Tag: professional indemnity insurance

SMDF 2009 annual report shows €14.3 million investment loss

[Update: link to report now included] The ongoing travails of the Irish legal profession is a subject of minority interest and, perhaps, one which I have already devoted too much time to.

Nevertheless, the 2009 annual report of the Solicitors’ Mutual Defence Fund Limited arrived in this morning’s post and, to throw some further light on previous posts, here are some highlights:

  • In relation to the SMDF’s case against Bloxham Stockbrokers, pleadings have closed and discovery is being finalised. It is expected that the case will be listed for hearing in late 2010 or early 2011. A similar case taken against Bloxham by a former director of the SMDF has been settled.
  • The accounts show a deficit of €15.9 million. This amount primarily consists of a realised loss on disposal of investments of €14.3 million. While the SMDF’s losses on the Saturn bond obtained from Bloxham were known, less known was the fact that, in addition to realising a loss on that bond, “the company disposed of Irish equities, which resulted in a net realised loss of €6,195,182.” The accounts record a further unrealised loss on financial assets of €228,720.
  • Over 70% of claims against solicitors covered by the SMDF arose from property transactions.

Breakdown of claims

  • The company’s auditors were unable to form an opinion as to whether the company’s financial statements give a true and fair view of the company’s affairs or whether they had been properly prepared in accordance with the Companies Acts. This is due to uncertainty caused by the availability of funding, notwithstanding the assistance provided by the Law Society.
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DoJ documents on solicitors’ insurance silent on bailout by Law Society

The solicitors’ profession faced a situation in late 2009 which was not dissimilar to that faced by the Irish banking sector in September 2008. I wrote about it in January 2010, outlining the chain of events that led to the Law Society guaranteeing a commercial loan to an insurance broker. The guarantee was conditional on the Law Society receiving counsel’s opinion to the effect that they could give such a guarantee and that opinion was obtained. Some of us wondered if there were not legal or regulatory issues which could affect this guarantee, given by a de facto State agency to a private company with more than half of the PI market.

So, I submitted freedom of information requests to the Department of Justice and the Department of Finance. To my surprise, the Financial Regulator is not subject to the Freedom of Information Acts 1997 and 2003 (FOIA), so no application could be made to it. The requests sought all records relating to:

  1. the difficulties experienced in the market for professional indemnity insurance for solicitors in 2009;
  2. the resolution of the Law Society to guarantee repayment of a loan facility to be obtained by the Solicitors Mutual Defence Fund (SMDF) from a commercial lender; and
  3. all communications to and from the Law Society, the SMDF and other insurance companies, underwriters and brokers in relation to same.

The Department of Finance had nothing. Some weeks after a decision was due I received 10 documents, all falling with the third category sought (the Department does not hold any records under categories 1 and 2).

The documents primarily consist of briefing notes for internal use within the Department of Justice, most of which reproduce or paraphrase the contents of the first note. They suggest that the Law Society, which sets the rules for the professional indemnity insurance (PII) scheme, operates independently of Government. Changes to the PII regulations do not require the Minister’s agreement but he can direct the Law Society to amend the regulations. For example, one note for the Minister says that although the Council of the Law Society met to consider the issue in August 2009 “we have no information on what transpired.”

The following points are of interest:

  • Ken Murphy, Director General of the Law Society, sought a meeting with the Minister for Justice in October 2009. This request is referred to in internal Department communications as relating to a briefing “on the looming ‘crisis'” in the PII scheme. The meeting took place on 15 October 2009.
  • The Minister indicated that the then Minister for Enterprise, Trade and Employment should be notified of the situation. A draft letter was prepared, but it is not clear if the letter was sent. The draft letter stated:

In the event that the measures already taken by the Society, and the additional measures planned, do not sufficiently address the concerns of insurers, there may be proposals to suspend or abolish the compulsory nature of the PII scheme for solicitors. I have indicated to the Society that, in the interest of protecting clients, I would not support such a proposal.

  • A later briefing note says that solicitors who have difficulty in paying their premium were told by insurance companies that they would “source the money for them (presumably involving a commission).” It also says that solicitors were being told that conveyancing should not make up more than 30% of their practice (hardly an issue for most solicitors at present).
  • The last document, from February 2010, states that 18 firms had failed to notify the Law Society of their insurers by 1 February. “This is 0.8% of the 2,249 firms on record and is on a par with previous years.”

The documents are interesting in that they show the extent to which the Law Society runs the show for PII, with the Government taking a detached role. They also show that the Minister is firmly of the view that abolishing compulsory PII is not an option.

However, the most interesting aspect of the documents is the lack of any reference to the Law Society’s provision of a guarantee in favour of the SMDF. Therefore, it remains unknown what the attitude of the Department of Justice and other insurance companies is to that arrangement.

Update

  • One of the measures adopted by the Law Society last year was to exclude from PII cover the giving of undertakings by solicitors to financial institutions in commercial property transactions. However, additional top-up insurance could be purchased to cover such transactions. This morning, the Law Society announced the expected ban on giving such undertakings, to come into effect on 1 December 2010 (the first day of the new insurance year).

According to Gerard Doherty, President of the Law Society:

[T]he experience of the Society’s regulatory committees, in particular the Professional Indemnity Insurance Committee, in recent years is that the banks’ ad hoc ‘system’ (with no agreed basis or consistent usage) under which solicitors gave certain types of undertakings in order to complete commercial property transactions exposed the public interest to an unacceptable level of risk. It was essentially flawed and beyond regulatory control with a range of damaging consequences for the public interest, as experience has demonstrated.

The frailties of the commercial undertakings ‘system’, which has been the subject of critical comment by members of the judiciary, has been reviewed by the Society in the light of its capacity to facilitate reckless lending and fraud – with massive losses to lenders as in the Lynn and Byrne cases. The conflict of interest in which solicitors can find themselves, acting for both the borrower and the lender in the same transaction, is at the heart of the problem.

During the boom years solicitors were pressurised, both by borrowers and by lenders, to give letters of undertaking to lenders in commercial property transactions. This frequently led to situations where the undertakings were not complied with and many substantial loans were not properly secured.

An essential part of any banking system is to ensure that proper security is in place where loans, particularly of a substantial nature, are advanced. The risk of failure in this regard is greatly reduced if lenders retain their own solicitors to take responsibility for ensuring the security is put in place.

Paper losses don’t bother the Law Society

I wrote in January about the Law Society’s secret arrangement to guarantee a loan in favour of a private insurance company, the SMDF, to make up for huge losses suffered by that company as a result of a disastrous investment. The Society has now released its 2009 financial statements and only one, brief reference is made to the guarantee, including the news that it has not yet been finalised.

That January post also mentioned massive losses suffered by the Society in a disastrous invesment of its own and the summary of the 2009 statements distributed to solicitors inlcludes the following disclosure:

[The Society’s after tax surplus for 2009] includes an exceptional loss of €480k, representing a further write down of the value of the Benburb Street site in 2009. The write down required by our auditors in 2008 was €14.7m.

In 2006 the Society appears to have been gripped by the property mania affecting the nation and this property was bought for unspecified and unexplored development purposes, at a cost of €22.4m. In 2009 it was revalued at around €7.7m and the 2010 write down brings it to €7.22m.



The then-President of the Law Society said at the time of the purchase:

I believe that the great majority of solicitors today, and in the future, will view the purchase of this Benburb Street site, like the purchase of Blackhall Place, as a wise and practical decision made in the long-term interests of the profession.

In 2010, the Society says of the €15.2 million lost:

These write downs must be put in the context of the Society never planning to sell the site. Importantly, the site is free of debt.

I don’t know which one of those sentences is worse.

Law Society council ensures it can proceed without financial restraints

I wrote previously about the professional indemnity insurance crisis that hit the solicitors’ profession in late 2009. The solution adopted was a guarantee by the Law Society in favour of a specialist insurance broker, the SMDF.

Before the deadline for renewal of insurance, many speculated that the crisis was a result of the economic turmoil generally or the actions of a very small number of solicitors. The guarantee was kept secret until well after that deadline passed. The Society then emailed its members outlining the real reason for the crisis: the SMDF could not offer insurance without plugging a hole that had emerged in its finances when one of its financial investments lost between 97-100% of its value. The Society’s guarantee would allow the SMDF to borrow the sum lost.

Many members of the Society (ie. solicitors) were incensed to learn the details of this rather shocking development and of the similarly disastrous investment by the Society in a property neighbouring its Blackhall Place headquarters, purchased for €22.4 million in 2006 and valued at €7 million in 2009. An EGM was called to discuss both incidents and various motions were to be debated seeking to limit the ability of the Society to enter into such transactions.

The motions were strongly defeated at the EGM. More than 100 signatories called for the convening of the EGM, yet each motion received the support of only 21 – 39 votes. The motions were soundly defeated, though that does not quite equate to the guarantee being “endorsed”, as reported by the Irish Times.

The votes have put an end to the story for now, but further detail is sure to emerge if the proceedings arising from the Saturn bond go to trial.

Endnote: The Society communicated details of the upcoming EGM by post. Solicitors receive a large volume of correspondence from the Society during the course of a year, most of it consisting of magazines, promotional brochures and the like. Much of it is binned or shelved, unread. Recently, however, the Society has made greater use of email to communicate urgent or important messages; indeed, the outcome of the EGM was communicated the next day by email. It appears quite odd that the letter notifying solicitors of the upcoming EGM was not also emailed, though it should be noted that the EGM was comparatively heavily attended.

Law Society follows emergency guarantee fashion

In late 2009 the Law Society bailed out a specialist insurance broker which provides cover to about 60% of solicitors in Ireland. The guarantee resulted from a crisis not unlike that which led to the Government bank guarantee in 2008. It caused a significant hike in premiums and was a contributing factor in the closure of a number of firms throughout the country.
Irish solicitors cannot incorporate as a company and therefore cannot avail of limited liability. Accordingly, solicitors are personally liable when sued and are required by law to have insurance (referred to as professional indemnity, or PI insurance).
In the 1980s the cost of PI insurance shot up and the profession reacted by establishing the Solicitors Mutual Defence Fund Limited, a specialist insurance broker which is separate from, but effectively a tentacle of, the Law Society. The PI insurance market came full circle in 2009 with rumours of premiums doubling and worse.
A common refrain was that the profession was paying for the mistakes of Michael Lynn and Thomas Byrne, but that assumption is incorrect. Where a client is owed money by a solicitor they may make a claim against the Law Society’s compensation fund; if the money is lost due to the fraud of a solicitor, PI insurance generally won’t cover that loss (see d-f here). The true cause of the PI insurance crisis was bad financial investment decisions made by the SMDF.
Once it became clear, to the Law Society at least, that premiums were going to rocket, the initial approach was to tweak the mandatory requirements, for example by reducing the minimum amount of cover from €2.5 million per claim to €1.5 million. Solicitors’ insurance premiums would likely still increase and they would receive less cover than in previous years unless they opted to top-up their cover.
The annual deadline for renewing insurance cover is 1 December. In Autumn 2009 most solicitors were not hearing from their insurers about renewal. Concern began to grow, as did calls to the Law Society. This resulted in regular email missives from the Law Society to its members. Some of these emails were alarming, such as that on 20 November 2009 informing solicitors that delay was due to “uncertainty until very recently over whether the insurance industry would quote at all”. Others passed the buck, like that on 25 November 2009 asking the main insurance companies to backdate policies which were not renewed on time (with no mention of the regulatory issues arising from the intervening lack of cover).
The other emails are available here: 24 November 2009; 2 December 2009; 4 December 2009; 14 December 2009.
The Law Society’s statement that there was uncertainty as to “whether the insurance industry would quote at all” was interpreted by some as a rather scary indication that the industry saw the legal profession in general as high risk. It did nothing to suggest that the problem might have resulted from the SMDF’s internal problems.
In its 2008 annual accounts published in July 2009, the SMDF revealed the near total loss of value in a Saturn bond in which it invested one third of its portfolio through Bloxham Stockbrokers. When the loss of value of the Saturn bond became known, many expected legal action to be taken and the 2008 accounts stated that Bloxham intended to do so. On 1 December 2009, coincidentally the first day of the new insurance year, the SMDF instituted proceedings against Bloxham in the High Court (2009/10863P, since transferred to the Commercial Court).
On 15 December 2009, with the deadline for renewal safely passed and most solicitors covered, the Law Society revealed to members what was really going on.
On 22nd September, 2009, the directors of the SMDF had the first of a series of meetings with the Society. The directors informed the Society that, as a result of [the Saturn bond] losses, the SMDF would not be in a position to write indemnity business for the new insurance year beginning 1st December, 2009 …
The Law Society claimed that the SMDF held more than 60% of the PI insurance market and their withdrawal would result in either a complete market failure or a massive increase in premiums. Either consequence could result in a huge number of solicitors having no cover and having to cease practising.
The delays and damage, with human and commercial consequences, resulting from this dislocation of the entire Irish legal system could be incalculable.
The result was that the Law Society would guarantee a loan to the SMDF of €8.4 million by a commercial lender on the condition that it provide PI insurance for the year beginning 1 December 2009. This was done without informing members despite the fact, as pointed out by Vincent Crowley, that a debate on insurance issues lasting one and a half hours took place at the Law Society’s AGM on 5 November 2009.
Poor investment decisions are not new to the profession. In 2006 the Law Society paid €22.4 million for a 1.09 acre property at Benburb Street, ostensibly to provide extra space for expansion. According to a report of the purchase in the Law Society Gazette (April 2006, p.12), a lengthy debate on the proposed purchase took place at the Law Society Council, which voted unanimously to purchase the site.
“[O]ne Council member seemed to sum up the view of most when he said that ‘very few purchasers ever regret acquiring the site next door'”.
That appears to have been the full extent of the thinking behind the decision to purchase. Michael Irvine, president of the Law Society at the time, said:
I believe that the great majority of solicitors today, and in the future, will view the purchase of this Benburb Street site, like the purchase of Blackhall Place, as a wise and practical decision made in the long-term interests of the profession.
In 2009, the value of the site was written down to €7 million (Annual Report 2008/9, p.21; Phoenix Annual 2009, p.12). A feasibility study on the potential uses of the site was carried out after the purchase was complete, concluding that, due to current economic conditions, no development will take place.
When the deadline for renewing practicing certificates arrives on 1 February 2010, the Law Society will know which solicitors are operating without insurance and will take steps to close them. It appears likely that the Law Society will seek the introduction of legislation allowing solicitors to incorporate, perhaps along the lines of the UK’s LLP system. Another proposal that has emerged to remedy the PI insurance problem, but is unlikely to attract much support, is that the obligation to hold insurance be abolished. This suggestion is accompanied by the surprising logic that the existence of the obligation to carry insurance has led some solicitors to cut corners in carrying out their work, safe in the knowledge that they can fall back on their insurance.
If nothing else, the debacle may at least cause professional representative bodies to exercise greater care in managing their investment portfolios.
  • Update (16 February 2010): Kelly J has granted Bloxham’s application to join Morgan Stanley to the proceedings.