The SIB, the City financial watchdog, told independent financial advisers (IFAs) last November to contact clients who may have been sold personal pensions when they would have been better to stay with company schemes. But the advisers' professional indemnity (PI) insurers have warned that doing so is likely to invalidate their cover.
It is estimated that at least half the UK's 20,000 registered IFAscould be forced either to meet individual claims of about £10,000 per case out of their own pockets - or go bankrupt.
The Independent Financial Advisers Association (IFAA), a trade body representing advisers, is applying for a judicial review, stating that the pension guidelines issued by SIB are illegal.
On Wednesday the High Court will be asked to rule that the proposals, outlined in a consultative document, are in violation of the Financial Services Act.
If the IFAA wins, hundreds of thousands of people with personal pensions will have to make their own assessment of whether they have lost out.
Garry Heath, chief executive of the IFAA, said: "We believe the Act lays down that clients instigate complaints against their advisers. But SIB is asking us to trawl through our clients' files and write telling them they may have grounds for compensationagainst us. In any case, our indemnity cover requires us not to actively go out and get claims against us because that would increase the PI insurer's risk."
A SIB spokeswoman said: "At the moment we have not been notified of the hearing. As soon as we are we will be considering our opinion."
It is believed SIB will defend its case vigorously, arguing that unless clients are contacted as it proposes, advisers will face massive public hostility.
The row between IFAs and their regulator, which threatens to tarnish even further the financial services sector's reputation, follows last year's SIB report on pension transfers. This suggested that up to 1.5 million people who started personal pensions since 1988 may have been wrongly advised to do so.
Industry sources have suggested that compensating the most urgent 350,000 cases could cost at least £2bn. IFAs, who advised in about a third of pension transfers and opt-outs, will face a large slice of the bill.
The bill can either be met out of an IFA firm's PI insurance, from its own assets or - if the firm goes bust - from the Investors Compensation Scheme. This has £100m a year to meet all its obligations.
The Personal Investment Authority (PIA), the new watchdog for financial services firms, has issued a paper supporting SIB's recommendations. These tell IFAs to send their clients a questionnaire informing them that they may have been wrongly advised and inviting them to send the completed form back.
The PIA document adds that if any IFA firm feels its PI cover will be jeopardised by sending out the questionnaire, the task will be carried out by the PIA's own pensions unit instead.
A PIA spokesman said: "We believe our proposals will not mean that PI insurance will be affected. We have taken some legal advice and are still in discussions with the underwriters on the subject."
However, Geoffrey Pointon, chairman of Pointon York, a leading PI insurance broker which provides cover for about a third of financial advisers, said this would not be enough.
"The underwriters we deal with are saying that PI cover will be invalidated if IFAs either write to their clients directly or if this is done on their behalf by the PIA," Mr Pointon said.
"An underwriter will not accept a claim if he believes the IFA is prejudicing the defence he is mounting against any action from a client."
He said underwriters would accept an SIB advertising campaign inviting clients to write in.Reuse content