In a strongly worded judgment, the Commercial Court has dismissed a large misselling claim brought by an individual in connection with a number of investments she had made in structured notes on a leveraged basis. The claim arose out of losses suffered following a margin call in October 2008 which was not met and which resulted in the forced sale of the structured notes. The claim, which sought damages of over USD30m, was brought against the private banking division of Credit Suisse in the UK and Plurimi Capital (an independent financial adviser, also based in the UK). The Court found that the claim failed on every issue and that the Claimant had been dishonest in the way she had pursued the claim. While there was sufficient documentary evidence to determine the case, the Court was also not satisfied that the Claimant had complied fully with her disclosure obligations. The case is fact specific and, for this very reason, highlights the importance of defendants not accepting at face value the professed lack of investment inexperience and limited financial position sometimes put forward by claimants in support of such claims.
- It will often be important for defendants to probe and to establish the true investment experience and financial position of claimants in such claims.
- The FSA conduct of business rules (COB and COBS) are concerned with substance and not form. If an investment is in fact suitable for the client, then it does not ultimately matter if there have been failings in the process. Failings in internal processes are not the same as failings in regulatory processes.
- In the circumstances of this case, explanations of the risks associated with investments did not need to be provided orally. The customer was literate and educated and therefore the bank was entitled to assume that she would read written risk warnings if expressed in straightforward terms.
- A written risk warning which did not specify the consequences of not providing additional collateral was not inadequate. The possibility of the margin call was clear if the customer had given it a "moment's thought".
- Where an investment was made on a leveraged basis, there was no regulatory requirement on an adviser to seek to estimate or advise the customer on the probability or likely size of any margin call, nor was there any obligation on the adviser to satisfy himself that a customer had sufficient assets to meet a margin call.
1. The facts
The Claimant, Mrs Basma Al Sulaiman, was a Middle Eastern individual who, in 2002, received a very substantial financial settlement as part of her divorce from one of Saudi Arabia's wealthiest men. In 2003, the Claimant decided to make investments with her new found independent wealth. At this time the Claimant had no experience of investment or financial affairs. In late 2004, the Claimant became a customer of the private banking division of Credit Suisse ("CS"), which agreed to provide her with investment recommendations on an advisory basis. The Claimant wanted to make investments which would provide her with a regular income to cover her lifestyle expenses. The adviser recommended investments in structured notes linked to equity indices and interest rates. These notes provided the investor with a periodic income provided that the underlying index did not drop below a certain level from the "strike" price at the date of purchase.
The adviser understood from discussions with the Claimant that she sought a "double digit" return from her investments. She was advised that returns on investments could be enhanced by investing using borrowed funds which would be made available to her from CS's parent, Credit Suisse AG ("CSAG"). The Claimant accepted this advice and, in the period between 2005 and 2007, she purchased 18 notes on a leveraged basis. The levels of leverage varied from 60% to 70% of the total nominal sum invested. The lending was secured (by way of a Pledge) against the notes themselves. The notes were exposed to market risk and could fluctuate in value. It was a condition of lending that the borrower was required to keep the loan to value ratio ("LTV ratio") of the portfolio at a level that was satisfactory to the lender.
In December 2007, the adviser left CS and founded his own investment advisory firm, Plurimi. The Claimant transferred her portfolio of six notes from CS to Plurimi after which she invested in a further five structured notes. In October 2008, the value of the notes dropped significantly in the wake of the collapse of Lehman Brothers and two Icelandic Banks. The Claimant was required, at short notice, to provide additional collateral to support her account, known as a "margin call". The Claimant failed to meet this margin call and CSAG forced a sale of her portfolio at a total loss of approximately USD31 million. The proceeds of sale were insufficient to repay the loans in full. Consequently, the Claimant lost all of her own capital investment and became indebted to the lender.
2. Claim under section 150 of the Financial Services and Markets Act 2000
As a "private person", the Claimant brought a claim for losses caused by alleged breaches of the customer information gathering, explanations of risk and suitability requirements of various FSA conduct of business rules. These rules were contained in the Conduct of Business handbook (COB) for the period up to 31 October 2007 and thereafter in the Conduct of Business Sourcebook (COBS) (so that the latter alone applied to the period of the Claimant's relationship with Plurimi). In particular, the Claimant alleged breach of COB 5.4.3, COB 5.3.5, COBS 9.2.1 and COBS 9.2.2.
Although a duty of care was pleaded in contract and tort, it was common ground that it added little or nothing to the claim for breach of statutory duty, since the alleged contractual and tortious duties (e.g. the duty to explain the risks associated with such investments) were the same as the regulatory requirements.
3. The scope and alleged breach of duty to explain the risk of a margin call
The nature of the Claimant's case developed significantly throughout the proceedings and also during trial. These developments were prompted by the late disclosure of documents held by third party institutions regarding the Claimant's other financial investments. The Defendants had been pressing for this disclosure for some time.
At trial, the Court found that a number of allegations made by the Claimant in her original particulars of claim were found to be unsustainable, false or dishonest. In particular, the Claimant was found to have misrepresented (i) her wealth and hence her ability to meet a margin call; (ii) her risk appetite and investment objectives; and (iii) her experience of leveraged investments through other financial institutions. The Claimant's revised (and more limited) case at trial was that her loss was caused by breaches of duty on the part of CS and Plurimi to take reasonable steps to ensure that she understood the risks associated with making investments on a leveraged basis, including in particular the risk of margin calls. It was alleged that that failure to explain meant that the Defendants had failed to take reasonable steps to provide suitable investment advice. In particular, it was alleged that CS and Plurimi failed to explain to the Claimant that:
- Notes that she purchased with money lent by CSAG would be pledged to CSAG as collateral for the loans;
- CSAG was entitled to call upon her to provide additional collateral, in the event that the value of the Notes dropped; and
- If she did not provide such additional collateral within the timescale stipulated by CSAG, her Notes could be sold, whereupon she could lose all or most of her capital.
It was further alleged that, had these explanations been given, then the Claimant would not have invested in the leveraged structured notes and would have invested in something different.
During the course of her relationship with the Defendants, the Claimant had been given numerous written warnings regarding these risks. However, it was the Claimant's evidence that she had very limited investment experience and was not financially literate. Therefore, she did not read these written warnings but relied upon her adviser to inform her orally of all the risks which she needed to be aware of. Even where the Claimant had signed documents which referred to the risks of leveraged investments, her position was that she was in the habit of signing these documents blind and that generally she did not read standard banking documents (whether provided by the Defendants, CSAG or other banks with whom she dealt). She claimed that, as a result, all references to collateral, margin, margin call and the consequences of non-compliance with the latter, had passed her by. She further testified that she did not read various emails from the adviser which warned her of potential capital losses, nor understood emails which advised her of the risk of leverage on other investments on which she sought his view. The Claimant testified that she did not understand the meaning of the words “pledge”, “margin” or “margin call”, if she was aware of them at all, as the subject was never mentioned in conversations with her adviser. As regards her requirement to have matters explained to her orally, the Claimant's position was that she would not have understood anything complex which was put in writing. However, she admitted that she had never told him (or any adviser, banker, trustee or trust manager) that she required all explanations to be oral, rather than in writing.
The Claimant adduced the evidence of a financial expert in support of her case. However, during cross examination, the expert (who had adopted unchanged the expert report of another who had died) stated that, in his opinion:
- The Claimant demonstrated an aggressive approach to investment.
- Structured notes were safe investments and, generally, in normal market conditions, the value of structured notes remained relatively stable.
- It was a benign market in 2006 and 2007 and the risk of a margin call between March 2003 and July 2007 was not one which an adviser would have concerned himself about.
- The existence of the “buffers” or “cushions” between the maximum LTV ratio permitted by CSAG and the actual LTV recommended by the Defendants reduced the likelihood of the margin call.
- The extreme events of October 2008 were unforeseeable until the brink of their occurrence.
It was also agreed between the parties' respective experts that there was no regulatory requirement on an adviser to seek to estimate or advise the customer on the probability or likely size of any margin call, nor any obligation to satisfy himself that a customer had sufficient assets to meet a margin call (which was recognised to be a practical impossibility for an adviser to do). The Claimant's expert's suggestion that it was "good practice" for the adviser to advise the customer of the minimum margin call was rejected by the court.
As regards the evidence of the Claimant herself, the Court found that her evidence regarding her understanding of leverage and the risk of margin calls was not only inaccurate and unreliable, but dishonest. The Court found that, however unsophisticated the Claimant may have been at the outset of her relationship with CS, she was an intelligent person who had no difficulty grasping financial concepts and that it was inconceivable that she had not discussed and understood the risks associated with leveraged investment.
The Court further found that there was no breach of statutory duty. The Defendants had provided adequate oral and written explanations of the risks associated with leverage, including the risks of a margin call (notwithstanding the fact that the term "margin call" may not have been used) and that the Defendants had taken reasonable steps to ensure that the Claimant understood them. The "Effect of Leverage" document made no specific reference to the consequences of not meeting a margin call but, given the nature of other warnings contained within this document, this possibility would have been apparent to a reader who gave it a "moment's thought". As to the oral explanations, the Court held that, in the context of the benign market conditions at the time that the investments were sold, together with the various steps taken by the adviser to mitigate against the risk of a margin call, the risk of a margin call and the consequences of not meeting one were remote and that there was no reason not to have explained them especially as there was no concern about the Claimant's ability to meet a margin call.
Reliance and causation
The Claimant was found to be a strong minded individual who was prepared to press ahead with investments against the advice of the Defendants and her other advisers. This was not itself enough to show that there was no reliance. However, by the time the Claimant invested in the first disputed note in April 2006, the Court was satisfied that the Claimant fully understood the risks of leverage and margin calls. Even if no explanations of the risks of a margin call had been given and she had subsequently discovered this risk at some later date, she would not have been put off from investing in the Notes right up to October 2008.
As to causation, the adviser had recommended to the Claimant that she should meet the margin call and the Court accepted that she had sufficient assets to do so. However, it was plain that a decision had been made by the Claimant not to meet the margin call. This was probably done in the hope that CSAG would not insist on the additional collateral. This decision was considered by the Court to be so irrational as to be almost incomprehensible. This irrational decision broke the chain of causation and any failure to explain the risks of margin calls did not cause the Claimant's losses.
This judgment follows the Court of Appeal's decision in Zaki v Credit Suisse (UK) Ltd  EWCA Civ 14 where it was also found that the rules are concerned with substance and not form. If an investment is in fact suitable for the client, then it does not ultimately matter if there have been failings in the process. In this case, there were no breaches of the regulatory requirements.
The case further emphasises the fact that the regulatory requirements are qualified by the requirement to take "reasonable steps". What constitutes "reasonable steps" will vary from customer to customer depending on their circumstances. The requirement to provide explanations of risk can be satisfied by both written and oral explanations. In the absence of a clear direction to the contrary, an adviser is entitled to assume that a literate and educated investor will read written warnings if expressed in straightforward terms.
The case also highlights the importance of defendants probing and establishing the true investment experience and financial position of claimants to such claims. There seems little doubt that the outcome of this case was significantly influenced by the Court's findings of dishonesty against the Claimant.