Investor Compensation Schemes: What They Are and How to Use Them

Investor compensation schemes are reimbursements targeted at investors of companies in crisis. The European Union’s aim is to protect the money of “classic” investors and Forex users.

“The Investor Compensation Scheme covers investors under Article 4 before one of the following has occurred:

  • specialist authorities have ascertained that, in their opinion, for reasons directly related to the investment company’s financial situation, the investment company does not appear momentarily able to meet its obligations concerning investors’ claims and there is no short-term prospect that it will be able to do so; or,
  • a judicial authority, for reasons directly related to the investment company’s financial situation, has made a decision that has the effect of suspending the investors’ ability to enforce their claims against the investment company.”

Why the European Union Has Created Investor Compensation Schemes

The European Union has asked member states (including the United Kingdom, which was a member until recently) to establish a system of reimbursement (the Investor Compensation Scheme) in the event that an investment company is unable to meet its obligations.

If you have invested money with a regulated company (including Credit Institutions) that has gone bankrupt, been involved in an unclear situation (where a judicial authority has intervened), or, for whatever reason, does not give you what you are owed, you have the right to be compensated for at least part of what belongs to you, including financial instruments that the company holds on your behalf.

“Coverage must be provided for claims arising from an investment company’s inability to:

  • repay funds due or belonging to investors and held on their behalf in connection with investment transactions; or,
  • return to investors assets belonging to them, held, administered or managed on their behalf in connection with investment transactions, in accordance with the applicable legal and contractual conditions.”

The European Directive has given each country flexibility to implement reimbursement in the way that they consider most appropriate for each situation.

Directive on Investor Compensation Schemes

Directive 97/9/EC, known as the Directive on Investor Compensation Schemes (ICSD), dates back to 1997. Over the years there have been attempts to update it; none of which have ever been successful.

The Investor Compensation Scheme comes into play if an investment company fails, for various reasons, to pay its clients. It can be invoked in cases of judicial intervention, administrative abuse, and managerial incapacity.

In fact, the Investor Compensation Scheme provides compensation to clients of investment intermediaries and their subsidiaries in host countries in cases where the investment intermediary is unable to meet its obligations to its clients, for reasons related to its financial status.

This directive, however, in no way covers losses related to investment risk but could be extended to losses resulting from poor investment advice.

Currently, only in the United Kingdom is “bad advice” included among the cases that merit coverage by the Investor Compensation Scheme.

“Claims arising from transactions for which a criminal conviction has been declared for money laundering, according to Article 1 of the Council Directive 91/308/EEC of June 10, 1991, relating to the prevention of the use of the financial system for the purpose of money laundering, shall be excluded from any compensation by the Investor Compensation Scheme.”

The Certified Broker is an Insured Broker

Assuming that all companies that provide investment services are required to be part of a scheme, it is evident how important it is to ensure that brokers are certified when deciding to invest. Only in such manner, can the protection of investors’ funds be guaranteed.

The broker’s account, in this case, is deposited into an independent bank and separated from the company’s account. Thus, even if a broker goes bankrupt, their clients are assured that they can get their money back.

How Does the Financial Services Compensation System Work?

The European Directive, which has been instated in its own way by each country, sets some basic requirements for national investor compensation schemes. In doing so, it provides a minimum level of protection throughout the European Union; It has established a minimum EU level of compensation of 20,000 euros per investor. Each country however is also authorized to provide a higher level of compensation.

Despite this, according to the European Directive, certain categories of investors may be excluded from the Investor Compensation Scheme or may only benefit from reduced cover. So-called “professional clients,” for example, are excluded and prevented from applying in the case of default by their broker.

Foreign subsidiaries of investment companies may choose to join either host or home country investor compensation schemes.

This coverage applies to all investors’ claims regardless of the number of accounts, currency and/or European country in which they are located. In the case of joint investments, the claims are divided equally between each investor.

The Investor Compensation Scheme sets a time limit within which you are entitled to make a claim. After which, it is not possible to submit a claim. However, the investor is always entitled to coverage, and this means that there is a good chance of obtaining what is due, even if they apply after the deadline.

The European Directive clearly states:

“The Investor Compensation Scheme (…) entails a fixed period during which investors are required to submit their claims, but this may be no less than five months from the date of the default declaration or publication. However, an investor cannot be denied coverage even if they have failed to assert their right to compensation before the deadline.”

Once it has been determined that the investor is entitled to compensation and the amount has been calculated, the Investor Compensation Scheme has three months to provide this compensation.

The Investor Compensation Scheme in case of Third-Party Losses

In cases where an investment companies holds investor funds in a bank or has transferred the funds to a third party, such as a broker, in order to engage in transactions on behalf of the investor, the Investor Compensation Scheme cannot provide protection for these investors.

In such cases, investors may not only be exposed to company failures, but also to failures arising from third parties.

If default of the third party that holds the goods of a customer triggers the default of the company, compensation may be owed by the Investor Compensation Scheme. The other scenario that could occur is when third parties are in default, but the company itself remains solvent.

Provided that a company has used due care and diligence in selecting a third party to whom it transferred customer assets, it cannot be held liable for any losses of customer assets if the third party is found to be at fault.

This creates an exceptional situation, which puts the investor in doubt as to whether they can claim compensation for their losses from the third party, especially as they may not have a direct contractual relationship with that party. This situation can only be resolved on a case-by-case basis with the intervention of a lawyer.

Who is Entitled to Compensation from the Investor Compensation Scheme?

The following conditions must be met in order to enable the compensation scheme:

  • The supervisory authorities have determined that the investment company is failing to meet its obligations to investors and the situation suggests that it will not be able to do so any time soon.
  • There has been intervention from a judicial authority, as a result of which investors cannot enforce their claims against the investment company.
  • The investment company, due to its own incapacity, is unable to deliver the funds, held on the investor’s behalf in connection with investment transactions, owed to them or the money belonging to them.

How to Use the Investor Compensation Scheme

According to the European Directive, each country can customize the procedures that serve to make those entitled to compensation, following the unfavorable outcome of a given investment company, aware of the progress. However, these procedures must follow a standard scheme:

  • The particular regulated entity must be insolvent.
  • The procedure for payment of compensation by the Investor Compensation Scheme must be initiated.
  • Based on the specific case, the procedure for submitting claims, the deadline for their submission, and the content of the clients’ statement must be aimed at demonstrating their right to compensation is established.
  • The information must be made public on the website of the control body that has taken charge of the claim and in addition (if foreseen) circulated it through the press in popular national newspapers. At the same time, those who believe they are entitled to compensation are requested to submit their claims.
  • The clients of the company must be able to find a description of how to submit claims and the appropriate forms.
  • In exceptional and justified cases, it must be agreed to extend the deadline for the submission of claims.
  • The claimant, once he has received a reply may object to it in writing, within a time limit from the date on which the decision was notified.
  • The reviewing agency shall reimburse each eligible claimant, within a time limit from the date the decision was notified.
  • Payment of the compensation shall take place.

The Investor Compensation Scheme according to the Main Control Bodies

The Investor Compensation Scheme in Italy: The National Guarantee Fund

Compulsory adherence to an investor compensation scheme recognized in Italy was introduced into the Italian legal system in 1997, to implement Directive 97/9/EC of the European Parliament on investor compensation schemes.

The National Guaranty Fund is a private entity recognized as an investor compensation scheme.

The purpose of this fund is to protect investors of participating entities in the event of a compulsory liquidation, bankruptcy or an arrangement with creditors:

  • Italian and European banks
  • Investment companies
  • Asset management companies
  • Securities brokerage companies
  • EU management companies
  • Trust companies
  • Intermediaries
  • EU investment companies
  • Third-party companies
  • Managers of multilateral trading facilities
  • Managers of portals that raise capital for small and medium-sized enterprises and for social enterprise subsidiaries established in Italian banks, EU investment companies, and EU management companies and limited to activity carried out in Italy in order to integrate the protection offered by investor compensation schemes from the country of origin.

The National Guarantee Fund provides compensation for investors, up to a limit of 20,000 euros per an investor. Investors will have to prove that they have a right to reimbursement as holders of a claim, which had derived from failure to repay, all or in part, the investor’s money and/or financial instruments, or their countervalue, in the provision of investment services and activities.

The procedure of the National Guarantee Fund Compensation System

  • A decree is issued ordering compulsory administrative liquidation, or a judgment of bankruptcy is issued, or a judgment approving the arrangement is issued.
  • The procedure for the payment of compensation begins.
  • The liquidation order or sentence is published in the Gazette Ufficiale.
  • A claim for compensation must be submitted to the National Guarantee Fund within 180 days of the date of publication in the Gazette Ufficiale, unless it can be shown that it was impossible to meet this deadline.
  • The fund arranges for the payment of compensation within 90 days following the submission deadline, once ascertaining the persons who are entitled among those who have made a request.
  • The fund deposits the compensation payment in a bank account indicated by the claimant.

CySEC Compensation System: ICF (Investor Compensation Fund)

The Cyprus Securities and Exchange Commission, better known as CySEC, is the supervisory authority in Cyprus and obliges all regulated companies to join the Investor Compensation Fund (ICF) and comply with client funds regulations.

It requires regulated companies to keep each client’s funds in a separate bank account so that if business were to face problems, the client would always be protected – as might be the case if a broker were to execute transactions that could damage the assets of its own company.

To protect investors, who are clients of such a broker, the Investor Compensation Fund would take over. The purpose of the fund is to guarantee clients’ claims through the payment of compensation.

Cyprus has set the maximum compensation ceiling for investors at 20,000 euros.

The CySEC Compensation Scheme Procedure 

  • The compensation payment procedure begins.
  • The ICF defines, for each case, the procedure for the submission of claims, the deadline for their submission (no less than 5 months, but no more than 9 months) and their content.
  • The ICF emphasizes the importance of this information by publishing it in at least two national newspapers and by encouraging compensation claims.
  • The ICF describes how to submit claims and provides forms.
  • In exceptional and justified cases, the ICF may extend the deadline for the submission of compensation claims by up to three months, giving notice in the same manner as it gave notice of the initiation of the compensation claim.
  • The claimant, to whom the ICF gives notice of its decision, may object to it in writing.
  • The ICF shall reimburse each eligible claimant within three months from the date on which the decision was communicated.
  • The ICF shall deposit the compensation payment in a bank account indicated by the claimant.

In the event that a client, who is entitled to compensation, is unable to make a claim within the time limit, they can specify what circumstances prevented them from meeting the time limit and attach evidence to support this.

FCA Compensation Scheme: Financial Services Compensation Scheme (FSCS)

The Financial Services Compensation Scheme (FSCS) is the compensation scheme for investor clients of UK authorized financial services companies. The FSCS can pay compensation in the event that a company is unable, or may not be able, to pay the claim that the client makes against it.

The FSCS is an operationally independent body, established under the Financial Services and Markets Act 2000 (FSMA). However, the rules are set by the Financial Conduct Authority UK (FCA): the UK’s financial markets regulator.

What is unique about the FSCS is that it also provides compensation for losses arising from bad investment advice. The UK’s experience suggests that bad advice can be the most significant risk for retail investors both in terms of frequency of occurrence and potential impact on their investments.

The maximum compensation provided by the FSCS for investments is £50,000 per person.

Who Can Access the FSCS Compensation System Procedure?

  • The FSCS covers investment activities made on or after 28 August 1988.
  • The FSCS can intervene if the investment provider, or adviser, is licensed by the Prudential Regulation Authority or the Financial Conduct Authority to carry out a type of regulated activity.
  • The company should no longer have sufficient funds to meet a compensation claim.
  • If the claim relates to negligent advice, the claimant must show that they lost their money after acting on the advice they received.
  • The claimant must be able to do so.

Poor investment performance is not covered.

The FSCS Compensation System Procedure

To file a claim, FSCS provides a direct online service that requires site registration.

  • Once the defaulting company is reported, documents supporting the claim must be attached.
  • The FSCS will then follow up with the person or company to contact them to inform them of the investigation and to request information from them about their ability to resolve complaints made against them.
  • If this information is not received from the affected person or company, a search will be conducted to retrieve information from public sources.
  • Once they are found to be in default, the affected person or company are given time to object.
  • When the investigation is complete, the claimant will be notified of the outcome.

The progress of the claim can be checked at any time through the claimant’s account. In addition, the claimant can contact the FSCS team for further information at any time.

The importance of Investor Compensation Schemes

Experience tells us that investor compensation schemes protect investor assets from investment company defaults, errors, systems failures, and control flaws. Although there should be alternative protections, there have been many cases where investors would have suffered significant losses without inventor compensation schemes, for example the AFX case. Therefore, it can be argued that the investor compensation schemes set up in the EU are a safety anchor for retail investors.

For years, Boccadutri International Law Firm has been following clients, from all over the world, who have engaged in similar compensation practices with specialist authorities. Contact the Forex Litigation Department for further information and advice.

Calogero Boccadutri
Calogero Boccadutri
Managing Partner

Calogero Boccadutri is the Managing Partner of Boccadutri International Law Firm. He has trial experience in Forex, Personal Injury and Administrative litigation.

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