German Federal Court of Justice Rules that Banks must disclose all Commissions received from Issuers

Federal Court of Justice, 3 June 2014, file No XI ZR 147/12

The Federal Court of Justice (Bundesgerichtshof, BGH) has ruled that, as from 1 August 2014, banks giving investment advice must disclose all commissions they receive from issuers – no matter which source they are paid out of, and what type of investment is concerned. For advice given prior to 1 August 2014, however, the BGH has ruled that banks cannot be held liable for failing to disclose "hidden" commissions of less than 15% of the investment value. This has long been an area of legal uncertainty, thus entitling banks, in the BGH's view, to counter any claims relating to advice given before 1 August 2014 with a defence of "unavoidable error of law".

The claimant in this case had, on investment advice from the defendant bank, in 1996 bought real estate from a company. The company intended to develop the site, with a shopping centre, and provided a rent guarantee to the claimant. The bank had received a commission from the seller's shareholders for brokering the sale of the real estate. The seller later fell insolvent, and the claimant sued the bank for damages on the basis of misselling/incomplete advice. The BGH left open whether the bank was actually obliged to disclose the commission, basing its decision on other considerations instead.

Uncertainty concerning disclosure of "hidden" commissions

Banks giving investment advice to clients in Germany have been facing an ever increasing range of BGH case law on whether distribution fees or commissions, received from issuers of investments, must be disclosed, and if so, how. ¹ Many prospectuses contain a statement that fees and/or commissions will be payable, but do not state to whom these are paid. There has been a concern by the courts that clients do not appreciate that their bank (from whom they have been receiving advice) receives some or all of these commission payments. Previous BGH case law has ruled that, if an issuer pays a commission which has been disclosed in a prospectus, a bank must nevertheless inform its client if it is due to receive part or all of the commission (commonly referred to as a "refund"), as this would, according to the BGH, place a bank in a conflict of interest.

However, much uncertainty remains concerning, inter alia, the treatment of distribution fees that have not been disclosed in a prospectus, but are paid out of the amount invested. These are known as "hidden" or "internal" commissions and have been the subject of extensive debate for many years. Previous BGH case law has ruled that if a hidden commission, payable by the issuer, is 15% or more of the total amount invested, its amount has to be disclosed by an adviser to its client, as this would significantly affect a client's perception of the investment's value. If a commission is less than 15%, an adviser must tell the client about it only if the prospectus mentions an amount but this is incorrect – then the actual percentage must be disclosed.

However, the conflict of interest concerns for the refunds of commissions to banks arguably also applied to "internal" commissions of less than 15%, and this left banks unsure as to whether they should also disclose if they receive such "internal" commissions from the issuers. Legal scholars and lower courts had differing views. The BGH has now ended this debate, with an answer that depends on whether the advice was given before or after 1 August 2014. The new decision does not change any of the previous case law² on banks' disclosure obligations in this context, eg on refunds.

Advice provided by banks prior to 1 August 2014

Advice by banks on or after 1 August 2014

Alternatively, if the investment advice is not fee-based, banks must disclose whether they are entitled to receive and keep benefits from third parties in connection with the investment advice, and thus disclose such benefits.
The BGH noted a comprehensive transparency principle guiding banks' regulatory obligations to disclose commissions, and chose to apply this to a bank's contractual obligations too. Relying on the argument that clients can expect banks to comply with their regulatory obligations, the BGH concluded that banks also have a direct contractual obligation towards their clients to disclose all commissions. The BGH emphasised that this rule applies whether or not the type of investment is covered by the new regulatory law.

Comment

The BGH's ruling on banks' disclosure obligations prior to 1 August 2014 is welcomed by banks, as it has been an uncertain risk area for years. Now it is clear that a bank cannot be held liable if it did not disclose, prior to 1 August 2014, internal commissions under 15%.

The ruling for the period from 1 August 2014 is very wide-ranging. The BGH requires banks to disclose every commission or distribution fee they receive, and holds them directly liable to their customers for damages if they don't. Though this is an obiter statement in the present case, it formulates the principles courts are likely to apply in the future. Furthermore, it is the first time the court has based the existence (not just the extent) of a contractual disclosure obligation on regulatory rules. Under the new regulatory regime, banks will already have to follow extensive disclosure obligations. Under the new BGH ruling they now also face a corresponding contractual liability.

Footnotes

_{¹ See German Federal Court of Justice (FCJ), 29 June 2010, file No XI ZR 308/09, expanding banks’ duty of care on disclosing refunds (EFLR November 2010) FCJ, 09/03/11 and 19/07/11, file No XI ZR 191/10, on the distinction between refunds and undisclosed commissions (EFLR September 2011); FCJ, 8 May 2012, file No XI ZR 262/10, on the burden of proof for causation (EFLR December 2012); FCJ, 14 January 2014, file No XI ZR 355/12, holding a waiver clause for distribution fees valid as long as the bank complies with its regulatory disclosure obligations (EFLR June 2014).}

_{² See footnote 1.
³ Section 31 paragraphs 4b and 4c no. 2 Securities Trading Act (Wertpapierhandelsgesetz, WpHG).}