as well as in respect of investment business firms which are authorised under section 10 of the Act.
Section 58 amends provisions in section 26 of the Investment Intermediaries Act, 1995, relating to restricted activity investment product intermediaries. It might be useful to recall what is meant by that term. Restricted intermediaries may only sell products such as unit trusts. They must not handle client funds, the only exception being where they have a written appointment as a deposit agent. Restricted intermediaries are deemed to be authorised on the basis of holding at least one written appointment from a product producer — in other words, they do not need to be formally authorised by the Central Bank. As a result of this amendment a person who wishes to start up as a restricted activity investment product intermediary in future will have to be fully authorised by the bank.
Section 59 inserts a new subsection in section 28 of the Investment Intermediaries Act, 1995. Product producers are required to give a written appointment to any investment business firm through which they sell their products and are required to ensure that the investment business firm complies with the Act. This element of industry self-regulation is central to the supervisory regime for restricted intermediaries under Part IV of the Act. The new subsection reinforces this provision by making it an offence for a product producer to deal with an investment business firm without giving an appointment in writing to the firm and without checking that the investment business firm meets the authorisation requirements of the Act.
Section 60 amends section 31 of the Investment Intermediaries Act, 1995, by the insertion of a new subsection which provides that a product producer who withdraws an appointment in writing from an investment product intermediary must publish notice of the withdrawal of the appointment in writing in one or more newspapers circulating in the State.
Section 63 amends section 52 of the Investment Intermediaries Act, 1995. Section 52 is designed to protect client funds in the hands of an investment business firm when a liquidator is appointed to the firm. The client funds must be kept in separate accounts and the liquidator will not be entitled to use those funds to pay off creditors of the firm. However, there may be cases where it is justifiable to use client funds to meet a liquidator's costs because the clients will derive benefit from the actions of the liquidator. It is now proposed to allow such client funds to be used to meet the costs of a liquidator of an investment business firm where the liquidator carries out functions under the Investment Intermediaries Act or under the Investor Compensation Act or distributes the client money and investment instruments, where the firm has no assets from which those costs can be paid. The High Court will have to approve any such use of client funds.
Sections 69 to 81 amend various sections of the Stock Exchange Act, 1995. The Investment Intermediaries Act and the Stock Exchange Act contain virtually identical provisions for authorisation and supervision of Stock Exchange member firms and investment business firms. I am, accordingly, proposing these amendments to the Stock Exchange Act to maintain consistency between the two pieces of legislation. I do not propose to bring the House through the Stock Exchange Act amendments individually. The text of the Investor Compensation Directive is included as the Third Schedule.
I hope this legislation will not be called upon to do what it provides for, that is, to pay compensation to clients of a failed investment or insurance intermediary. Realistically, however, that is a forlorn hope. Human nature will always be there and so we are unlikely to achieve the perfect world. The least we can do is try to minimise the number of defaults and to ensure that, where they occur, there is some alleviation of the hurt and misery that can result from them.
The provision of compensation to investors where an investment firm fails to meet its liabilities to its clients is another important step in putting in place a regulatory system for financial intermediaries and an essential element in protecting investors. The presence of investor compensation arrangements will play an important role in promoting confidence in the investment intermediary sector. This will, in turn, benefit the financial sector as a whole.
This Bill gives an important role in the operation of investor compensation to the investment services industry and to investors. I am confident that they will discharge that role efficiently and well. We have consulted widely in the preparation of this Bill with the financial services industry and with consumer interests and I thank all who contributed to the development of this legislation. I commend the Bill to the House and I look forward to hearing the contributions of Members.
