On October 4 2011 judgment was handed down in Zaki v Credit Suisse (UK) Limited.(1) The case highlights the stark difference in approach between the issue of when a bank is liable for advice or recommendations under the Conduct of Business (COB) Rules, and the question of whether the same sort of advice or recommendation gives rise to liabilities at common law.
The claim was brought by Mr Mohamed Magdy Zeid, along with his wife, Mrs Soheir Ahmed Zaki, and two daughters who were joint account holders with him. Between 2003 and September 2008 Zeid purchased 39 structured products from Credit Suisse (UK) or its predecessor, Credit Suisse First Boston. During the same period Zeid also bought structured products from other banks, including Barclays and Citibank.
The claim was advanced in relation to 10 notes that Credit Suisse (UK) sold to Zeid between February 2007 and June 2008. All 10 notes were leveraged (ie, bought with the assistance of loans) and none were capital protected. Of the 29 previous products purchased by Zeid from Credit Suisse (UK) or Credit Suisse First Boston, 14 were capital protected and 15 were not.
In October 2008 Credit Suisse (UK) issued a margin call. Zeid did not transfer the required additional collateral and Credit Suisse (UK) liquidated the 10 products at issue in the claim, causing Zeid to suffer a loss of nearly $70 million.
Zeid claimed that Credit Suisse (UK) had breached its statutory duty to comply with the COB Rules, in particular its duty under COB 5 to ensure that any personal recommendation was suitable for him. Section 150(1) of the Financial and Services Markets Act 2000 provides that:
"A contravention by an authorised person of a rule is actionable at the suit of a private person who suffers loss as a result of the contravention, subject to the defences and other incidents applying to actions for breach of statutory duty."
By the end of the trial, it was not disputed that Zeid had been a 'private customer' for the purpose of the rules. The fundamental issues in dispute were:
- whether Credit Suisse (UK) had made a personal recommendation to Zeid to purchase the notes; and
- if so, whether it had taken reasonable steps to ensure that its advice was suitable for him.
There was a factual dispute as to whether Credit Suisse (UK) had made a personal recommendation to Zeid to purchase the 10 notes in question.
A 'recommendation' is defined as "advice on the merits" of buying a particular investment. The judge considered that 'advice on the merits' must refer to the advantages and disadvantages of purchasing the notes, but that it differs from the mere giving of information.(2) Further guidance is provided in Paragraph 2.7.15 of the Perimeter Guidance Manual issued by the Financial Services Authority (FSA), which states that:
"the context in which something is communicated may affect its character; for example, if a person gives information on share price against the background that, when he does, that will be a good time to sell, then this will constitute advising on investments."
Zeid died before a draft statement or proof of evidence had been prepared and there was no evidence from him. The judge held that Zeid's daughters' evidence should be treated with caution and that his wife had little relevant evidence to give.
Mr Mahmoud Zaki (who was no relation of Zeid's wife, Mrs Zaki) was a relationship manager, employed by Credit Suisse on the Middle East desk. He gave evidence on behalf of Credit Suisse (UK). He stated that he would explain the notes to Zeid in detail, including the risks associated with the notes and the effect of leverage on such risks. The conversations were described as "two-way", but Zeid would decide which trades to execute.
The judge's impression was that Zeid had "his own ideas as to what he wanted, examining critically the notes offered to him [by Zaki] and suggesting changes to the notes offered to reflect his wishes".
However, Zaki's role was to sell products to Zeid and the judge considered it unrealistic to suppose that he did not, at least from time to time, cross from the territory of information into the territory of recommendation or advice. The judge also relied on an internal Credit Suisse (UK) note which recorded that Zaki had advised against a purchase on the grounds of shortfall:
"Although this was advice against rather than for a transaction it is, I think, unreal to suppose that Mr Zaki scrupulously avoided giving advice as to the merits of a transaction and restricted himself to providing information, save when advising against a purchase."
Accordingly, the judge held that, on the balance of probabilities, Zaki made recommendations to Zeid to purchase each of the notes.
In making personal recommendations, Credit Suisse (UK) was under a duty (under COB 5.3.5) to take reasonable steps to ensure that the notes were suitable for Zeid.
The COB rules do not specify the factors to be taken into account when assessing suitability. However, the judge held that the three factors set out at Rule 9.2 of the Conduct of Business Sourcebook Rules (which replaced the COB Rules from November 1 2007) were relevant. These factors were the client's:
- knowledge and experience in the investment field relevant to the investment;
- financial situation; and
- investment objectives.
Zeid was described as a very successful businessman whose interests and responsibilities extended into financial services and banking. For example, he had been on the board of Sigma Capital, which had an investment banking role.
The judge considered that Zeid had understood the essential characteristics of the notes, including the circumstances that might lead to margin calls and the fact that his capital was at risk. He also considered that Zeid had been able to form a view of how the markets were likely to perform and, consequently, what risks he ran in holding the notes.
Zeid's family wealth in 2007 was not less than between $600 million and $700 million and there was no suggestion that Zeid was unable to bear the risks associated with the notes.
In relation to Zeid's investment objectives, the judge considered that his aim was to receive an enhanced or high-coupon payment - he had a desire for "double-digit" returns - and if this aim led to the purchase of a non-capital-protected note, he was prepared to take that risk.
Therefore, the judge considered that nothing suggested that the recommendation or advice to buy the notes was unsuitable for Zeid. The notes provided him with the enhanced return that he sought and he understood the risk that he might not recover his capital.
However, notwithstanding Zeid's appreciation of the risks and his ability to bear the consequences, the judge considered that a line had been crossed in May or June 2008. By this time, Zeid's account was already particularly exposed to the volatile equity market because of a lack of diversification. It was held that the notes entered into at this time were unsuitable, and that a prudent adviser would have recommended that Zeid reduce his exposure to equities. Accordingly, Credit Suisse (UK) had been in breach of its statutory duty.
Although Zeid ultimately lost on causation, this decision will be welcomed by private banking clients. It seems to be generally accepted for all purposes that the sales process will, as a matter of fact, generally involve giving advice and making recommendations. At common law, there appears to be a presumption that such investment advice, when given as part of the sales process, will not generally give rise to a duty of care in respect of such advice - unless, for example, there is an advisory agreement. However, under the statutory regime this case also recognises that at some point salespeople will always cross from the territory of information into the territory of recommendation or advice, and that a bank will be liable for unsuitable advice or recommendations to a private customer under the FSA Rules. This leads to the odd conclusion that an investor such as Zeid, a man of great wealth and no little sophistication, could claim under Section 150 of Financial and Services Markets Act, but would be unable to do so if he had instead opted - simply for tax purposes - to invest through a holding company. It seems odd that a bank's liability for exactly the same advice should be so radically altered by the way in which a client decides to structure an investment.
Nonetheless, this decision will provide comfort to investors in relation to suitability. In this context, banks cannot rely simply on the sophistication of their clients or the fact that a client has adopted an aggressive investment strategy. Rather, the court will take all factors into consideration, including market volatility and the client's portfolio of investments with the bank in question, in considering whether the bank took reasonable steps to ensure that the product was suitable.
Some of the notes at issue were structured capital at-risk products. The FSA recently fined Credit Suisse £5.95 million for selling £1 billion-worth of such products to private banking clients without ensuring that the sales were suitable and properly explained. The FSA's criticisms are echoed in the judge's comments in this case. It is to be expected that Credit Suisse will face further litigation in this respect.
For further information on this topic please contact Andy McGregor at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email ([email protected]).