Insurance challenge will test immunity of City watchdog

The civil immunity granted to City watchdog, the Financial Services Authority, is to be challenged in a test case being brought this autumn.

Class Law, the solicitor acting for employees and investors who lost out when Independent Insurance collapsed last year, is to attempt to bring an action against the FSA claiming it breached the European Union's insurance directive in its regulation of the collapsed insurer.

If successful, similar actions may follow over the closure of Equitable Life and the split capital trusts debacle, both of which have brought hundreds of millions of pounds of losses for small investors.

Under the act that brought the FSA into being last November, the regulator was given immunity from any civil litigation though negligence in its regulation of the financial services industry – though it can be sued if it acted in bad faith or malice.

This immunity is fairly standard for regulators around the world to avoid their being bankrupted if they close a business. However, the immunity of the Bank of England, which regulated banking before the FSA was founded, is being challenged in the European Courts over the collapse of Bank of Credit and Commerce International 14 years ago.

The long-running case could leave the Bank liable for damages of up to £1bn if it loses.

The FSA has been heavily criticised over the collapse of Independent, which was given a clean bill of health by the regulator only a couple of months before it went into liquidation.

It has also come under fire over failing to spot financial problems at Equitable, despite numerous concerns being raised over a number of years. Recently, The Independent on Sunday revealed that the FSA had not heeded warnings given last year by the Guernsey regulators over the looming problems afflicting split capital trusts.

Stephen Alexander, a partner at Class Law, said: "What we have with the FSA is that it is responsible to people it regulates but not accountable to the people it regulates for."

Sir Howard Davies, the chairman of the FSA, had admitted to problems in the regulation of insurance companies. This is partly due to the pass-the-parcel nature of insurance regulation prior to the creation of the FSA, which saw three different government agencies regulate the sector in less than five years, and partially due to not having enough resources in that area.