'Frankenstein's monster' fights on

When Mr Justice Langley sits down on Friday, he will have a lot to think about. The opening speeches in the Equitable Life trial, which he has been presiding over, concluded this week. All of the parties have had their say, and will now set about cross-examining witnesses. What, then, does the judge have to consider?

The case began with Equitable QC Iain Milligan setting out the society’s claim two weeks ago.

Equitable is fighting the battle on two fronts – against its former directors and against Ernst & Young, its former auditors.

The claim against the directors aside, the E&Y case boils down to two points. One is that Equitable says the Big Four firm ought have advised it that it should include in its accounts a note about the possible losses from the pivotal House of Lords ruling on how Equitable paid policy bonuses. That ruling created the £1.5bn hole in Equitable’s accounts.

But the central plank of its claim for damages is that E&Y should have advised Equitable that its provision for guaranteed annuity rates (GAR) was not significant enough.

In the late 1990s, GARs became an issue for many life companies. This came about because falling interest rates changed the returns that policyholders could get on their pension policies. They could either get the current annuity rate (CAR) or a guaranteed annuity rate. A current annuity rate would give you an income according to the percentage of your lump-sum payment, relating to what the market was offering at the time – for example, following long-term interest rates.

A guaranteed annuity rate was a rate specified by Equitable – a minimum rate it would give policyholders.

When interest rates plummeted in the nineties, life companies were caught on the hop. GARs, which had been set many years before in the higher interest-rate environment, now exceeded CARs, meaning the mutuals were now paying out to policyholders at a higher rate. That gave rise to extra liabilities, which Equitable says E&Y failed to warn it about.

E&Y disputes this claim, and utterly rejects the idea that any note in the accounts about the House of Lords case has any significance whatsoever (in that the lack of a note led to no financial loss).

E&Y’s defence on the provisioning claim is that the method of provisioning advanced by Equitable is not the only way to provide for it.

The society included a provision in its accounts for 1998 of £200m for the possibility that it would have to pay out more for GARs. Equitable’s case is that £200m was not enough, that it should have been around £1.6bn.

If the society had been aware GARs would cost it £1.6bn, it says, it would have done one or both of two things – sold the society (in terms of selling off administrative functions and so on, as it did to HBOS later), or dramatically cut-back bonuses on the with-profits funds (life companies can effectively reduce bonuses at their discretion).

E&Y disputes the idea that it should have advised the society to include a £1.6bn provision. GAR issues only emerged in the late 1990s, it says, and there was no agreement between experts on the best way to provide for them, and hence no self-evident case for including the £1.6bn provision, as Equitable likes to assert.

E&Y has landed some telling blows on this issue. Jonathan Gaisman QC, who has been handling the liability issues for the Big Four firm, said on the first day of its defence that Equitable had in fact evidenced ‘the rankest hypocrisy’ on the issue.

Gaisman pointed to the fact that Equitable’s new management and auditors, PricewaterhouseCoopers, had itself approved the £200m provision for GARs, in accounts in 2001 (which necessarily included a statement that previous accounts were correct).

Not only that, but those accounts had been released on the same day Charles Thomson, Equitable’s chief executive, had signed off a claim against E&Y.

Essentially, Gaisman argued, Equitable and PwC had been simultaneously saying that the £200m figure was fine, and saying that it was professionally negligent of E&Y to say that it was fine.

The trial has already seen several such lively exchanges. Christopher Headdon, a former CEO of Equitable who is representing himself, called the whole litigation a ‘Frankenstein’s monster’ that had got out of control.

E&Y has been particularly dismissive of Equitable’s claim. Its written submission released before the trial began contained a litany of vicious criticisms of the case.

Some have even speculated that E&Y’s criticisms have been so compelling the judge might be moved to throw the case out early. Experts say that is unlikely, as the judge will want to at least hear the witnesses, and once he has done that he might as well hear the closing statements as well.

It looks set to go the full distance of 27 weeks, which includes a summer recess. Many will no doubt sympathise with Mr Justice Langley, who is charged with absorbing all this detail.