English High Court Finds Conduct of Business Failings at Credit Suisse
Judgment has been given by the High Court in London in a claim by a high net worth individual over losses of $69.4 million incurred on 10 structured financial products bought from Credit Suisse (UK) Limited (CSUK). The decision of Mr Justice Teare is of interest as it concerns issues such as the nature of a personal recommendation, the Financial Services Authority’s (FSA) suitability rule for investment advice and causation in the context of breach of statutory duty.
Nature of Relationship
The claim was brought by the family and estate of the late Mohammed Magdy Zeid, a successful and wealthy Egyptian businessman.1Originating in the oil industry and diversifying into a wide range of international businesses, the family’s net worth would have been at least $600 million. While the structured products in question were sold between 2007 and 2008, Zeid’s purchases dated back to 2003 and were made through a relation manager, Mahmoud Zaki, with whom he and their wives had become friends.2
Zaki and Zeid would discuss investments either at the latter’s London home, often followed by dinner, and or by telephone. Zaki would dictate a note of their meeting and this would be entered on CSUK’s Private Client Relationship Management system (PCRM) by his assistants. For each transaction Zaki would sign a “Transaction Suitability Form,” which allowed review and approval by senior management.
The structured products were a form of bespoke “yield enhancement product” providing the holder with a periodic coupon payment at rates substantially in excess of what could be earned from monies on deposit. They were also known as “worst-of-barrier reverse convertible securities” because they were linked to one or more market indices and the return was based on the worst performer. On maturity, if the indices remained above their starting level and had not been bought back, the entirety of the capital was returned to the holder. If, on the other hand, one of more “barriers” were breached then there could be a significant loss of capital and income.
To add to their risk profile these products were highly leveraged. Credit Suisse in Geneva provided Zeid and his family with loans of up to 80 percent of their cost which were secured on the products.
With the advent of the financial crisis and the fall of many market indices, a number of the barriers on 10 of Zeid’s structured products were breached. Furthermore, Credit Suisse in Geneva reduced the loan to value ratio to 60 percent. A call for margin for $31 million was made on 30 October 2008, which having gone unanswered, led the bank to liquidate the products the following day at a loss of $69.4 million to Zeid and his family. According to the PCRM, despite Zeid receiving warnings, he did not have sufficient cash available to meet this call. Rather, he blamed CSUK for “proposing investments knowing that the market will collapse.”
The claimants argued, and CSUK denied, that Zeid and his family had invested on reliance of personal recommendations that were not suitable as required by the FSA’s Conduct of Business Rules (COBS). On this basis, CSUK was liable for damages under section 150 of the Financial Services and Markets Act 2000 for breach of statutory duty.3
The Court first considered whether Zaki had made personal recommendations (i.e., provided advice on the merits). With reference to the FSA’s Perimeter Guidance manual (PERG) at PERG 2.7.15 and the decision of the High Court in Bank Leuimi (UK) v Wachner,4 Teare J distinguished advice on the merits from merely providing information. Furthermore, advice was said to require an element of opinion. While in evidence Zaki did not expressly concede having given advice, he did accept that the account was an advisory one and most products would be purchased on his advice. Moreover, as it was his function to sell products, for which he received commission, Teare J considered it:
unrealistic to suppose that he did not at least from time to time, cross from the territory of information into the territory of recommendation or advice, at least in the sense of either pointing out that a product was advantageous . . . or in agreeing with such an observation by Mr Zeid.5
In any event, if there were any doubt, Zaki had completed the Transaction Suitability Form for seven of the 10 transactions on the basis they were non-execution only and were suitable. CSUK’s argument that Zaki had to be satisfied over suitability as a matter of internal procedure irrespective of whether advice was given was unsuccessful.
Having concluded that the transactions arose as result of personal recommendations, it fell on CSUK to take reasonable steps to ensure that its advice was suitable for Zeid and his family. The judge adopted the practical approach that while the family as a whole were clients as they had left matters entirely in Zeid’s hands they could not now argue that suitability should be viewed distinctly as regards themselves.6 The regulatory duty under COBS 9.2.1 R required CSUK to have sufficient information of their client’s 1) knowledge and experience of these investments, 2) financial situation, and 3) investment objectives. Teare J found that the bank’s approach to obtaining and recording client information “lacked the rigour and care” required by the rules. However, while this might show a breach of the duty to take reasonable steps it did not per se prove that the recommendations were unsuitable.
Zaki was found to have likely understood the design of the structured products and their associated risks. As to his financial position, aside from the issue of liquidity, the loss amounted to no more than 10 percent of the family’s wealth. The key area of dispute turned on his investment objectives. Teare J considered that an analysis of his investments since 2003, together with his use of leverage, revealed a desire on Zeid’s part to achieve high returns without risk to capital but that he was prepared to do so if necessary.7 On this basis, the Court held that the recommendations for the first seven structured products were suitable.
There were, nonetheless, degrees of risk. In respect of leverage, there was guidance at COBS 9.3.4 to the effect that in respect of linked loans the bank should have, when considering the suitability of its recommendations, taken account of the suitability of the overall transaction. While the first seven transactions were considered suitable despite their high leverage, the market volatility of 2008 and the absence of any diversity within these investments persuaded the Court that for the remainder the line had been crossed.
Although Teare J found that CSUK was in breach of its statutory duty, given its contravention of COBS 9.2.1 R, it remained necessary for the claimants to establish causation. Would Zeid have acted differently in the absence of Zaki’s advice? In this regard, the judge accepted Zaki’s description of Zeid, in evidence, as “very formidable, he would like to get his own way.” The judge concluded that he would have made his investment decisions based on his own views of the market and would not have relied on Zaki’s advice.
Despite the bank’s failings and lack of rigour in complying with the relevant regulatory requirements, the Court refused to accept that Zeid, as a successful and wealthy businessman, would in fact have followed anything other than his own views. The claim therefore failed not only on the first seven, but all 10 transactions.
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