The Investors Compensation Scheme, which helps victims of fraud and bad advice, was plunged into chaos yesterday after a High Court ruling allowing an insurer's legal challenge against it to go ahead.
The court's decision to grant Sun Life a judicial review over whether it should pay towards the pounds 15.8m ICS levy could mean thousands of investors not being offered compensation.
Members of the ICS board have already agreed that if the judicial review was granted, they would halt all future offers of compensation. An emergency board meeting will take place this afternoon to decide whether to press ahead with this policy.
It is believed ICS members are under heavy pressure from the Securities and Investments Board, the City's most senior financial regulator, to change their minds. But ICS sources said this was unlikely to happen.
More than 1,200 investors who were due to receive offers will be immediately affected, with hundreds more joining them every month until the review, due to be heard on 23 August, is concluded.
The compensation scheme's collapse would be the most serious blow yet faced by the already-battered system of financial services regulation.
The ICS is a central part of the lifebelt for investors who have been defrauded. It has paid out more than pounds 80m since 1988.
At stake in the legal case is Sun Life's claim that its share of the annual levy towards the compensation scheme, which is raised by the Personal Investment Authority, should be in relation to failed members of the PIA only. Last year, 49 out of the 53 firms whose investors qualified for compensation were not PIA members. Sun Life argues that if it were to pay towards compensating those investors, its own policyholders might mount a legal challenge against it.
The PIA decided two weeks ago not to raise money for the levy. Faced with that, the ICS board decided not to make further use of its pounds 10m overdraft facility with Royal Bank of Scotland unless it could be sure that more money was coming in.
David Cresswell, investor relations manager at the ICS, said: "We are not parties to this dispute but our lawyers were able to argue that the case should be expedited.
"Although it is to be heard in about six weeks, it will take some more time for the results to be known. Then there is the possibility for either party to appeal against the ruling, so it is not clear that this will be resolved quickly."
Mr Cresswell said the ICS board meeting today might decide to go ahead with processing all the work involved in investors' claims but stop short of making compensation offers.
The Treasury has been under pressure to intervene to resolve the problem, but a spokesman said yesterday that he had no comment to make.