misrepresentations were made about the nature of the instruments she traded; and

Transcription

1 slaughter and may Short shrift for sophisticated clients: Bank Leumi (UK) PLC v. Wachner BRIEFING april 2011 The High Court case of Bank Leumi 1 is another in a line of cases dealing with attempts by relatively experienced clients to recover damages from, or resist claims by, their broker-dealers in respect of trading losses incurred as a result of the financial crisis. The clients concerned have been those classified as intermediate customers or professional clients under the FSA s rules, and, broadly speaking, the relationships with their brokers were documented as execution only. To mount a credible legal challenge, the clients have therefore had to allege that their classification was arrived at incorrectly and/or that the brokers had assumed advisory or fiduciary duties which they then breached, causing losses to the client. The courts have so far shown scant sympathy for such allegations, with the tone of some of the judgments bordering on being outright hostile to the claimants. The judgment in Bank Leumi is another such case. The facts The case involved a wealthy American businesswoman who over a period of time ending in November 2008 incurred losses of over 13 million on trades in currency options with or through Bank Leumi. In seeking to resist the bank s subsequent claim for payment in respect of these loss-making trades, the defendant alleged various matters: the bank had improperly categorised her as an intermediate customer or elective professional client. She should have been classified as a retail client; accordingly she would never have been able to trade the instruments that she did in fact trade and/or various retail client protections under the FSA s rules would have applied which the bank s conduct breached; the bank was therefore liable for breach of statutory duty under section 150 of FSMA; misrepresentations were made about the nature of the instruments she traded; and the bank had assumed an advisory role and therefore undertook a duty of care, which it had breached by reason of giving negligent advice. Revisiting contractual estoppel In Bank Leumi, as in other recent cases, the most potent legal tool for the bank was the doctrine of contractual estoppel, recently confirmed by the Court of Appeal in the Springwell case, another client-bank dispute. This 1 [2011] EWHC 565 (Comm)

2 doctrine holds that where, as in the present case, parties have agreed that certain factual assumptions are to underlie their contractual relationship, then a party is estopped from denying those factual assumptions, in the absence of fraud or sham. In Bank Leumi, the customer documentation stated that the defendant agreed that she relied on her own judgment and that any trading recommendation from the bank would be incidental, with no representation given as to accuracy or completeness. The recent line of legal precedent in support of the effectiveness of such provision, starting with Springwell, would alone have been fatal to the defendant s case, unless she could succeed in her argument that she had been wrongly classified as an intermediate customer/professional client in which case, the court may have held that retail regulatory protections applied regardless of the contractual provisions agreed between the parties. This is considered further below. Bank Leumi acting as agent Bank Leumi is not remarkable merely for applying the views expressed by the Court of Appeal in Springwell. The judgment breaks new ground on its own in a way which could have many unintended consequences if it remains good law. A distinctive feature of Bank Leumi was that the defendant initially had a customer relationship with the bank s US affiliate, Bank Leumi USA (BLUSA). BLUSA made the original introduction to the UK bank and, for much of the relevant time, the defendant was a customer of both the UK bank and BLUSA. During most of 2008, a period critical to the judge s findings in the case, the defendant had an arrangement whereby trading for her account with BLUSA could be executed through the UK bank prior to New York opening for business, with the trades being booked to BLUSA. The arrangement was documented by what was known as the BLUSA/Agency Agreement. The judge found that the arrangement worked as follows: the defendant would speak to the traders at the bank in London, who would agree a deal as agent for BLUSA. Subsequently (or contemporaneously) and not involving the defendant, a back-to-back transaction would be entered into between BLUSA and the UK bank, each acting as principal, with the bank further laying off the trade into the market with a third party bank. From this finding of the UK bank s agency role (by itself a sensible analysis), the judge drew some rather startling conclusions under FSMA and the FSA s rules: the bank was engaging in the regulated activity of dealing as agent ; the defendant was not a client of the bank in respect of this activity. A client is defined as a person to whom a firm provides, intends to provide or has provided a service in the course of carrying on a regulated activity. The judge held that: in so far as [the bank] was providing a service, it was a service to BLUSA for which it was acting as agent, not to [the defendant], who was BLUSA s counterparty ; and the dealings engaged in with the defendant by the bank, as agent for BLUSA, therefore fell outside the UK regulatory regime. The judge considered that there is nothing remotely surprising or unusual in that conclusion. After all, the relevant option contracts were all between a US citizen and a New York Bank. Why, one might ask rhetorically, should those contracts be regulated by the United Kingdom regulatory regime, any more than any other option or other foreign exchange contract entered into by the [the defendant] with BLUSA over the years? 02 SLAUGHTER AND MAY

3 The judge concluded, therefore, that no FSA conduct of business protections could apply in these circumstances. However, although the judge claimed that this conclusion was unsurprising, the legal characterisation of the relationship and the regulatory consequence that those protections do not apply would also seem to apply to rather more surprising cases: a UK firm acts as agent for its US affiliate firm in dealings with the UK customer of the US affiliate (this is merely to change the jurisdiction of the defendant in the Bank Leumi scenario); or a UK firm acts as agent of its UK affiliate firm in dealings with a UK customer (where in the absence of an appointed representative arrangement there is nothing in the regulatory regime per se which imputes regulatory responsibility for the activities of the regulated agent to the regulated principal); or a UK firm acts as agent for an unregulated booking company in a third country jurisdiction in dealings with a UK customer (the legal purist might now argue that the relationship with the customer is thus entirely unregulated). Can the judge s conclusions be right? There are good reasons to think not. Does an agent only provide services to its principal? The judge appears to have been influenced by the fact that the only regulated activity being carried on by Bank Leumi under the RAO was dealing as agent (it could not also be arranging, because that activity does not take place if the putative arranger is itself a party to the arranged transaction either as principal or, as in this case, agent). It appears that because the concept of dealing as agent implies that the agent is dealing for its principal, the judge concluded that any investment business conducted by Bank Leumi was conducted for BLUSA and not for the client: there is no question [ie no possibility] of that designated investment business [within the meaning of the RAO and the FSA s conduct of business rules] having been conducted with or for [the defendant] as client of [the bank]. However, the definition of a client for the purposes of the FSA s conduct of business rules is subtly different and does not quite accord to the judge s conclusion. In this context a client is a person to whom a firm provides a service in the course of carrying on a regulated activity. Was Bank Leumi, in the course of dealing as agent for BLUSA, providing a service to the defendant client? By concentrating only on the service which the bank was undoubtedly providing to BLUSA, the judge s answer was no, apparently on the ground that the service of an agent is exclusive of any other service being provided. Service is a term undefined in the FSA s rules; though by its ordinary meaning, agents may clearly provide services to persons with whom they deal on behalf of their principals (for example, an insurance agent can provide services to policyholders notwithstanding that its role is agent for the insurer). In the present case, it seems quite evident that Bank Leumi, acting as agent for BLUSA, could be said to have been providing a dealing service to the defendant. 03 SLAUGHTER AND MAY

4 MiFID aspects underplayed In any case, the judgment is perhaps fatally flawed by there being scant mention, let alone discussion, of the substantive impact of the Markets in Financial Instruments Directive on the legal position. This piece of European legislation is implemented in large part by the FSA s conduct of business rules and so now governs the interpretation of both those rules and the RAO (so far as relevant to the case). It is therefore somewhat odd that the proper construction of MiFID was not referenced in argument during the case but that is the implication of the complete absence of such reference in the judgment. Looking at the dealing arrangement from a MiFID perspective, it is reasonably clear that Bank Leumi was providing the MiFID investment service of execution of orders, and that service was provided to the defendant client who gave her dealing orders to the bank. Whether a firm is providing the service of executing orders is not dependent on any particular status it has as agent or principal (the European Commission has recently confirmed that a firm dealing for its own account can also be considered to be executing orders in the appropriate circumstances). The bank might also have been considered to be providing the service of reception and transmission of orders, in the sense given by Recital 20 to MiFID: bringing together two or more investors and thereby bringing about a transaction between those investors. This activity also appears to be neutral as to the legal status of the intermediary. Had the judge considered this MiFID angle to the interpretation, and thereby reached the conclusion that the relationship between Bank Leumi and the defendant client fell within the scope of MiFID, then it would have followed that he should have interpreted the provisions of the UK regime to give effect to this conclusion. Such an exercise cannot be considered to have necessitated any strained interpretation. Customer classification Although the facts are somewhat messy, a brief mention of the judge s findings on customer classification is in order. The requirements under the relevant FSA rules were, in summary: Prior to 1 November 2007, the FSA s conduct of business rules required a firm to take reasonable steps to classify a customer (who would otherwise be a private customer) as an intermediate customer on the basis of the customer s knowledge and understanding. Also prior to 1 November 2007, those rules required that the status of an intermediate customer be reviewed annually. On 1 November 2007, when the FSA s new (MiFID-compliant) conduct of business rules came into force, a customer who was correctly classified as an intermediate customer was grandfathered into the status of elective professional client under the new rules. After 1 November 2007, the FSA s conduct of business rules do not mandate any particular periodic review of a client s categorisation. Nevertheless a firm is required to take appropriate action (including, if necessary, recategorisation) if the firm becomes aware that a client no longer fulfils the criteria which made him eligible for elective professional client status. 04 SLAUGHTER AND MAY

5 The judgment is very favourable to the bank on the question of initial classification under the conduct of business rules. Among other matters, the judge found or emphasised that: The pre-mifid conduct of business rules did not require a customer classification to be objectively right but required only that a firm take reasonable steps to arrive at the correct classification. (The position under the post-mifid conduct of business rules is that a firm must make an adequate assessment of a client s expertise, experience and knowledge. The client must also meet certain objective criteria.) Reasonable steps could include a brief informal meeting between a dealer at the bank and the defendant during which the dealer, on the basis of their conversation, formed the view that [the defendant] had sufficient expertise of FX trading. Although the information which Bank Leumi obtained from BLUSA about the defendant s experience was decidedly patchy, it is legitimate to ask whether the characterisation of the defendant provided by her relationship manager at BLUSA would have been materially different if it had been provided by [the defendant herself]. The judge noted that: she is no shrinking violet, rather someone quite capable of a self-assessment that she had the appropriate experience and expertise to be classified as an intermediate customer or elected professional client. Although the assessment of the defendant did not comply with the bank s own compliance procedures, this was not evidence that reasonable steps had not been taken, as there was no legal obligation so to comply in order to meet the conduct of business rule requirement. The judge also held that at no time subsequently had the bank been obliged to revisit the categorisation of the defendant client. One principal reason for this was the finding, discussed above, that the conduct of business rules did not apply during the period of the BLUSA/Agency Agreement arrangement during the currency of which a trader at BLUSA, speaking to an officer of the bank, was highly critical of [the defendant], saying that from the outset she had been telling [the bank s officer] that she was insane. Further, when (after 1 November 2007) the new FSA client categorisation and conduct of business rules applied, none of the facts gave rise to the conclusion that the bank was aware of a relevant change of circumstances in relation to the defendant. Nor did those new rules trigger a requirement to review the defendant s status, or apply the lower threshold of ought to be aware. (Both MiFID and the FSA s conduct of business rules support this conclusion, providing for the onus to be on the client to inform a firm of relevant changes in circumstances.) Conclusion Banks and brokers can take comfort from the fact that yet another High Court case has shown that the judiciary is in general not eager to assist long-standing sophisticated clients avoid their financial responsibilities by challenging their client status and clearly-expressed contractual documentation. The message is that such clients should take the legal and financial rough with the smooth. As to the case s conclusions on the status of dealing agents and the absence of regulatory responsibilities towards those with whom they deal on behalf of their principals, clearly banks and brokers can choose to rely on the judgment as expressing the current state of the law. This may be especially tempting for a multi-national institution where clients of branches/affiliates in many overseas jurisdictions are to a greater or lesser extent serviced through dealing rooms in London but booked to accounts maintained outside the UK. 05 SLAUGHTER AND MAY

6 But caution must be urged: for the reasons given above, the judgment in this respect could well be found to be bad law if appealed or revisited in a subsequent case. For that reason, it is unlikely to impress the FSA who may well seek to distinguish or minimise its significance. If you would like to discuss the issues raised in this briefing paper, or any other financial regulatory matter, please contact one of the following or your usual Slaughter and May contact: Ruth Fox: ruth.fox@slaughterandmay.com Jan Putnis: jan.putnis@slaughterandmay.com Ben Kingsley: ben.kingsley@slaughterandmay.com Slaughter and May One Bunhill Row London EC1Y 8YY United Kingdom T +44 (0) Slaughter and May 2011 This material is for general information only and is not intended to provide legal advice. For further information, please speak to your usual Slaughter and May contact. bjk50.indd411