Regulatory Law Alert - September 2016
Recent mis-selling cases: banks losing out?
The 2008 financial crisis spawned numerous lawsuits against banks by investors who were aggrieved by the aggressive sales of investment products. Most of these cases were won by banks1, however, the tide may be turning as evidenced by two recent Hong Kong cases. In the first case2, the Plaintiff ("Mr Li") had an account with the Defendant ("SCB"). In 2005, Mr Li invested US$1 million into a fund ran by Bernie Madoff ("Fund"). When the Fund was revealed as a fraudulent investment scheme in 2008, Mr Li lost his investment. He sued SCB for misrepresentation (which he won) and breach of duty of care (which SCB won). There was a more decisive win for the Plaintiffs (the "Changs") in the second case3. The Changs sued ING Bank (now Bank of Singapore) ("BOS") for selling them risky products4, negligent advice, misrepresentation and breach of contract. The Court held that BOS did negligently sell high risk products to the Changs without providing proper explanations of the risks. The Court also held against BOS in respect of its advisory duty despite extensive exclusive/limitation clauses.
Background: The Plaintiffs
Mr Li was a PwC audit partner and an independent non-executive director of several listed companies.
In 2000, he opened an account with SCB5. He had regular contact with his SCB bankers, Ms Chau and Ms Yau. In 2005, Mr Li met with Ms Chau and Ms Yau who introduced the Fund6 to
him, gave him the Fund fact sheets and told him, among other things, that the Fund was a "low risk investment with moderate returns". Mr Li subscribed for US$1 million worth of shares. In 2008, Mr Madoff's fraud was revealed and Mr Li lost all of his investment. He sued SCB for misrepresentation and breach of duty of care.
By contrast, the Changs were of modest background:
Mr Chang had worked as a janitor, an assistant cook, a manager, a messenger, a sandwich maker and a factory foreman.
Mrs Chang had been a primary school teacher prior to her marriage to Mr Chang. After the marriage, Mrs Chang worked at the post office, as a movie theatre ticket vendor, a receptionist and as the cashier at a sandwich shop.
In 1997, due to family ties, the Changs received around 1% of the shareholding of Shiu Wing Steel Limited. When Shiu Wing sold a large portion of land in Hong Kong in the same year, the Changs received approximately HK$120 million from the proceeds of the sale.
At the time of account opening in 2004, the Changs were already in their 70's and 80's.
By March 2008, the Changs had invested around US$4.1 million with BOS which was around 60% of their savings.
Many of the practices of banks in this area, such as the position that bankers do not provide "advice" or "recommendations" and the reliance on disclaimers in client agreements to minimalise liability, were not accepted by the court or interpreted very narrowly. In the following tables, we set out the arguments of both sides and the court's conclusions.
Mr Li SCB gave him the Fund's fact sheet and told him that over 15 years the fund returned a net compounded interest rate of 11.23%, outperformed the S&P 100 Index and that the fund was a low risk investment with moderate returns.
SCB SCB did not make any representations these were made by the fund.
Ms Chau / Ms Yau said they were permitted by SCB to give advice to their clients regarding their investments.
Mr Li would take Ms Chau's / Ms Yau's advice when deciding what to invest in.
Court SCB relied on the fact sheet and other documents when presenting and explaining the fund to Mr Li. SCB knew that Mr Li relied on SCB's recommendations and SCB endorsed the fact sheet when making the recommendation that the fund was appropriate for Mr Li.
The representations about the fund based on the fact sheet and other documents had been adopted by SCB and made to Mr Li.
Changs They had little understanding of the investments products sold to them and completely relied on Mrs Li's recommendatio ns.
Mrs Li never told them how risky the investments were.
BOS BOS argued that Mrs Li only introduced investment products to the Changs and did not given any investment advice.
The biodata of BOS described the Changs as experienced investors with experience in a number of products and keen investors. Mr Chang was described as an experienced businessman who pioneered his family steel company.
Court The Changs were not experienced investors and had no substantial understanding of their investments. Although they appreciated that they were taking risks, the Changs did not know how substantial those risks were.
Mrs Li also did not explain whether the products were suitable for the Changs or that they should think over the investments being recommended.
BOS's biodata contained many inaccuracies.
Mr Li Disclaimers in terms & conditions/risk disclosure statements were unreasonable7.
SCB cannot rely on them.
SCB Relied on terms & conditions/risk disclosure statements.
Mr Li cannot argue that he relied on any advice/ representation or that SCB assumed any duty of care.
Relied on Springwell8 and SanHot9 cases, where customers were held to the terms of their agreements with their banks.
Court The disclaimers were interpreted narrowly. For example, the risk disclosure statement applied to higher risk transactions and did not apply to Mr Li's purchase of shares in a low risk fund.
The disclaimer that "[o]ur employees do not have authority to give you advice...you may not rely on any statement...as advice or...recommendation" was contradictory to reality10. It was artificial for SCB to rely on them.
The Springwell and San-Hot cases were distinguished on their facts.
The disclaimers failed the reasonableness test: the unequal bargaining position between the parties, the nonnegotiability of the provisions, the wide and vague drafting.
Changs BOS should advise and make recommendatio ns with reasonable care, skill and diligence.
BOS The bank account held by the Changs was operated only on client's instructions. The bank had no duty to advise.
Court The contractual provisions must be construed in their context and with regard to the facts of the case.
Various disclaimers in the client agreement meant that the Changs were contractually prevented from bringing a claim.
(Examples of the various disclaimers in the client agreements appear at the end of this article).
The client agreements construed together with BOS' marketing brochures clearly indicate that BOS was giving advice.
The extensive limitation clauses did not apply.
3) Breach of duty of care
SCB had assumed a duty of care when giving advice and recommendation s.11
SCB did not have a general duty to advise its clients.
Court SCB had assumed a duty of care, based on the evidence of Ms Chau and Ms Yau and its internal documents (including call reports).
Ms Yau made the advice and recommendations in a commercial and contractual context, not gratuitously or on a friendly basis. She knew that Mr Li would rely on the advice / recommendations in making his investment decision.
its duty of care
as it made false representations12
SCB had not been negligent. It had conducted due diligence on the Fund.
SCB's initial due dlligence SCB engaged professionals, Global Investment Group to conduct due diligence; SCB had considered 12 years of audited unqualified financial statements of the Fund; SCB relied on Citco Bank13 as the independent custodian; The Fund's directors answered questionnaires and provided a information Memorandum; Staff of the Fund's directors were interviewed.
SCB had conducted initial due diligence and ongoing monitoring with reasonable care and skill.
On the grounds14 of whether SCB was negligent in not discovering the fraud, SCB was not negligent. SCB had reasonable grounds to believe that the Fund was legitimate and was not negligent in failing to discover the Fund was a Ponzi scheme.
Ongoing monitoring The Fund was monitored on a weekly and monthly basis; The Fund was subject to a Quarterly Review and Annual Visits; SCB reviewed the yearly audited financial statements.
Changs BOS must consider their investment objectives and risk appetite.
BOS must only offer products which are suitable to their investment objectives and their risk appetite.
BOS must warn them of the risks inherent of the investments.
Court The Court agreed with the standard of care proposed by the Changs. It held that BOS had breached its duty when Mrs Li advised the Changs to purchase products which did not match their investment objective of being medium risk investors and which raised the risk level of their portfolio to high risk. Such breaches continued due to Mrs Li's failure to reduce the risk level of the Changs' portfolio.
Some Do's and Don'ts from these cases
Do you take the position that you do not provide "advice or recommendations"; you merely provide factual information or execution-only services? Don't. In both cases, the banks argued there was no duty to provide advice. However, the court not only looked at the client agreements15 but also considered the conduct of the bankers and the overall facts and concluded that the banks did provide advice and recommendations.
Do you disclaim responsibility for third party fact sheets? Don't. The court looked at the use of the fund fact sheet by SCB and concluded that they had adopted the representations in them as their own.
Do you rely on disclaimers or limitation clauses? Don't (or, at least, reconsider the wording of your clauses) The court interpreted these narrowly.
Do you depend on the Springwell and San-Hot cases? Don't. The court distinguished these cases on their facts.
Are you carrying out due diligence on the products that you offer to clients? Do. Examine if your due diligence process is sufficient and whether you have met your Suitability obligation16 - effective June 2017 - to ensure that the product is suitable for your client.
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1 JP Morgan Chase Bank v Springwell Navigation Corporation  EWHC 1186 (Comm.); DBS Bank (Hong Kong) Ltd. v San-Hot HK Industrial Co Ltd & Anor  4 HKC 1; Kwok Wai Hing Selina v HSBC Private Bank (Suisse) SA  4 HKC 260 (c.f. Rubenstein v HSBC Bank plc  EWHC 2304 (QB)).
2 Li Kwok Heem John v Standard Chartered International (USA) Limited (formerly known as American Express Bank Limited)  1 HKC 535.
3 Chang Pui Yin and others v Bank of Singapore Limited (unrep., HCCL 12/2013, 8 August 2016). 4 Equity-linked notes, options, forwards and accumulators. 5 Previously American Express Bank Limited. 6 Known as the Fairfield Sentry Fund. 7 Under the Control of Exemption Clauses Ordinance and Misrepresentation Ordinance. Another challenge
that the disclaimers were unconscionable under the Unconscionable Contracts Ordinance failed, indicating that "unconscionability" requires something more than unreasonableness. 8 See (1) above. 9 See (1) above. 10 Ms Chau and Mr Yau did give advice to Mr Li. 11 Under common law or the Supply of Services (Implied Terms) Ordinance. 12 The representations were false as the Fund was not an authentic investment and did not have any of the
characteristics in the Fund fact sheet. 13 One of the largest custodian banks. 14 Please note these are quite narrow grounds. 15 See examples attached at the end of this article. 16 Please see the Securities and Futures Commission's ("SFC") recent amendment to the Code of Conduct for
Persons Licensed by or Registered with the SFC, which requires financial institutions to add the following provision to their client agreements : "If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives. No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause." All client agreements must include this on or before 9 June 2017.
EXAMPLE OF DISCLAIMERS:
In respect of all transactions entered into by you or by the Bank on your Instructions or on your behalf, you understand and agree that:
(i) you make your own judgment in relation to investment or trading transactions;
(ii) the Bank assumes no duty to give advice or make recommendations;
(iii) if the Bank makes any such suggestions, it assumes no responsibility for your portfolio or for any investments or transactions made;
(iv) any risk associated with and any losses suffered as a result of the Bank entering into any transactions or investments on your behalf are for your account; and...
The Bank, its Affiliates and/or their staff may provide you with information and express views in relation to Investments. Such provision of information and expression of views shall not constitute the giving of investment advice (save for the giving of advice in respect of a Client's Discretionary Account) and the Bank, its Affiliates and their staff shall have no liability in respect thereof. The Client will make its own decisions regarding investments and may accept or disregard, in the Client's sole discretion, any views expressed for recommendations made by the Bank, its Affiliates and/or their staff, none of whom accept any liability (including but not limited to liability for any diminution in the value or loss or damage to any Investment) for any such decision made by the Client.
The Bank will have no duty or responsibility to supervise Investments or to make recommendations with respect to the purchase, retention or sale of Investments. The Bank shall be under no duty to assess the prudence of any instructions given by the Client or on the Client's behalf, or to warn the Client if any instructions are ill-timed or inadvisable or if any instructions are likely to lead to a loss to the Client.
All transactions for the Client's Accounts whether Discretionary, Non-Discretionary or Custody, will be for the sole account and risk of the Client.