Who bears responsibility for losses arising out of market movements?
Last November, we reported on the High Court's decision in Rubenstein v HSBC [2011] EWHC 2304 which held that, even though HSBC had mis-sold an investment product to Mr Rubenstein, it was not liable for the subsequent losses he suffered, as these flowed from the collapse of the markets which were outside the scope of the adviser's duty (click here to view article). While the Court of Appeal has upheld the first instance judge's finding of negligence and breach of duty as against HSBC, it found that the losses suffered were precisely the type Mr Rubenstein wished to avoid and which HSBC were under a duty to protect him from. They were therefore not too remote and were in fact recoverable.
Background
The Claimant, Mr Rubenstein, a private individual and retail client, sought damages for breach of statutory duty, negligence and breach of contract from HSBC for alleged wrongful investment advice. In 2005, he had wished to invest the proceeds of the sale of his matrimonial house, £1.25 million, while he looked for a new property. He approached HSBC, telling a financial adviser employed by the Bank that he was seeking a better rate of return than advertised deposit rates, but with ready access as he planned to buy within a year. He made it clear in correspondence that he and his wife could not afford to accept any risk in the capital.
The adviser told Mr Rubenstein that an alternative to placing the money on deposit was to invest it in an insurance based bond with AIG Life, the AIG Premier Access Bond ("PAB"). He suggested investment in the Enhanced Variable Rate Fund ("EVRF") within the bond. On being questioned as to the risk involved, the financial adviser asserted that the investment had the same risk as cash deposited in one of HSBC's accounts (which, as determined by the judge at first instance, was not the case).
Mr Rubenstein subsequently invested in the EVRF in September 2005. He did not reinvest the money within a year. Instead, in the wake of the credit crisis which arose due to the impending collapse of Lehman Brothers in 2008, investors began withdrawing their money from AIG based on the rumour that it was going to go bankrupt. This clamour by investors forced AIG to suspend withdrawals from the EVRF for three months and, subsequently, to close the fund altogether. Mr Rubenstein chose to partake of AIG's "exit plan", and suffered a loss of approximately £180,000.
The decision – issues of remoteness
In his leading judgment, Lord Justice Rix agreed with the first instance judge's finding that HSBC was in breach of its statutory duty as set out in the FSA's Conduct of Business Rules ("COB"), for failures including the making of a recommendation without taking reasonable steps to ensure that Mr Rubenstein understood the nature of the risks involved (COB 5.4.3R). HSBC also breached various procedural requirements such as a failure to meet its obligations to “know your customer” (COB 5.2.5R). The Court of Appeal therefore upheld the decision that HSBC was liable for breach of contract and in tort.
The key issue to be determined was in relation to remoteness. The judge at first instance held that the losses flowed from the collapse of the markets and were therefore outside the scope of the adviser's duty. However, the Court of Appeal unanimously held that this analysis was incorrect. They held that what had caused Mr Rubenstein to suffer a loss was the very thing which he had wished to avoid: the risk of loss to his capital. There were two risks potentially involved: the first, the risk that the institution to which Mr Rubenstein entrusted his money would default (a risk to which he would also have been exposed if his monies were in a deposit account, and which he was therefore prepared to accept). The second was a risk that arose from market movements (a risk to which Mr Rubenstein had no idea he was exposed and to which he would not have been exposed had his monies been held in a deposit account). Mr Rubenstein was looking for a product which did not subject him to market risk.
The Court of Appeal agreed that the losses were caused by the unfavourable movements of markets in the assets held by the fund. Therefore, as it was the bank's duty to protect Mr Rubenstein from exposure to market forces (when he made clear he did not want to risk his capital), the losses fell within the scope of HSBC's duty.
Comment
The case turned on the fact that Mr Rubenstein did not want to be exposed to market risk at all (and the losses which flowed were therefore within the scope of HSBC's duty). It appears, therefore, that if private persons want full capital protection, then advisors need to be careful not to expose them to market risk.
However, what about the situation where an investor is willing to take market risk? Will an adviser be found to be liable for all losses flowing from a subsequent crash in financial markets of the type which occurred in 2008, if he negligently advised a client to invest, or will that be held to be unforeseeable and outside of the scope of the adviser's duty? There is no definitive guidance to be gleaned from this decision. However, Rix LJ made several interesting comments in this regard. For example, he stated that although losses caused by the financial crisis might have been unforeseeably high, that is the nature of markets at the time of stress, and in any event that merely represents an unforeseeable extent of loss of a kind of type which is foreseeable. And, as he pointed out, the underlying cause of the financial turmoil was a failure of confidence in marketable securities, "[a]nd what is new about that?". This, of course, leaves open the possibility that significant losses resulting from the financial crises could well be held to be foreseeable and that an investor who accepts any exposure to market risk may therefore not be able to look to an adviser in such circumstances.
Ultimately, the decision in Rubenstein turned on its own facts, and the losses which will fall within the scope of an adviser's duty will differ accordingly. However, the court's decision does appear to have been heavily influenced by the statutory purpose of the FSA's COB regime; namely, consumer protection. In this case, there had been a failure by HSBC to undertake the standard statutory procedures designed to protect consumers (such as the "know your client" regime). Whether a similar decision would be made where there are more sophisticated investors with comprehensive contractual frameworks in place, or express disclosures of market risk remains to be seen.
A further point which was discussed in the judgment was whether the losses were within the scope of the bank's duty, as they arose three years after the investment was made, when at the time the advice was given, Mr Rubenstein had said that he intended to reinvest the funds within the next year. This was acknowledged by Rix LJ as a powerful submission; however, he rejected this point on the facts as Mr Rubenstein did not realise that he was exposed to market risk, and therefore had no reason to move the monies. However, one can see that if an adviser gives advice to a sophisticated customer on the basis of a short term investment, and the customer then elects to keep his funds invested for longer, the result might be different and the bank might not be liable for losses arising after the original short term period comes to an end.
It is also of interest that this decision follows the decision of the Financial Ombudsman Service in a similar case decided in February 2012¹ and the FSA's Final Notice of November 2011 which criticised Coutts & Co for failure to comply with COB rules in relation to its recommendations to different individuals in relation to the suitability of an Enhanced Variable Rate Fund (also describing it as a "cash product"). Both the FOS and FSA found that customers had been exposed to market risk due to the negligent advice, which had ultimately caused losses. The FOS and FSA decisions contradicted the judge's first instances findings in Rubenstein, and some measure of clarity has now been brought to this area thanks to the Court of Appeal's latest decision.
Lawyers Tim Strong, Stuart Broom
1) See our article on this case, "FOS departs from established law to hold that losses caused by the financial crisis do not break the chain of causation".
