Counting the costs in life savings and reputations

By Nikki Tait and Andrea Felsted
Financial Times 5 December 2005

http://news.ft.com/cms/s/04d73874-6504-11da-8cff-0000779e2340.html

When the multi-billion pound litigation brought by Equitable Life against its former auditors and directors finally came to an end on Friday it was less with a whimper than a concluding cry of anguish from frustrated policyholders.

"Litigation isn't a strategy – it's a rich man's game that policyholders just couldn't afford," said Paul Braithwaite, of the Equitable Members Action Group. "Disgusted" was the blunter reaction of Ann Berry, a retired physiotherapist whose with-profits annuity now pays benefits well below her expectations.

To say that the ripples from the Equitable Life debacle have been extensive would be an understatement.

The near-collapse of Britain's oldest mutual five years ago has prompted changes to life assurance regulation and scrutiny of the actuarial profession.

It has led to lawsuits and legal bills – more than £75m in the High Court action against the former auditors and directors alone. Promising careers have been cut short; established reputations tarnished. Above all, policyholders have seen their hopes of stable, secure benefits dashed. But perhaps the most remarkable aspect of the Equitable saga is that – in contrast to most financial scandals – none of this resulted from dishonesty, fraud or even excessive personal greed.

Now the full story can be told it is clear that misplaced convictions, complaisance, questionable advice and inadequate regulation all played a part. Corruption, however, has been conspicuously absent. The earthquake that was to engulf Equitable would have seemed a million miles away when the society's board met on December 22, 1993 to vote on some amendments to the statement of bonuses. At that stage, the public perception was that Equitable was riding high. But unknown to most people the society did have a problem. Since the late-1950s it had sold with-profits pensions policies which gave holders a choice. They could take their ultimate benefit as an annuity pegged to a guaranteed rate (GAR). Or they could opt for a cash sum and an annuity set at the current annuity rate (CAR). While current interest rates exceeded the guaranteed rate this was not too troubling. But in late-1993, interest rates fell and GARs began to top CARs. According to evidence from Chris Headdon, who succeeded Mr Ranson as the society's appointed actuary in 1997, ways to handle this scenario had been the subject of internal discussion dating back to the 1980s. Equitable’s solution, under consideration since the 1980s and in effect approved at that board meeting, was to apply a higher terminal bonus level to the cash fund form of benefits rather than the GAR form – in short, equalising the annuities payable. To this day, Chris Headdon, who took over from Roy Ranson as the society’s appointed actuary in 1997, maintains his predecessors saw this differential terminal bonus policy (DTBP) as “the fair and logical reaction” and legally uncontroversial in light of broad powers over bonuses given to directors in the society’s articles. For a while the matter simmered. But by September, 1998, interest rates were falling and the media was increasingly focusing on GARs – an issue at several life companies.

Policyholder complaints about potential unfairness began to rise and the board was warned that the cost of abandoning the DTBP and paying out fully under the GARs would be £1.5bn – although it was stressed that this assumed an “inconceivable” take-up rate. So, amid concerns that it could face an adverse ruling from the Personal Investment Authority ombudsman, the society decided to initiate the now-renowned Hyman litigation, named after a retired stockbroker and GAR policyholder who was selected to test the legitimacy of the society’s approach. Meanwhile, its auditors, Ernst & Young, included a £200m provision for GAR liabilities in the 1998 and 1999 accounts. But in July 2000, Equitable finally lost the Hyman litigation on appeal in the House of Lords. The DTBP was, in effect, declared unlawful.

The timing could not have been worse. The £1.5bn impact of that decision coincided with the stock market downturn – and Equitable's business model no longer looked so clever. In December, having failed to find a buyer, the society closed to new business. The following year, part of the business was sold to the Halifax and policy values were cut sharply. Policyholders were understandably unhappy. Management changed with Charles Thomson and Vanni Treves arriving as chief executive and chairman respectively.

Then a second front opened up. In November 2000, the society had consulted another barrister – Terence Mowschenson QC – over whether directors had been negligent for not taking legal advice about the introduction of the DTBP. Mr Mowschenson concluded they had not. But in April 2001, reports surfaced that Equitable had hired Herbert Smith, one of the City's heavy-hitting litigation law firms, to investigate possible damages claims. On May 20, 2001, a concerned John Sclater, former non-executive chairman, phoned Mr Treves to ask about the purpose of the new lawyers' appointment – and whether he was at risk of being sued, imprisoned or made bankrupt. According to Mr Sclater's account, Mr Treves replied that the society just wanted to see "if there was a deep pocket anywhere that could be made to pay up, for example E&Y". Equitable has never commented on this conversation. But seven months later the first "pre-action protocol letters" – a standard preliminary to civil lawsuits – began to drop through directors' letter-boxes. At the same time, less formal letters were also sent to lawyers who had advised the board during the Hyman litigation.

In these, Herbert Smith wrote: "From the documents seen by us, it appears to us that at no stage did you advise the society that there was a real risk of losing." It was a statement that would later be seized on by the defendants' lawyers. Finally, on April 15, 2002, the first writs were formally filed against E&Y, claiming £2.6bn in damages because of allegedly negligent accounting for the GAR provision. Claims against 15 former directors, who had all served on the board in the late-1990s, followed a week later.

Damages sought, also for negligence and breach of duty, topped £3bn. Some of the directors still bridle at the memory. Jennie Page, a former non-executive better known as the Millennium Dome's ex-chief, points out that for the first year of the litigation former directors did not even know if they would have their legal expenses paid under the mutual's directors' & officers' policy. It was not until early-2003, following an arbitration, that they finally secured a £5m pool – although it was to prove completely inadequate. In fact, by the time the writs arrived, Ms Page says that much of her own spare cash had been "exhausted on lawyers".

Today Equitable says publicly – and has repeated many times – that it was consistently advised that there was a cost-effective case against the defendants and a duty, on behalf of policyholders, to pursue this. But one insider does concede that the legal advice was always that there was a greater prospect of a settlement than there was of winning at judgment, and that, right up until the beginning of the trial, the society believed that the case would settle.

"They were always fixated on settlement," is how he recalls the discussions. According to Nick Land, E&Y's UK chairman, several offers were made over the course of the litigation.

"They approached us on four occasions to settle," he divulged this autumn, recounting how the sums went down from more than £150m, to around £85m, to £35m and finally about £12m. E&Y rebuffed them all. Meanwhile, an attempt at mediation with the non-executive directors took place in July last year. Some individuals, although stoutly denying any negligence, offered to contribute personal funds to the then-outstanding insurance sums. The upshot was that the society was offered several millions of pounds. But the deal was rejected – and in a manner that was to rankle, and perhaps harden some individuals' resolve, in the months to come. "They were so arrogant they walked out without responding," says one participant.

It was all to no avail. E&Y, far from blinking, had scored an initial courtroom win in early-2003 when Mr Justice Langley struck out part of Equitable's claim saying it had no reasonable prospect of success. The Court of Appeal subsequently overruled this, deciding Equitable did at least have an arguable case. But by the time the matter came to court E&Y had dug its heels in – and added a second hard-hitting barrister to an already impressive legal team.

When the case finally began in April this year, it was downhill most of the way for Equitable. "The miscalculation that the Equitable board made is that when they launched this action they thought E&Y would settle. The turn of events is that E&Y stared out the tiger. Then, when the lights went on in court, the game changed, and almost from day one, Equitable was on the back foot", is how the insider puts it. As hearings progressed, the case was clearly swinging in the defendants’ favour. Most crucially the directors all dismissed the simplistic notion that, if E&Y had made a larger GAR provision, the board would automatically have slashed bonuses or been able to sell the society for more money. By the summer talk of a better settlement deal started to circulate. Finally, on August 23 in a letter faxed to all the defendants, Equitable offered a "drop hands" deal, under which each party would bear its own costs.

There were two conditions: E&Y had to settle first, and all the directors had to agree. From then on things got messy. Frustrated litigants struggled to find holidaying lawyers but in late September E&Y and the society did agree a "drop hands" deal.

Shortly afterwards, the society abandoned its "all or nothing" approach in relation to the former directors and agreed similar deals with half-a-dozen defendants. But those directors who had used success-related "conditional fee agreements" – and hence had put forward the more formidable legal teams – hung tough. So did David Thomas, a former investment director, and Chris Headdon, who had in effect stopped working to handle his own case.

Eventually, though, the society agreed to repay the legal costs of all those individuals in full. Equitable's bill (including its own costs) was £45m, and the total litigation cost £75m. The Equitable story is not over.

Professional disciplinary proceedings still loom for some individuals; the parliamentary ombudsman is due to release a second report on the alleged supervisory failings; and EMAG is pursuing a claim against the British government, over regulatory aspects, to Europe. But a few lessons shine through. Many lawyers and executives, uninvolved with the case, have said they would liked a judgment in order to clarify the responsibilities of non-executive directors. They make the point that existing case-law is several decades old and that the current Company Law Reform Bill barely addresses the issue.

"It would have been better for non-executives as a whole if the Equitable case had gone ahead. At least we would have had a 21st century ruling which would clarify exactly where non-executives now stand," said Janice Shardlow, at the Halliwells law firm.

In the meantime, the Equitable experience may simply make boardrooms harder to fill. By coincidence Peter Sedgwick, the former Schroders chairman and Equitable non-executive, says he was approached on Friday morning about joining another board in a non-executive capacity.

His reply? "I will certainly never take another non-executive job – it's absolutely not worth the risk.” He adds: "I've heard other people say the same thing.” The entire episode, meanwhile, highlights once again what a high-stakes game litigation can be.

As the society learnt to its cost in the Hyman test-case, there is always litigation risk. Moreover, while policyholders may have suffered much-reduced expectations as a result of the DTBP imbroglio and the upheavals of 2000, the money which has actually been lost to the society are the sums spent on legal fees and the like.

Meanwhile, the climbdowns and bills raise ongoing questions about the credibility of Mr Treves and Mr Thomson. EMAG's Paul Braithwaite claims both are "totally discredited". But although Mr Treves says they take responsibility for the outcome, both he and Mr Thomson insist they will not resign. The ending of the litigation may also be a further step towards an eventual break-up of the society and an abandoning of the 250-year-old Equitable name – an outcome that an increasing number of insurance industry commentators believe likely.

Mr Treves says Equitable has had “a significant number of unsolicited offers” but industry experts warn a break-up will be neither quick nor easy. Already, however, this speculation has prompted policyholder concerns. Their travails may not be over yet.

‘I am too old to start again’ Ann Berry, a physiotherapist from Selsey in West Sussex, had pension plans with four different life assurance companies until her retirement in 1998, writes Charles Batchelor. Then she made the fateful decision to consolidate the policies, worth a total of £110,000, with Equitable Life. As a self-employed person, Ms Berry, now 68, realised she had to make her own plans for her later years. “I have a small state and NHS pension but my Equitable annuity was to be my main source of income,” she says. “I have been totally let down. At my age I am too old to start again.” She put £25,000 into a with-profits bond with Equitable. The returns were so poor – about £500 over the first five years – that she took it out and has now reinvested it elsewhere. But this left her with a further £85,000 that was still with Equitable in a with-profits annuity, a scheme that would pay out amounts – in theory increasing as the scheme’s investments blossomed – until her death.

“I had no reason to think it was not safe,” she says. “I seem to recall the phrase, ‘This is the next best thing to a building society account’, passed the representative’s lips.” Ms Berry cannot get out of her annuity with Equitable. The society first said this was a Revenue requirement but, says the Equitable Members’ Action Group, it was forced to admit that it had set the rules. Ms Berry says the annuity was predicted to start paying out £8,000 a year but she is now receiving just under £6,000.

“I know that amount will be revised down at the next review on the anniversary date in February,” she says. “It should be revised upwards but I just know it will go down.” Ms Berry also complains of a lack of communication from the society.

“The first thing I knew about the poor returns was when I consulted my bank account,” she says. Of the society’s decision to drop its legal action against the last of its former directors on Friday, she says:

“I am disgusted. I didn’t think the case would go anywhere in the first place. I am not a lawyer. Mr Treves is. He should have known what he was doing. It is absolutely appalling.”