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Peter Hamilton: High Court Judgment gives advisers comfort

Peter Hamilton MM blog

On 1 March 2013, Mr Justice Cooke, sitting in the High Court, rejected a claim for damages in the region of $30m brought by a wealthy woman on the grounds that the investments in question were not suitable for her and the risks involved were not explained properly explained to her.

After a 13-day trial, the judge concluded that the claimant had been dishonest in the way she had pursued her claim, and decided that the claim failed on every issue.

The facts were remarkable, but in the end, the value of the judgment will be the comfort it will give to the vast majority of financial advisers who try to do a good job.

The claimant was Basma Al Sulaiman who is a Saudi national born in 1959. In 1980, when she was 21, she married into one of the richest families of Saudi Arabia. By 2000, she was living in London, and she separated from her husband. In due course they were divorced. The divorce settlement received wide publicity. The main element of the settlement was the payment of a capital sum of US$56m to be paid in instalments.

In December 2004 Basma Al Sulaiman became a customer of the private banking division of Credit Suisse who agreed to give her investment recommendations on an advisory basis.

Through the bank, she invested in a structured note using funds from her divorce settlement.

Between January 2005 and October 2008, when Lehman Brothers collapsed, she invested in a further 23 structured notes, 18 through the bank and five through her IFA.

The judge explained that virtually all of them were “leveraged by loans from [the bank] and secured by a Pledge Deed on the notes themselves”. The notes stood as collateral (together with any deposits of cash) for the loans on those notes and also for another loan for other investment purposes unconnected with the notes.

The terms of the Pledge Deed allowed for margin calls to be made by the bank in order to maintain sufficient collateral, as assessed by it and for the realisation of the pledged assets if such calls were not met. This collateral requirement was put into effect by requiring the loans to be no more than a specified proportion of the current value of the assets at any time, with the proportion varying according to the type of asset.

In October 2008 when the financial markets were in turmoil, the bank told the IFA that it would be making a margin call on the claimant. A week later, it made the call in an amount of just over $7.5m which was to be paid within two days.

The claimant set about procuring guarantees and also sold one of the notes. Shortly after that, the bank made a further margin call of $10.2m. She refused to meet the call, and the bank proceeded to liquidate the Notes in her portfolio.

The sum realised was less than the amount owed, and the bank appropriated her cash deposits and called on the guarantees. She said she had lost about $31.7m.

The claimant blamed the bank and her financial adviser for her losses. She began the trial by saying that the defendants had recommended that she enter into the leveraged transactions without taking reasonable steps to ensure that she understood the risks associated with the leveraging and without taking reasonable steps to ensure that the investments were suitable for her.

By the end of the trial, she had conceded that the investments were in fact suitable. Thus the remaining allegations were the defendants’ failure to explain the risks and to satisfy themselves that the products were suitable.

The judge did not believe that she did not understand the risks as they were explained to her. He held that the cause of her losses was her failure to follow the advice of her financial adviser to sell the Notes before the call and to put up the required margin when she was in a position to do so.

The judge said that the failure to produce the margin was explicable only as an attempt to play “hard ball” with the bank or as a result of a fit of pique. The consequent losses were her own fault.

The claimant alleged that the defendants were not only in breach of their duties under the FSA’s conduct of business rules, but also in breach of their duties imposed under the ordinary law.

On the facts of this case, it was accepted by all those involved that the duties under the ordinary law did not add anything of substance to the duties under the conduct of business rules.

That was a sensible conclusion in the circumstances of the case, but it is usually better to approach the problem of deciding whether an adviser has failed in his or her duties by starting with the ordinary law and then looking at the specific relevant rules in the FSA’s hand book.

The ordinary law imposes a general duty on all advisers to carry out their duties with reasonable skill, care and diligence. The standard of skill, care and diligence required in the circumstances is that of the ordinary competent member of the same profession as the defendant; in this case, the profession of financial adviser.

Most questions of breach of duty or negligence can be answered by applying those tests of the ordinary law.

The conduct of business rules are much more specific, and may or may not apply in every case. Thus, for example, the ordinary law takes a pragmatic view of the processes involved in the giving of advice under the FSA’s rules. If an investment is in fact suitable, it does not matter if there has been a failure of process, such as the failure to explain the risk. In other words, if the product is suitable, there will be no liability for the failure of the process.

The expert evidence in the case was also instructive. The experts agreed that:

  • The structured notes were inherently suitable investments, and suitable for someone of her wealth and expectations of return.

  • There was no regulatory requirement on an adviser to seek to estimate or advise the customer on the probability of, or the likely size of, any potential margin call.

  • Leverage did not change the nature of the risks of any of the transactions – it merely magnified the potential profit or loss that could be generated by the investments.

  • The timing and extent of the market crash which occurred in September and October 2008 was not foreseeable before August 2007.

  • Historic performance of the equity indices prior to 2005, whilst a factor to be considered in advising on investment, was not a reliable guide to the future.

Some of those points are of limited relevance in most situations, but nevertheless they illustrate the approach of the ordinary law: what would a reasonably competent financial adviser have thought or done in these circumstances?

The other reassuring aspect of the case is that the well-worn process of a trial in open court with witnesses being examined and cross-examined worked well. In the end, common sense prevailed, and the way in which the claimant put her case was exposed for what it was: a fabrication.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk

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Comments

There are 7 comments at the moment, we would love to hear your opinion too.

  1. This is excellent news for those advisers and managers being sued by their client in court.

    Unfortunately, this is definitely not the approach taken by the FOS or the FSA/FCA. I have no doubt the client would have won had this been assessed by the FOS. Recent cases I have seen have been decided in the client’s favour on the sole basis they [claimed] they didn’t understand the investment. In another case the client’s own actions, against advice, caused loss but the adviser still ended up paying out on spurious grounds.

    The courts aren’t the problem, they have always been, and remain, sensible and apply the law. The problems lie elsewhere so this case is cold comfort at best…

  2. Incompetent Regulators Award Team 8th April 2013 at 9:42 am

    Quote

    “The other reassuring aspect of the case is that the well-worn process of a trial in open court with witnesses being examined and cross-examined worked well. In the end, common sense prevailed, and the way in which the claimant put her case was exposed for what it was: a fabrication.”

    How many more dodgy claims are in at the FOS being totally ignored by staff who are on a financial incentive scheme? Answer = thousands

    Audit required on the FOS urgently please, and where the staff have been aiding claims through fraudulently, let them face court as individuals!

  3. Bearing in mind the background of this client, I wonder if any consideration was given to whether the contracts themselves were Sharia Compliant and secondly whether the refusal to pay of the client was either?

  4. @11:00am: If the client was a white UK national would you be asking if the court had considered the (equally restrictive) Christian laws on usury?

  5. I was the 11am poster – To be “one of the richest families of Saudi Arabia” would suggest, (but I have not researched the woman) that she was married to a family member of one of the ruling party in Saudi who promote the Whabbi sect and are non democratic.
    I have read the Quoran and do believe that what Mohamed (PBH) wrote was propehtic despite being brought up a Christian (which also means I have read the Bible, but not recently). I have also studied Islamic Finance because I find the whole idea intriguing as it is all about honesty and trust, so thought it somewhat ironic that this lady refused to pay something she had agreed to and then tried to hide behind English Law…..

  6. Is this the same lady as the findings of the UK Court seem at odds with her statements to the BBC in the article http://www.bbc.co.uk/news/magazine-17446831 ? I quote from the article “the way in which the claimant put her case was exposed for what it was: a fabrication.”

  7. RegulatorSaurusRex 9th April 2013 at 2:18 pm

    As the previous Chief Ombudsman Walter Merricks once said: “We unashamedly make new law”.

    Are the procedures of the Financial Ombudsman Service (FOS) fair and reasonable? Is it a workable adjunct to an already creaky legal system or is it a monster, out of control and careering across the financial services landscape doing immeasurable harm? The answer is likely to depend on whether you are an adviser, a consumer or a regulator. This article aims to highlight adviser concerns about FOS fairness and accountability.

    “FOS is an unusual creature. One that I suggest Parliament would not have dared to create had the groundwork not been laid by a series of voluntary initiatives. It is a one-sided scheme offering an unlevel playing field broadly supported by those playing up hill” – these are the words of Chief Ombudsman Walter Merricks.1

    Regulated firms are likely to have their own descriptive terms for FOS, which is increasingly being used as a last resort tactic by claims management firms and complainants who often view it as a consumer champion.

    FOS is, “not accountable to ministers”
    Walter Merricks admission1 will dismay advocates of democracy. FOS derives its powers from the Financial Services Authority (FSA) which sets out the parameters within the Dispute Resolution Rules (Disp.2). FOS is not subject to the Freedom of Information Act and, apart from acts of ‘bad faith’ and a breach of the Human Rights Act (HRA); it enjoys immunity from legal action. “Accountability is extremely important to me”.2

    Does FOS disregard the law?
    The dictum ‘he who asserts must prove’ forms the basis of English Law and was also established within the procedures of predecessor body, the Personal Investment Authority Ombudsman Bureau (PIAOB). Thanks to the Financial Services and Markets Act 2000 (FSMA) FOS allows no such proximity to the law as is evidenced by the current standard adjudication response – “Where there is a dispute about what happened, we base our decisions on the balance of probabilities – in other words, on what we consider is most likely to have happened in the light of the evidence”.3 This fundamental change enables FOS subjectivity to replace any previous vestiges of objectivity.

    FOS also ignores a firm’s right to cross-examine the complainant and evaluate all evidence as sanctioned within the court system. It is proud of its ability to cut through what it considers to be irrelevancy. “Our authority entitles us to go straight to the evidence we know to be relevant”.4

    However not only are established legal procedures ignored but also the law itself. Individuals and firms enjoy protection under The Limitation Act 1980, as amended by the Latent Damage Act 1986. This provides a 15 years longstop after which claims for negligence cannot be pursued. Unlike its predecessor, FOS denies this legitimate protection arguing that FSA time-barring rules take precedence, although it then confesses to being unsure. “There is no such limitation in the rules that the FSA made for the ombudsman and the FSA has recently made it clear that it has no intention of altering that”.5 Conversely, FOS has no compunction in quoting the relevant Partnership Law when chasing the spouses of deceased advisers to recover case fees even when they have been exonerated from mis-selling claims.

    FOS contends that the FSMA makes no reference to the 15 years longstop. The FSA concedes that it is subject to English Law yet the provisions within Disp 2 clearly show that it is able to create new law without reference to parliament or the courts. Both the FOS and the FSA can ignore statutory law and generate new law, or apply variations of existing law, at their behest.

    Anthony Speaight QC affirmed, “there is an authority from a Lord Chancellor that an arbitration clause that permitted arbitrators to disregard the law would render them arbitrary in their dealings with the parties”.6

    Simon Orton, partner at Freshfields Bruckhaus Deringer, was more pointed, “it is one thing for the FOS to depart from the law where it is unclear or does not properly address a situation, but the proposition that it can simply ignore an important legal principle – and, significantly, that there is no check on it if it does so – is quite concerning. 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”.7

    Are FOS procedures fair and reasonable for firms and consumers?
    “In determining complaints FOS should take into account legal rights and industry codes, but should decide on the basis of what is fair and reasonable”.1 FOS revels in its ability to work outside the parameters and principals of established law, asserting, “we comply with the rules of natural justice”.8

    FOS was established as an efficient and cost-effective alternative to the courts, but efficiency and cost-effectiveness suggest hurried conclusions and corner-cutting. Both of these may serve to deliver injustice and injustice is never fair and reasonable.

    Precedent or President?
    History points to the erosion of law and the creation of new non-parliamentary, non-judicial law, as the first stumbling steps down the road to oligarchy.

    FOS not only imposes law via precedent but also alters its stance as and when it deems it appropriate. “We do not have to pretend to ‘find’ what the law is. We unashamedly make new ‘law’”, boasted Walter Merricks1 in a June 2001 speech to the Financial Regulation Industry Group. Revealingly, an identical speech given to the Cardiff Faculty of Law, in 2002, found this astonishing admission expurgated. The Financial Services Practitioner Panel has also expressed its unease. “The panel has repeatedly pointed out the concern over the FOS’s quasi rule-making abilities and the often blurred line of demarcation between the FOS and the FSA”.9

    Are personal hearings cumbersome, expensive and wildly uneconomic?
    Walter Merricks believes so, which is a major shift from the views he expressed in 1999. “As a result of Article 6 of the European Convention on Human Rights, and the HRA, we shall be obliged to offer hearings if parties wish it where their civil rights and obligations are at stake”.10

    FOS rarely allows personal hearings, only eleven were heard in 2005 from nearly 111,000 cases. Lack of accountability and the refusal to allow personal hearings no longer concern Walter Merricks, however, when a practicing solicitor in 1986 and an unashamed advocate of the jury system, it troubled him greatly. “To entrust this judgment to experts I find dangerous. There is the problem that currently, as a matter of law, the standards to be applied in assessing honesty are those of ordinary people. Experts are by definition not ordinary people and they may find it difficult, not to say impossible, to envisage that the standards by which they must judge the accused are not those they would normally apply to themselves or their colleagues”.11

    The lack of an appeals process exposes FOS to being in breach of Article 6 of the HRA. Speaking with regard to the Pensions Ombudsman, Mr Justice Lightman observed, “it is troubling that the Ombudsman as the investigator sets the standard and as judge rules on compliance and decides the remedy. Since the decision of the Ombudsman is final on questions of fact, there is likely to be an entitlement to an oral hearing and the examination of witnesses…though he recognises the right to both the Ombudsman has had very few such hearings”. 12

    The lack of a personal hearing disadvantages the firm but serves to lessen the burden on the complainant. After all, it easier to contrive imaginative reconstructions of historic conversations, develop selective memory syndrome, exaggerate or lie when using a remote paper process.

    Should FOS decisions be subject to appeal?
    FOS believes that it offers an adequate appeals system, that by enabling an Ombudsman to review the adjudication it meets the appeals requirement of the HRA. It suggests that remedies are also available via the FOS Service Review Manager, the Independent Assessor and, ultimately, a judicial review. Regrettably, not one of these processes allows an appeal against the merits of the decision. “In a judicial review a court would overturn an Ombudsmans decision only if he or she had committed such errors as to deprive the decision of logic, making it legally irrational. As an appeal, judicial review is likely to be of very little use to firms in practice”.13

    The Government believes the existing appeals arrangements to be broadly proportionate

    “Such reviews do not re-examine the decision, rather they focus on whether or not the matter has been handled with de process, has applied the law correctly, has taken the right things into account and has acted rationally”.16.

    Is FOS a ‘no lose’ situation for consumers?
    FOS allows a firm two ‘free’ complaints each year before applying a £360 case fee. A fee is levied whether the claim is genuine, opportunistic, malign or fraudulent. The firm pays whether innocent or guilty. “The person who has a complaint can approach the ombudsman, without fear of having to pay more, or of forfeiting any legal rights – a real ‘no lose’ situation”.1 When it determines a claim as fraudulent FOS refuses to upset the fraudster with any implication of deceit, preferring to invest the rejection letter with euphemisms suggesting the matter should be dealt with through the court system.

    FOS derives its rules from the FSA which has, as one of its statutory objectives, the reduction of financial crime. It is therefore incumbent on FOS to report fraudulent tactics to the authorities in the same way that it reports ‘problem firms’ to the FSA.

    Is the adjudication system balanced and logical?
    The vast majority of cases are determined by an adjudicator without an Ombudsman being involved. Unlike financial advisers FOS adjudicators do not have to pass examinations and nor do they have to be licenced. Attempts to extract details of how many adjudicators are FPC qualified have been unsuccessful. However we know that most adjudicators have little practical experience with 25% having less than one years service and 75% less than two years. “It appears that training provision has developed in a somewhat ad hoc manner”14

    FOS is currently looking to implement a ‘specific software-based skills set’ which will work in conjunction with the existing Knowledge Information Toolkit, an intranet based series of guidance notes. Given the numerous examination passes, training and experience required to become a qualified licenced adviser it poses the question, how can a firm expect an inexperienced and less knowledgeable individual to competently assess a complex, historic situation where there is often a contrasting account of what, when and why? Both the author and other advisers have encountered examples of FOS illogic which would not have survived a courtroom scrutiny.

    An adjudicator’s decision can be ‘appealed’ to an Ombudsman but only 5% of adjudications are overturned suggesting flawless, high quality adjudications or, alternatively, a cynical rubber-stamping exercise. Interestingly, the attentions of a rampaging MP seems to act as an effective appeals method.

    How do false re-projections impact on FOS deliberations
    “I do believe that generally within the UK there is a growing culture of compensation whether they perceive they have been treated unfairly or not”.15 Endowment policies currently generate the majority of complaints to FOS – 63% during 2005. The catalyst is usually the annual re-projection letter mandated by the FSA. My article in Money Management (August 2005) explained how and why such re-projections often veer from reality proving highly misleading. “There are more spurious than valid complaints going in”.16

    In 1999 the regulator reduced growth projections and instigated the mandatory sending of re-projection letters and until then few policyholders had suggested rule breaches. Had the re-projection been truthful the ‘red’ letter might have been ‘amber’ or ‘green’ and no complaint would have eventuated.

    Investment performance is not cause for a complaint but it is clear that the re-projection letters have launched an avalanche of dissatisfaction. The mathematical illogic of projecting future maturity values using surrender values is unacceptable. To then find that this nonsense has stimulated complaints is beneath contempt. “Some firms’ complaints systems are currently snowed under by indiscriminate claims for compensation by endowment mortgage policyholders”.17

    Regardless of the specific complaint FOS assumes its inquisitorial role and assesses ‘suitability’. Suitability is subjective and offers infinite scope for absurdity as the adjudicator takes a view regarding some historic action.

    What is the impact of bogus LAUTRO charges?
    Between July 1988 and January 1995 the Life Assurance and Unit Trust Regulatory Organisation (LAUTRO) insisted that providers use fictitious low charges when providing illustrations for endowment and pension plans. Money Management campaigned against this practice on the grounds that it misled the buyer. Something not fully realised at the time was the impact that the false charges had on the potential for these plans to hit their targets.

    One example, supplied by Standard Life (before it reconsidered and refused to divulge further information), highlighted an endowment based on a 7.5% p.a. growth assumption. The effect of false LAUTRO charges pushed the plan off-course and reliant on annual growth of 8.4%. The true premium should have been 11% higher. The plan was never on course from the outset. Standard Life knew this, LAUTRO/FIMBRA/PIA and the SIB all knew this, only the adviser and the policyholder remained unaware’. LAUTRO’s actions ensured considerable consumer detriment.

    This is extremely significant because it is reflected within the re-projection shortfall figures which then prompt the complaint. FOS and the FSA consider this a ‘red herring’ and FSA redress guidance ignores the impact of LAUTRO’s false expense charges. Ludicrously the FSA also argues that LAUTRO was a non-connected body and therefore it bears no responsibility for its predecessor’s initiatives. Perhaps, like FOS, we should ignore law and look at what is ‘fair and reasonable’.

    The recent case of Seymour v Ockwell & ZIFA Ltd highlighted the concept of shared liability due to malfeasance. I suggest that the FSA, as the current regulator, should be liable for a substantial portion of redress for the majority of investment contracts purchased between 1988 and 1995.

    Why are redress calculations unfair and unreasonable?
    A firm adjudged guilty of mis-advice has to abide by FSA rules regarding redress. This involves calculations to determine whether there has been a financial loss. Such a calculation will use the surrender or transfer value to arrive at a conclusion.

    This again promotes injustice as the surrender or transfer value involves a financial penalty, sometimes ferociously high. Indeed, the annual Money Management with profits endowment surveys highlight the disparity between surrender and maturity values. “The standards prescribed for compensation on a mass basis may not be those that a court would use in a single case”.1 If the successful complainant retains the tainted endowment it further inflates the injustice to base redress on the penalised surrender value when the ultimate maturity is penalty-free. After all, if the surrender value is representative of the true value why are so many companies clamouring to buy them?

    At the beginning I asked if FOS procedures were fair and reasonable. I believe this not to be the case. The FSA/FOS axis has contrived a system which mitigates against fairness, justice and accountability, in each instance factored against the firm. “An unappealable, compulsory, summary jurisdiction against small traders making awards as great as £100,000 is, in my view, both wrong in principle and producing injustice in practice”.7

    The FOS case fee structure is currently being consulted on, but even if the current one-sided system is altered it is akin to applying a small bandage to a massive area of infection. Powerful medicine is needed in the form of changes to FSMA 2000, which is only likely to be achieved by application to the European Court of Human Rights in Strasbourg.

    “On its face, the entire scheme is hopelessly non-compliant with European Court of Human Rights (ECHR) requirements”.18 “The Ombudsman procedure clearly does not comply with Article 6 (1) of the ECHR”.19

    References
    1 Walter Merricks speech to Cardiff Faculty of Law October 2002
    2 Andreas Whittam Smith when Chairman of FOS April 1999
    3 FOS adjudicator standard paragraph
    4 Walter Merricks speech to British & Irish Ombudsman Association May 28
    5 Walter Merricks speech to the Council of Mortgage Lenders December 2003
    6 Anthony Speaight QC
    7 Simon Orton of Freshfields Bruckhaus Deringer re. Judicial Review, IFG Financial Services Ltd v FOS Ltd May 20052
    8 Walter Merricks in evidence to Treasury Select Committee June 8 2004
    9 Financial Services Practitioner Panel 2003 Report – March 2004
    10 Walter Merricks address to The British Insurance Law Association December 1999
    11 Walter Merricks in a response to the Roskill Report 1986
    12 Mr Justice Lightman speech to the Association of Pension Lawyers march 2001
    13 Building Societies Association response to FSMA 2 year review September 2004
    14 An Assessment of the FOS by Personal Finance Research Centre University of Bristol July 2004
    15 John Goodfellow Chairman of the Building Societies Association on Moneybox 13 April 2004
    16 FSA spokesman Rob McIvor
    17 Sir Howard Davies July 2003
    18 Philip Parish of Linklaters and Alliance in the Journal of International Business Law 2000
    19 Tim Pinto of Taylor, Johnson Garnett in the International Company and Commercial Law Review 2001

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