Morrogh affair highlights vulnerable reserves

The collapse of stockbrokers W&R Morrogh in 2001 has been a major drain on the resources of the Investor Compensation Company Limited (ICCL), the scheme set up in 1998 to protect consumers who lose money when investment firms fail.

Worryingly for the industry-funded ICCL and investors alike, the Morrogh affair showed how quickly the ICCL's reserves could be depleted as a result of the failure of just one firm.

The Morrogh Working Group report, published this week, said the case "emphasised the requirement for alternative funding options" to be put in place. But accessing commercial borrowing is problematic for the ICCL, while approaching industry firms for more money is likely to be met with resistance.

Some €7.1 million has been paid out in compensation to 2,372 Morrogh clients. This has wiped out the reserves in Fund A, which covers stockbrokers, credit institutions and larger investment intermediaries.

The report favours a status quo for the funding of the ICCL, which is made up of two compensation funds. Fund B has decent reserves and mostly covers insurance brokers. But the report does recommend that any top-up funding sought should be capped at twice the usual contribution rate in any one year.

"The industry must have some idea of how much they could be levied. Firms have to be able to manage their own cashflow," says Frank O'Dwyer, chief executive of the Irish Association of Investment Managers.

Two years ago, the 228 Fund A members agreed to a 10 per cent increase in their contributions and the ICCL also approached them for a top-up of €5 million.

Under the "cascade" model of funding proposed by the Morrogh Working Group, once the top-up payments reach the cap, the ICCL will resort to "inter-fund borrowing" - in other words, using the reserves in Fund B to compensate the victims of Fund A companies (or vice versa).

The other alternative is commercial borrowing, which would probably require a State guarantee. But the mechanisms for such a guarantee are not in place and are not especially favoured by the European Commission, which is reviewing compensation schemes in the EU.

The idea of inter-fund borrowing will not please groups such as the Professional Insurance Brokers Association (Piba), which believes the ICCL would require legislative change to do it. Piba argues that, with a healthy Fund B cushion of almost €10 million, any further contributions by Fund B's 3,000-plus members should be limited to maintaining the fund.

"The irony is that, in 1998, when this was set up, it was the big boys in Fund A who did not want to be associated with the little guys in Fund B, who they thought were too high risk," says Piba chief executive Diarmuid Kelly. "Now that it has gone the other way, we are not anxious to mix with the big cash-handling Fund A boys."

In eight years, just €20,000 has been drawn down from Fund B - as a result of the failure of life and pensions broker Andrew Casey - and €15,000 of this was recovered, giving a net claim of €5,000.

"Insurance brokers generally do not handle cash and when they do it is under indemnity from the insurance company. There is a very minuscule risk," says Kelly.

Shortly before the Morrogh collapse, Fund A had to meet 313 claims amounting to €772,000 arising from the collapse of MMI Stockbrokers.O'Dwyer says investors should be comforted that the ICCL has been able to meet its obligations.

"At the time when Morrogh happened, the ICCL had only a couple of years' experience," said O'Dwyer. "It took a hit, but everybody got paid."

But ICCL payouts are limited to €20,000, leaving larger investors exposed to sizeable losses.

The Morrogh report does not discuss a raising of this limit. But it suggests that as part of a speedier certification process by the liquidator or receiver, investors with a valid claim for far larger amounts should receive early payment of their €20,000.