Li Kwok Heem John v Standard Chartered International (USA) Limited

The Hong Kong Court of First Instance recently handed down the highly anticipated judgment for the case of Li Kwok Heem John v Standard Chartered International (USA) Limited HCA 498/2010 which a client (the “Client”) of Standard Chartered International (USA) Limited (the “Bank”) tried to recover his losses resulted from investing in a fund introduced to him by the Bank.

The Client alleged that the Bank failed to make any reasonable enquiry on the Fairfield Sentry Fund (the “Fund”), which turned out to be one of the Ponzi schemes operated by the infamous Bernard Madoff1. As a result, the Client relied on the misrepresentations made by the Bank regarding the Fund and virtually lost all the money he invested into the Fund.

Background facts

The Client opened an individual account with the Bank in 2000. In 2005, the Bank presented the Fund’s fact sheets (the “Fact Sheets”) to the Client, in which it was represented that the Fund is a low-risk investment which had produced consistent low volatility returns. The Client alleged that, in reliance of these representations, he applied more than 1 million USD to subscribe to shares in the Fund and to pay other servicing fees to the Bank. He was then recommended to keep the Fund as an investment in his portfolio as of June 2008.

At the end of 2008, Bernard Madoff revealed his Ponzi schemes and the Fund was one of them. He pleaded guilty to securities fraud charges on 12 March 2009 and was sentenced to 150 years imprisonment.

On 13 December 2008, the Client found out that the net asset value of his shares in the Fund was adjusted to US$0.01. The Client then sued the Bank for (1) misrepresentation and (2) breach of duty of care, in relation to his investment through the Bank in the Fund.

Decision

The Court held that on the specific facts of the case the Bank did provide advice to the Client in relation to the Fund. Nevertheless, the Bank was not liable as its advice was not negligent, given that it had conducted its due diligence on the Fund with reasonable care and skill. Instead, the Client suffered loss because the Fund was not genuine. It was held that any reasonable financial institution at the time could not and would not have discovered the Ponzi scheme.

However, despite the Decision, the Court nonetheless upheld the Client’s contentions in a number of areas, of which the following two issues are of particular prominence.

Duty to advise

In previous leading English and Hong Kong mis-selling cases such as JP Morgan Chase Bank v Springwell and DBS Bank (Hong Kong) Ltd v San–Hot HK Industrial Co Ltd & Anor, the Court has refused to imply the duty to advise a customer. These were in circumstances where breaching contracts in question explicitly stated that the banker-customer relationship was “execution-only”, that the bank was not required to provide any advice, and that the bank assumed no responsibility for the accuracy of the information provided. In this case, however, the Bank’s General Business Condition, stated that the Bank may provide the Client with information, advice and recommendations in respect of dealings in securities (although it was under no obligation to do so). On that basis, the Court concluded that, by pro-actively making recommendations to the Client, the Bank assumed a duty to advise the Client in relation to the Fund.

Reasonableness of exemption clauses

In addition, the Risk Disclosure Statement issued by the Bank, which was signed by the Client contained terms which stipulate that the Bank would not advise its clients in relation to the suitability or merits of any transaction (the “Exemption Clauses”). However, the Court considered that (i) the Exemptions Clauses were inconsistent with the contractually explicit duty to advise as noted above, such that it would not be reasonable for the Bank to exclude liability for the very thing it was contracted to perform; and (ii) in any event, the Exemption Clauses were expressed only as being by reference to certain high risk transactions, and not to supposedly low risk products such as the Fund.

Comments

This case might at first sight seems like a departure from previous authorities with the Court finding duty to advise on a private bank. However, as noted above, there are a number of specific factual differences between this case and earlier authorities, in which the Court had upheld the banks’ limited scope of services and exclusion clauses. The decision thus highlights the importance of the way such scope of service and liability limitations are drafted.

That said, banks and other financial institutions’ hands will soon be forced in relation to contractual duties to advise. On 8 December 2015, the Securities and Futures Commission (the “SFC”) published its Consultation Conclusions on the Client Agreement Requirements. It noted that the SFC will in 18 months’ time, amend the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code”), to require all licensed or registered person to:-

  1. only solicit the sale or recommend a financial product to a client if the product is reasonably suitable for the client, with regard to the client’s financial situation, investment experience and investment objectives; and
  2. not incorporate any clause, provision or term in the client agreement or in any documents which is inconsistent with its obligations under (1) above in relation to such transactions.

In practice, in the provision of private banking or investment account services, financial institutions would pro-actively recommend or suggest financial products to their customers. The amendments above will therefore affect materially the extent to which banks can now in fact exclude their duty to advise customers as regards the suitability of products for them.

This is so despite the Code being expressed as not having legal effect, because the SFC can treat any violation of the Code as an indication that a licensed or registered person is not fit and proper to be so licensed thus affecting their ability to work in the finance industry. This (although the SFC had previously rejected this suggestion) gives rise to the question of whether such specific fettering with private parties’ right to contract can or should be fettered through the Code instead of through legislation. Regardless of whether this ends up being challenged by any licensed entity, the contractual nature of the banker-customer relationship looks set to continue to be subject to close scrutiny by the SFC and the finance industry.