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