A couple complained to the Financial Ombudsman Service (FOS) that IFG Financial Services Limited (IFG), their financial adviser, had wrongly invested their money in a high-risk investment fund rather than in a medium-risk investment as they had requested. They wanted compensation because they had suffered a significant loss. The loss had been caused by the fraud of the investment manager of the fund, not by the nature of the fund's investments. IFG contended that as loss from fraud was unforeseeable (which was accepted by all parties) it should not have to compensate its clients.

The rules governing the FOS require the Ombudsman to determine complaints on the basis of what is, in his opinion, fair and reasonable in all the circumstances of the case, taking into account (among other things) the relevant law. IFG obtained counsel's opinion, which concluded that as a matter of English law the couple were not entitled to recover damages from IFG in respect of this loss. Although the Ombudsman accepted the correctness of the opinion, he found in the couple's favour.

The Ombudsman rejected IFG's contention that it should not be liable because the fraud was unforeseeable, and decided instead that it was fair and reasonable in all the circumstances that the firm should be responsible for all the consequences of making an investment which should never have been made.

IFG applied to the High Court for judicial review, arguing that the Ombudsman had failed to take account of the relevant law. The court held that:

On a narrow legal view the decision in this case is unremarkable as it reflects a straightforward application of well-established principles governing judicial review. However, considered more widely, this case is a stark illustration of the extensive scope of the Ombudsman's discretion.

The very imprecise basis on which the Ombudsman operates (simply what he considers "fair and reasonable"), the fact that he is not bound by the legal position, and the very limited powers of the court to intervene, raise important issues about the certainty and predictability of the environment in which firms have to transact business. These issues are more than theoretical when the Ombudsman has shown, both in this case and elsewhere, that he is quite willing to depart from the legal position in practice, even on substantial issues, and where the law has been clearly and recently stated by the House of Lords.

The FOS was set up to provide a reasonably quick and easy to use forum for consumers to obtain redress in cases worth up to £100,000. The fact that the Ombudsman is not bound to decide in accordance with the law is essential in enabling him to deal with cases quickly. It enables him to avoid the intensive and detailed legal argument and analysis which would be necessary if his decisions could be appealed on points of law.

But the benefits of the FOS come at the expense of depriving the defendant firm of the procedural and substantive protections it would have under the formal court system. It is therefore particularly important that the system should be reasonably predictable and be subject to appropriate checks and balances. The principle of legal certainty requires that firms should be able to manage their customer relationships and their risks in a reasonably predictable legal and regulatory environment. This may be difficult to achieve where the Ombudsman can, in effect, disregard the law.

The Financial Services Authority (FSA) has signalled that a firm should have regard to FOS decisions in order to meet its regulatory obligations (in particular its duty to pay due regard to the interests of its customers and treat them fairly (Principle 6, Principles for Business, FSA Handbook of rules and guidance)). So these decisions have significant influence on the way firms conduct their business, in particular, the way in which they settle complaints made against them (only a small proportion of which are ultimately referred to the FOS) and their strategies for dealing pre-emptively with problems before complaints are made.

A recent review of the FOS system ruled out introducing any appeals process for significant FOS decisions. As a result, not only is the Ombudsman's approach to an issue capable of being unpredictable in legal terms and wide-ranging in effect, but it is also almost impossible to challenge.