For banks, investment advisers, and their professional indemnity insurers, the Court of Appeal ruling in Rubenstein v HSBC has been eagerly anticipated. The Court of Appeal’s judgment was reported on 12 September 2012.

At first instance, the Judge found that although an IFA was negligent (and in breach of the COB Rules) in advising a retail client to invest in the Enhanced Fund of the AIG Premier Access Bond, the IFA was not liable for losses that flowed from the investment. It was deemed that the losses were caused by the run on AIG in 2008 and that this was not a reasonably foreseeable event when the advice was given in 2005.  

The first instance judgment supported the principles of scope of duty of care and remoteness, established in SAAMCO v York Montague Ltd [1997] AC 191, in holding that losses attributable to unforeseeable market falls are not recoverable against a negligent third party professional.  

This was welcomed by the financial services industry, but the Court of Appeal (led by Rix LJ) has overturned this finding and held that where a loss results from the specific risk from which a professional adviser was under a duty to protect an investor, the adviser could not invoke SAAMCO principles as a defence; and that an investment loss caused by adverse market movements, including a loss of confidence, affecting securities was not an unforeseeable event.  

We consider below the factual background, the key findings of the Court of Appeal and the implications for financial institutions and their insurers.  

The facts

The Appellant, Mr Rubenstein, was a retail client of HSBC. In August 2005, he approached his local branch to discuss investing the sum of £1.25m. Mr Rubenstein wanted to locate a temporary income-earning investment for monies that he would ultimately use to buy a new home. After receiving a brochure for the AIG Premier Access Bond (which included the “Enhanced Fund”), Mr Rubenstein emailed the IFA stating:  

“We can’t afford to accept any risk in the investment of the principal sum. Can you confirm what – if any – risk is associated with this product”.

The IFA responded by stating:  

“We view this investment [the Enhanced Fund] as the same as cash deposited in one of our accounts … [T]he risk of default … is similar to the risk of default of Northern Rock”.

In September 2005, Mr Rubenstein invested his £1.25m in the Enhanced Fund. Mr Rubenstein was still in the investment (having been unable to buy a new home) in September 2008 when the well-publicised run on AIG occurred. Mr Rubenstein was eventually permitted to withdraw his money in November 2008, but received approximately £180,000 less than the original £1.25m invested.  

Mr Rubenstein alleged negligent advice had been received from the Bank.

The first instance judgment

The judge found that Mr Rubenstein’s claim raised significant issues as to the scope of duty, causation, foreseeability and remoteness. He discussed SAAMCO (and other cases on remoteness) for the purpose of considering HSBC’s submission that the Bank’s duty was like that of the valuer in SAAMCO, namely to take responsibility only for the consequences of his information being incorrect.  

The judge found that HSBC was negligent in the advice which it gave, and in breach of statutory duty, and that Mr Rubenstein relied on the bank’s advice. He found that the Enhanced Fund was an unsuitable investment for Mr Rubenstein. Given the relevant COB rules, the bank had been under a statutory duty effectively not to recommend an investment such as the Enhanced Fund, which exposed him to capital losses due to market fluctuations, and the bank had breached that statutory duty. AIG Life offered a sister-fund to the Enhanced Fund (the Standard Fund) under which there was no risk to capital from market fluctuations. The bank could have and should have recommended that Mr Rubenstein invest in that fund instead.  

However, because the judge considered that Mr Rubenstein’s loss had been unforeseeable and too remote, and had been caused not by the IFA’s negligent recommendation but by the “extraordinary and unprecedented financial turmoil which surrounded the collapse of Lehman Brothers”, the loss was held to fall outside the scope of the duty of care and to have been outside the reasonable contemplation of the parties.  

Mr Rubenstein was therefore awarded merely nominal damages in contract.

Mr Rubenstein’s arguments on Appeal

Mr Rubenstein’s case on appeal was essentially that his loss was caused by the very thing which he had wished to avoid, namely, the risk of loss to his capital. There were two risks: (1) the risk of default of the institution to which Mr Rubenstein entrusted his money, the “default risk”; and (2) the risk of market movements, the “market risk”. Mr Rubenstein claimed he had no idea that he was exposed to “market risk” at all.

Mr Rubenstein claimed he wanted an investment without risk.  

HSBC’s defence on Appeal

It was conceded that the bank provided advice and not merely information; and it was accepted that Mr Rubenstein relied on that advice.  

HSBC raised three arguments as to why the judge at first instance was correct to conclude that the loss was too remote:  

The loss was caused by the extraordinary/unprecedented financial turmoil which surrounded the collapse of Lehman Brothers

Rix LJ considered this proposition and found that:

  • The insolvency of Lehman Brothers may have been unforeseeable, but Mr Rubenstein was not invested in Lehman Brothers, so it was irrelevant;
  • The run on AIG may have been unforeseeable, but it was not the run which ultimately caused Mr Rubenstein’s loss;
  • Ultimately, it was the collapse in the value of the marketable securities in which the Enhanced Fund was invested which caused the loss. At the time investors were scrambling to withdraw their money these securities were at a depressed value;
  • Further, although the Lehman Brothers collapse was both a symptom and a contributory cause of market turmoil, the underlying causes went beyond Lehman Brothers’ difficulties to a failure of confidence in marketable securities and: “... what is new about that?”

Since, in this case, the bank’s duty (which it had breached) had been to recommend an investment that insulated Mr Rubenstein from capital losses due to market fluctuations (ie “market risk”), and since the cause of the loss was the market risk, Rix LJ did not consider it could be argued that the loss was too remote:  

“It was the bank’s duty to protect Mr Rubenstein from market forces when he made clear that he wanted an investment which was without any risk (and when the bank told him that the investment was the same as a cash deposit); it is wrong in such a context to say that when the risk from exposure to market forces arises, the bank is free of responsibility because the incidence of market loss was unexpected”.

Rix LJ determined that what connected the negligent advice and the loss was the combination of advising Mr Rubenstein to invest in a fund which was subject to market losses, while at the same time misleading him that his investment was the same as a cash deposit. It was HSBC’s duty to protect their retail customer from exposure to market forces when he made it clear he wanted no risk.  

At the time of the investment in September 2005, the Enhanced Fund would have been regarded as without risk

Rix LJ did not doubt this proposition; however, his response was simply to state: “So it might, but then nearly all the greatest losses come out of a cloudless sky”. In his view this did not matter since, as above, (a) the bank’s duty had been to protect Mr Rubenstein from market risk; (b) in recommending the Enhanced Fund it had breached that duty; and (c) in those circumstances it could not be said that the fact that the risk materialised meant the loss was too remote.  

The point Rix LJ was making was that, where a bank is under a duty not to put a retail customer in an investment exposed to market forces, where loss occurred due to such forces – however unforeseeable that might have been at the time of the advice – the loss is not too remote.

Mr Rubenstein’s investment was contemplated as being a 12 month investment, so loss that occurred two years outside this period is beyond the scope of HSBC’s duties of care and foresight

Rix LJ described this argument as a “powerful submission”. However, on balance, he was not persuaded by this on the basis that the period for the investment was undefined – it was intended to be in place until Mr Rubenstein had bought a new home, which was contingent on a number of factors.

The Court of Appeal’s conclusions

Ultimately, the question of remoteness is a matter of the reasonable contemplation of the parties. After considering the authorities on causation, Rix LJ determined that, in the context of statutory protection for the consumer, a bank (or IFA) must reasonably contemplate that, if it misleads its client into an unsuitable investment, it may well be liable for that loss, even if such loss was unexpected.

Whether the test of remoteness is expressed in the classic terms found in the leading authorities, or whether it has been nuanced to reflect an exercise in judgement, Rix LJ found that Mr Rubenstein’s loss was caused by HSBC’s breach and was not to be regarded as too remote. What connected the negligent advice and the loss was HSBC’s advice to Mr Rubenstein to invest in the Enhanced Fund (which was exposed to market forces), while misleading him that his investment was equivalent to a cash deposit.  

Conclusions and commentary

It is clear from the judgment that Rix LJ did not believe that HSBC should be able to take advantage of a loss causation defence based on SAAMCO principles where the bank was clearly negligent.  

He points to the fact that the bank adviser had been guilty of serial negligence; as he put it: “This is not, to my mind, a promising context in which to find that a loss suffered as a result of following a recommendation to enter into an unsuitable investment … was too remote to be recovered from the defaulting advising bank.” He also volunteered that there was “something counter intuitive” in a judgment in which the bank had been held to be negligent and in breach of the COB Rules, where the loss was easily quantifiable, but had been held to be too remote to be recoverable in law.  

Rix LJ distinguished the loss suffered by Mr Rubenstein from a loss which would be irrecoverable on principles of duty of care and remoteness, on the basis that the loss flowed from the same cause from which HSBC had been instructed to insulate Mr Rubenstein ie “the market risk”. He therefore held that there was a causative link between that loss and the negligence on the part of the bank, and that it was not disconnected from that negligence by an unforeseeable event.  

In relation to the SAAMCO defence, Rix LJ stated that a range of factors, including “bad markets” cause investments to fall but pointed out that it was a matter of legal judgement as to whether the impact of that cause was “so extraneous to the validity of the investment advice” as to afford the adviser a defence, on the basis that the result was not within the scope of his duty of care. This is a key element of the reasoning by which he disapplied the SAAMCO defence and will be a key qualifying factor in the success of SAAMCO based defences in future claims.  

Rix LJ adopted a line of authority from which he extracted the conclusion that where it was the duty of an adviser to protect a claimant from losses of the kind which he suffered, it was no answer for the adviser to argue that the kind of loss suffered was either unlikely to occur or unlikely to occur on a much larger scale than might have been anticipated.

At the core of the judgment on the SAAMCO principles and the issue of foreseeability were Rix LJ’s factual findings that the loss was not in fact attributable to a run on the AIG Fund, but to the impact of adverse market forces on the underlying assets which made up the Fund. He held that this impact was perfectly foreseeable; firstly in the light of the AIG brochure which expressly contemplated the potential need to sell assets prior to their maturity date; and secondly on the basis that a failure of market confidence in a particular asset class is nothing new. He therefore held that the loss was foreseeable and would not be barred from recovery on SAAMCO principles.  

Finally, and importantly, Rix LJ held that the decision in Camarata v Credit Suisse, in which a SAAMCO based defence was upheld where an investment loss was caused by the collapse of Lehman Brothers, had been correctly decided. In this context he distinguished between an unforeseeable insolvency ie “issuer default”, on the one hand and the position in the HSBC case where the loss flowed from a market risk to which Mr Rubenstein was exposed.  

The key messages to be derived from the judgment

  • Where the investment loss flows from a cause from which a client has expressly sought protection, a loss of that same nature is likely to be recoverable in damages.
  • The SAAMCO defence remains available where the source of the investment loss is extraneous to, and unforeseeable as a consequence of, the investment and is unrelated to the express terms of the brief provided by the client in relation to the scope of the investment that he would accept.
  • Losses attributable to the collapse of Lehman Brothers can be correctly regarded as unforeseeable and too remote to be recoverable as damages. Losses caused in the capital markets by the impact of the credit crisis are also arguably irrecoverable on SAAMCO principles, except where they flow from a risk in relation to which specific protection is sought by the investor.
  • We do not agree with Rix LJ’s finding that merely because there is standard reference to the potential for early sale of securities from the AIG portfolio it follows that a collapse in the fund’s value was reasonably foreseeable (ie objectively foreseeable) or within the contemplation of the parties (ie subjectively foreseeable). Similarly, whilst in principle the impact of market forces must be foreseeable, it does not follow that the unprecedented and unique impact of the credit crisis on an asset class and the degree of that impact were foreseeable.
  • The SAAMCO defence ought in principle to remain available to banks and investment advisers, notwithstanding the line of authority which Rix LJ quoted in the judgment.
  • It is noteworthy that even though Rix LJ borrows from a recent FOS decision and an FSA final notice against Coutts to support his findings, the FSA have recently stated (in the context of a fine levied against a director of HBOS) that the credit crunch and its financial consequences were not foreseeable.
  • Of key importance is the recognition by Rix LJ in the judgment (at paragraph 115) that this case should be distinguished from the position where an investor is a sophisticated investor ie “familiar” with investment markets. It therefore seems unlikely that this judgment would have application in the context of most claims between investors and hedge funds/private equity funds or other commercially orientated investments.
  • Nevertheless, this judgment and its consequences will need to be carefully considered in the context of all current and prospective claims by retail investors against banks and IFAs.