Retail investors who lost £236m in the collapse of London Capital & Finance are entitled to payouts that were refused to them by the UK financial compensation scheme, the High Court in London was told on Tuesday.

The argument was made on the first day of a judicial review of the Financial Services Compensation Scheme’s decision brought by lawyers acting for four of LCF’s 11,600 customers, who lost out when the mini-bond issuer went into administration in January 2019.

The dispute stems from the lifeboat fund’s decision to compensate only a fifth of customers after it ruled last year that LCF had offered mini-bonds — a type of unregulated loan investment — on a non-advised basis. This meant that while LCF itself was regulated by the Financial Conduct Authority, its mini bonds were not.

As a result, the FSCS decided that only a limited number of customers, who had received financial advice from LCF or had switched out of stocks and shares Isas into the bonds — both of which were regulated activities — were covered.

One of the barristers acting for LCF customers Emmet Donegan, Nathan Brown, Joanne Ellis-Clarke and Alan Considine said the scheme had been wrong to deny redress to the majority of victims.

“At its bottom [this] is a very human case,” said James McClelland. “It concerns the interests . . . of thousands of retail investors who placed their trust in a seemingly reputable, Financial Conduct Authority-regulated company which it now appears may have been the instrument of a systematic fraud.”

The collapse of LCF wiped out the savings of thousands of people in one of the UK’s largest alleged frauds against retail investors. Administrators have launched legal action against 13 individuals connected to LCF claiming that investors funds, which were ostensibly invested in company and property deals, were “misappropriated”. The scandal has also triggered criminal and regulatory probes.

For some customers, many of whom had invested their redundancy packages and pensions, the impact of the scandal had been “life changing,” Mr McClelland added, “and for others it has been little short of catastrophic.

“These investors were not high rollers. They were largely small investors investing personal savings . . . persons who could little afford to lose the money they invested.”

The claimants argued that the scope of the regulated activities undertaken by LCF was wider than the FSCS definition. They are seeking redress for investors who bought in after January 3, 2018 — when a new law known as MIFID II was introduced.

The dispute hinges on whether or not LCF engaged in a regulated activity by issuing illiquid mini bonds to customers. According to the claimants’ filings, LCF engaged in a regulated activity by agreeing to provide investors with transferable bonds, even though the bonds contained “non-transfer” clauses meaning they could not be easily traded.

In response, the FSCS argued in court filings that the bonds “were not transferable securities”, meaning they could not be classed as investments and LCF could not be said to have been “dealing in investments as principal” — a regulated activity warranting investor protection.

As of mid-December, the FSCS had paid out £50.9m to 2,584 LFC bondholders, 22 per cent of the total number affected.

If the High Court rules in favour of the claimants, it could leave the FSCS having to compensate more than 10,000 people who invested £143m in LCF.

Late last year, an independent review of the FCA’s handling of the scandal by Dame Elizabeth Gloster concluded that the watchdog “did not effectively supervise and regulate” LCF.

Following the publication of its findings, the government said it would set up a separate compensation scheme to consider one-off payouts to investors.