Hedge funds fight hard for Northern Rock compensation

Shares in Northern Rock last traded at 90p before they were acquired by the Government. But SRM argues that its 48,452,655 shares were each worth at least £3, valuing its stake at £145 million. On that basis, the Treasury would have picked up a company worth as much as £1.3 billion.

Nobody is shedding any tears for a hedge fund run from Monte Carlo whose gamble may have backfired. "But it's not just my client," says John Reynolds, SRM's solicitor and City-based head of banking litigation at global law firm White & Case. There are 150,000 individual shareholders, owning as much as 25% of the shares.

"They have each seen their shares expropriated for what amounts to zero compensation," says Reynolds. "Many of the small shareholders stand to lose their life savings."

Their claim, SRM's challenge and proceedings issued on Friday by another fund, RAB Special Situations, are likely to be heard together later this year.

SRM has filed evidence from a valuer, David Ashton, who says there is every reason to expect banking stocks to recover if and when the credit crunch eases. At last summer's prices, its holding would be worth more than £500 million.

The fund did not start buying shares in Northern Rock until 14 September, the day the Bank of England moved in and small savers tried to get their money out. Though it owns 11.5% of the bank's equity, SRM expects any compensation to be, "at best, negligible".

This is because the Banking (Special Provisions) Act 2008, under which all shares in Northern Rock were transferred to a nominee of the Treasury, requires shares to be valued on the assumption that the bank will not receive financial assistance from the Bank of England and cannot continue as a growing concern.

SRM has lined up economist Tim Congdon as an expert witness. Congdon, who also bought shares in Northern Rock last September, says it is an accepted function of central banks to act as "lender of last resort" to solvent banks that have difficulty in funding their assets - in other words, are "illiquid". There was no basis on which the Bank of England's assistance could properly have been withdrawn once granted, he says.

So the human rights expert David Pannick QC argues in written submission for SRM that the 2008 Act is not compatible with the right to peaceful enjoyment of the fund's possessions granted by protocol One of the Human Rights Convention.

Governments are allowed to confiscate possessions, including shares, but only if the law strikes a "fair balance" between the demands of the public interest and the protection of individual fundamental rights. That has not happened here, according to Philip Price, SRM's chief operating officer. The compensation is "grossly disproportionate" to the true value of its shares. "In these circumstances, nationalisation amounts to confiscation of shareholder value," he claims.

SRM will therefore be asking the High Court to quash the order made by Parliament under the 2008 Act. This will be firmly resisted by the Treasury. Its solicitors, Slaughter and May, say that any action by shareholders would be "misconceived and without merit".

But the Bank of England is under no legal obligation to prop up illiquid institutions. Only time will tell whether SRM is now throwing good legal fees after bad loans.