Clients' assets will pay receivership costs in spite of introduction of new rules, writes Colm Keena

The implementation of the recommendations of the Morrogh Working Group, published on Wednesday, will not mean that future receiverships of collapsed investment firms will run smoothly and without rancour.

Not even the working group's report holds out that hope.

Furthermore, the aspect of the receivership process that caused most alarm remains in place. In future receiverships, as in the Morrogh receivership, once the firm's assets have been used up, client assets will be used to pay the receiver's costs.

Investors concerned about the issues brought into focus with the collapse of W & R Morrogh in 2001 can only take comfort from the fact that a broad range of interested parties have given the matter sustained consideration, and came up with their best shot.

As the report makes clear, no jurisdiction has come up with a satisfactory model for dealing with the issues that can arise after an investment firm's collapse.

At the core of the report's recommended approach is the creation of new statute-based rules to be applied during the distribution of client assets in a situation where there is a shortfall. The hope is that this will mean less involvement by the courts.

However, it is unlikely that detailed general rules, due to be drafted over the coming year, will be capable of being applied neatly to the particular scenario that will be thrown up by an actual firm's collapse.

Investors who are unhappy with the way the rules are being applied in their case are likely to seek to have the application of such rules clarified by the courts.

In the Morrogh case, huge legal bills run up by the receiver, Tom Grace, had to be paid for using client assets. However, in the scenario that would pertain after new binding general rules are in place, an investor going to the courts would risk ending up shouldering the legal bills that would arise.

Also, the rules could result in fewer matters needing to be cleared by the courts, speeding up the process and reducing costs.

The working group looked at the issue of getting the industry to fund a receiver's costs, or having high minimum capital requirements, but came down against such options for competition and entry barrier reasons. It also noted that the industry might be against such moves. That said, the industry does end up funding at least some of the costs, by way of its contributions to the Investor Compensation Company Ltd (ICCL).

In the Morrogh case, the receiver's costs ended up being equal to 28.5 per cent of the assets available. A client whose holding with Morrogh was intact had to pay such a percentage of the value of his or her holding to the receiver, before getting back the asset.

A client whose assets, for instance, had been put into a pooled account - such as a nominee account - and which account had a shortfall of, say, 30 per cent, would receive 70 per cent of his or her claim, less 28.5 per cent of 70 per cent.

This sort of scenario seems set to continue. The working group listed some principles it said should be incorporated into the distribution rules that are to be drawn up. The first principle listed was that the concept of a proportionate rateable distribution of assets should be accepted. Also, there should be respect for intact pools of stock (if unaffected by a fraud, intact pools should be left intact).

A perception that arose during the Morrogh case has also been addressed by the report. The wording of the relevant legislation created the impression that a receiver might be able to access funds held outside the investment firm.

The issue is best explained by way of an example. Say a person has an investment account in his or her name with AIB but had authorised an investment firm, ABCD, to issue instructions in relation to the account. A receiver appointed to ABCD, under the current wording of the 1995 Stock Exchange Act, might be able to get access to the assets held by AIB, to help fund the receiver's costs.

A change recommended by the group, the deletion of the word "control" from the Act, will ensure that such a scenario cannot occur.

An issue not addressed by the report was the issue of deterrence and criminal sanction for fraudsters.

W&R Morrogh collapsed because of the activities over a lengthy period of junior partner Stephen Pearson. Pearson is now serving a five-year prison sentence, having pleaded guilty to 31 charges of fraudulently converting clients' funds, 11 charges of forgery and five counts of obtaining funds under false pretences between November 1995 and April 2001.

"The word must go out to the public that white collar crime of this nature will attract serious sentences," Mr Justice Nicholas Kearns said when granting the DPP's appeal against the initial three-year sentence given to Pearson.

Would-be fraudsters have no doubt taken note.