He claimed that the blame for losses of almost £20m, which six investors attribute to him and Arch Financial Products, should fall at the feet of the global financial crisis and the company that took over investment management from Arch in 2009.
Under cross-examination, Mr Farrell insisted that he had a blemish-free career and resented allegations of dishonesty against him.
In his written witness statement before the court, Mr Farrell said: “I understand that the claimants have made a number of serious allegations against me, including that I have acted dishonestly in relation to the Lonscale transaction. I am mortified by these allegations and deny them in the strongest possible terms.
“In particular, I believed at all times that the Lonscale transaction was in the best interests of the Lonscale investing cells and that it was legitimate for Arch Financial Products to receive a fee from the transaction.
“I have had a successful and unblemished career in the investment industry for over 25 years and I have always acted professionally. I take grave exception to any allegations of dishonesty on my part and consider these allegations to be entirely misconceived.”
Richard Coleman QC is representing the six cell companies that claim they lost almost £20m in the acquisition by Isle of Man-based special purpose vehicle Lonscale Ltd of the Club Easy group, and that Arch Financial Products took an unauthorised payment of £3m from the transaction.
Mr Coleman asked Mr Farrell if he regarded it as a fair statement to say he had an unblemished career, following an FSA finding against him that he had breached its principles, which led it to withdraw his approval to perform regulated functions and impose a £650,000 penalty against him.
Mr Farrell said he is appealing that decision to the Upper Tribunal, and so the FSA’s finding currently has no effect.
In his statement, he said that under the investment management agreement entered into with each cell, AFP had a discretionary investment management mandate and did not have to seek approval from cell directors for any particular transaction. Nevertheless, he said that cell directors were regularly kept up to date with investment details.
He said that AFP’s funds and assets grew from £20m in July 2006 to approximately £210m by May 2007, with a further substantial increase of £80m in September 2007, and that it was during this period of rapid growth that he became aware that the Club Easy student accommodation group was for sale.
He said that Club Easy had grown substantially in the preceding years by being one of the cheapest large-scale student accommodation providers in the UK, and was a “prime acquisition opportunity” which had the potential to be a good deal.
It had a portfolio of more than 400 properties across Durham, Exeter, Lincoln, Loughborough and Hull, with close to 100 per cent occupancy and a due diligence report showed it had positive net assets of £30.6m, albeit with a significant debt burden of £86m.
He said: “The AFP team considered the running losses at the Club Easy group as part of the opportunity set for the transaction and one of the reasons why the deal was attractive.
“It was a medium-term turnaround project which would require additional capital over time, but would be capable of giving substantial returns to investors over time.”
He said that Storeys produced a valuation report valuing the Club Easy properties at £122.5m, and that, while the claimants have questioned Storeys’ independence and asserted that that report was inadequate, he maintained that it was “entirely appropriate” to use Storeys.
This was because they specialised in regional valuations of this type and their valuations had been accepted by major lending banks that provided substantial amounts of debt finance to the Club Easy group.
He said that AFP succeeded in driving down the purchase price from the £16,587,266 agreed in August 2007 to £15,043,078 on completion, with the final purchase price being £13.2m as an element of deferred consideration never became payable, which AFP had calculated at the time was likely to be the case.
He added: “AFP’s £3m fee was used as working capital and therefore re-invested in the Arch business. I did not personally receive any of this £3m fee.”
He said the plan was to bring Club Easy back to profit through a combination of capital injections, corporate restructuring, rental increases and cost reductions, while interest rate reductions would also have a “significant impact on the overall profitability”.
He said: “Prior to the global financial crisis and subsequent collapse in bank lending capability, this was a credible strategy and one that was to be implemented over at least two years.”
He said that, in the wake of the financial crisis, AFP’s authorised corporate director Capita Financial Managers Ltd’s attitude to AFP changed in February 2009 and prevented it from operating its normal liquidity management mechanisms, ultimately forcing AFP into requesting the suspension of the UK funds and subsequently the cells, despite AFP’s view that this was “against the best interests of investors”.
He said: “In the absence of a suspension, I firmly believe the liquidity position would have been optimised and AFP could have carried out its normal liquidity management processes.
“The inability to resolve these issues with Capita and the consequent inability to provide any funding to assets in need of such led to a destruction of value for the UK funds. The change in investment policy of the UK funds (by Capita) and Guernsey cells (by the claimants) in late 2009/early 2010 further compounded any losses investors may have suffered.”
He said that, in November 2009, AFP transferred its investment management role to Spearpoint, adding: “In my view, since the transfer of the investment management function to Spearpoint, the Lonscale investment has been mismanaged and it is this mismanagement that has caused any losses suffered by the Lonscale investing cells.
“Any losses suffered by investors have been compounded by the fundamental change in investment strategy, the withholding of liquidity/funding from the investment, the manner of disposal, the mismanagement of the business and some of its banking relationships, and the premature sale of the investment on terms that were heavily influenced by the claimants’ self-induced distressed position.
“Had events been allowed to take their normal course, and AFP been allowed to implement its turnaround strategy unhindered, the Lonscale investing cells would not only have had their principal returned to them in full, but would have made a generous return on those investments.”
The six cells’ claim involves one of eight investments in a larger overall claim brought by 18 cells in which is said that around £463m was invested in all of the cells managed by Arch, primarily by UK retail investors, with an estimate of 6,400 investors in total, many of which suffered heavy losses.
Mr Justice Walker is expected to reserve his judgment at the end of the case, which is scheduled to last four weeks, and to give it in writing later.
