UK: Financial Lines - October 2012

Impact of the financial crisis on professional negligence claims against sellers of financial products: was it predictable?

In the current wave of litigation affecting the financial sector, it is not uncommon for issues to arise as to whether a claimant's losses from a given financial product arising from the severe market turmoil that overtook the entire market in 2008 are recoverable from a professional defendant advising on the investment, or whether the turmoil was unforeseeable and therefore irrecoverable. The recent Court of Appeal decision in Rubenstein v HSBC [2012] demonstrates that the defendant will not always be able to rely upon the unpredictability of what happened in the financial markets, especially in the face of evidence showing the claimant clearly indicated a desire to preserve the capital invested.


The claimant, Mr Rubenstein, a solicitor and private retail bank customer of "medium sophistication", was advised by an HSBC IFA in 2005 to invest in an AIG Premier Access Bond ("PAB"), specifically in the Enhanced Variable Rate Fund ("EVRF"). The claimant wished to invest the proceeds from the sale of his matrimonial home (amounting to £1.25 million) for a short period until a new property could be found. He wanted the money to earn a good rate of interest, to be readily accessible, and he did not wish to accept any risk in respect of the capital sum.

The fund had been selected and approved by the defendant's Product Research Team and the defendant advised the claimant that "we view this investment as the same as cash deposited in one of our accounts" in terms of its security. Investors would purchase units in the fund, which was invested in a range of different securities with mainly AAA and AA rated companies, with the remainder in A rated companies.

Although marketed as a product for cautious investors, the collapse of Lehman Brothers and the unprecedented investor run on major financial institutions including AIG and Merrill Lynch in the week beginning 15 September 2008, led to the temporary suspension of withdrawals from AIG's EVRF. When the claimant eventually cashed in his investment, he suffered a loss of capital.

In April 2011, AIG paid the claimant £7,195 after distribution of the assets of the EVRF after the closure of the fund. AIG claimed the payment was made on an ex gratia basis.

First Instance Proceedings

The claimant claimed damages for negligent mis-selling and breach of the FSA's Conduct of Business Rules ("COB") (since replaced by COBS, the relevant Conduct of Business Sourcebook) by the defendant. The defendant argued that its IFA had only performed an "execution only" role rather than advising on the investment.

The Court held that the contract between the claimant and the defendant was for advice and was not "execution only". The claimant had asked for a recommendation and the adviser had recommended the EVRF. The bank's own process for "non-advised" (or execution only) sales was not followed and the financial adviser referred to providing advice in correspondence with the claimant. Without any express disclaimer, any response to the claimant's inquiry would constitute advice, as it would imply the advisor considered that the product met the criteria.

The Court also held that the defendant had been negligent in advising that the EVRF was suitable. This was because (a) the defendant suggested that the EVRF was the same as a cash deposit; and (b) made no attempt to consider other funds in the PAB as an alternative, such as the Standard Rate Variable Fund (SRVF), would have been more suitable, in breach of COB.

The Court accepted that, but for the negligent advice, the claimant would not have invested in the EVRF. However it did not consider that the loss suffered by the claimant was caused by the negligent advice. The claimant's losses had been triggered by unprecedented turmoil in the financial markets following the collapse of Lehman Brothers; the run on the investments and collapse of the secondary market for the fund's assets. The Court held that what happened was wholly outside the contemplation of the defendant or any competent financial adviser in September 2005. The loss was not reasonably foreseeable, and was too remote in law to be recoverable as damages for breach of contract or in tort.

The Court of Appeal's Decision

Both sides appealed the original decision. It was accepted by the defendant by the time of the judgment that it had given advice and that the claimant had relied on it.

Rix LJ gave the Court's judgment.

The Defendant's Negligence

The Court of Appeal agreed with the first instance court that the defendant had been negligent in advising the claimant. Some of the key points relevant to the finding were:

  • The claimant had made it clear to the defendant that he wished to invest his money in a product with no risk to the underlying capital, and had not rejected the concept of a deposit account
  • The individual at the defendant bank did not explain to the claimant and did not even understand for himself that the EVRF was not akin to a cash deposit but involved the investor taking the risk of market movements
  • The presumption was that the claimant would not have proceeded with the investment if he had properly understood the EVRF. Indeed if the individual adviser at the defendant had properly understood the EVRF himself, and that he was advising the claimant and not acting as an execution only conduit and that the rules in COB applied, it seems unlikely it would have even been recommended in the first place
  • Arguments that the investment was appropriate because there was no-risk over the short timescale that it was required (of one year) were rejected. The claimant was not looking for a product subject to market-risk that could be discounted as a matter of judgment on a short-term basis and in any event the claimant had clearly required the investment for an indefinite basis: i.e. until he found a new home
  • There had been an alternative AIG fund, the SRVF, which had clearly been a much more suitable investment

The Foreseeability of the Loss

The Court of Appeal disagreed with the first instance court's findings that the losses sustained by the claimant by investing in the EVRF fund had not been foreseeable and were therefore irrecoverable from the defendant.

The Court held that the scope of the defendant's duty was to be considered by reference to the statutory regime and the purpose of COB, pursuant to FSMA, is to afford protection to the private person. The defendant had failed to undertake standard statutory procedures and misled the claimant as to the nature of the investment, which was not a promising context in which to find the loss suffered as a result was too remote.

The Court found that although the collapse of Lehman Bros. may have been unforeseeable, the claimant had not invested in Lehman Brothers. A run on AIG may also have been unforeseeable but that did not cause the loss either, as the SVRF survived the apprehension about AIG's solvency and in any case such an event had been foreseen in AIG's brochure.

What had caused the loss was the sharp decline in the value of the securities attached to the EVRF which was forseeable. Rix LJ summarised

"...the underlying causes of the turmoil went infinitely beyond Lehman Brothers' difficulties. It stretched to a failure of confidence in marketable securities in which there had previously been greater confidence. And what is new about that?"

The Court of Appeal considered that the first instance judge had been wrong in selecting the run on AIG as the essential cause of the loss. The bank's duty was to protect the claimant from exposure to market forces, and it was wrong to say when the risk from exposure to market forces arose the bank was free of responsibility because the incidence of the loss was unexpected.

Rix LJ considered the greatest factor that might have caused the court to find the loss was unforeseeable was the one year timeframe specified by the claimant as the duration of the investment. The defendant's submission was that in the circumstances, a loss three years after the investment was beyond the scope of its duty of care. However, Rix LJ found that the claimant's goal of purchasing a new home as the end point for the investment was too undefined and uncertain to sustain this argument. This was even more the case given that the claimant had been advised his investment was the same as a cash deposit and thus carried no market risk meaning that timing was a factor. In essence, the Court found that the duty of the defendant could not be limited by a risk factor the claimant was not aware of at the time of investment.

Rix LJ found that whether the question of remoteness is what is in the reasonable contemplation of the parties, whether it is expressed in classical terms found in the leading authorities or it has to reflect an exercise in judgment referred to in SAAMCo, he would have reached the same conclusion.

Thus, the Court found that it wasforeseeable that the claimant, who believed he was investing in a cash deposit like financial product, would suffer loss as a result of investing in a financial product determinate on market securities. Rix LJ noted that this decision was in line with the findings of two decisions of the Financial Ombudsman Service on investments in the same product.

The Court of Appeal therefore held that the claimant was entitled to damages.


Given the level of losses that were undoubtedly sustained as a result of the financial crisis, it was inevitable that claimants would look to recover these losses from their professional advisers. Whether they can do so is currently a live issue in a number of cases and therefore the outcome of this decision, the first at Court of Appeal level, was awaited with interest.

It should be noted however, that the decision was highly fact-specific. The claimant had clearly expressed a desire to put his capital in a risk free or near risk free investment and was advised by an individual (who failed to understand the product himself or that he was even advising) that the particular investment chosen was virtually risk free. Additionally, the facts of the case indicate that a standard fund existed which would have eliminated the market risk which caused the loss to the claimant. Given that this presented a clear, suitable alternative to the advice given by the defendant's IFA, the Court of Appeal may have found the loss suffered more foreseeable as a result.

In other cases decided by the High Court the decisions have gone the other way. In Camarata Property Inc v Credit Suisse Securities (Europe) Ltd (2012) the Commercial Court dismissed a similar claim on the grounds the claimant suffered loss because of the collapse of Lehman Brothers and this was unforeseeable. In that case however, the claimant was advised to enter into a note issued by a Lehman Brothers' subsidiary which would have paid off if it were not for the issuer's default. Rix LJ in Rubenstein commented that the fact the loss was unforeseeable in Camarata stemmed from the fact that the investment in Camarata was a suitable product for the investor in terms of logic and risk and would have been successful but for the collapse of Lehman Brothers. Thus the loss turned wholly on the creditworthiness of Lehman Brothers and not the advice given. In Zaki v Credit Suisse (2011), another similar claim, the claimant lost on causation because he was held to have sufficient experience of investing such that the same notes in which he invested would have been bought even in the advice had been against investing in them. However, a judgment from the Court of Appeal is awaited in Zaki.

Clearly, whether or not negligent advice by a party selling financial products will be considered to cause a loss generated during a period of financial turmoil will be dependent on a number of factors including the exact advice given to the purchasing client, the sophistication of the client and the expressed risk tolerance of that client, as well most likely the remove in time that the advice was given before the financial crisis set in.

The Court of Appeal's decision leaves open the possibility that in other circumstances, professional defendants will be able to raise arguments that their duty did not extend to credit-crisis related losses, particularly where sophisticated investors are involved.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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