German Federal Supreme Court Rules on Mis-Selling Claim Against Direct Bank Providing Execution-Only Services
June 2013
On 19 March 2013, under file No XI ZR 431/11, the German Federal Supreme Court clarified the circumstances in which an investor may have a misselling claim against a “direct bank” (ie a bank holding an account for the deposit of securities on an execution-only basis only).
No implied advisory agreement generally exists between an investor and a direct bank. Incorrect advice by an independent adviser instructed by an investor cannot be attributed to a direct bank. Only the financial institution which has the closest relationship to an investor has a duty to enquire as to investment experience. A direct bank may, however, be liable if it is aware or should have been aware that an investor is receiving negligent advice. The burden of proof is on an investor to show this knowledge.
The claimant investor (investor) sought damages from the defendant direct bank (bank) for loss-making investments in various securities. The claimant had opened a securities deposit account at the bank with the help of a securities trading firm (firm), the latter having the claimant’s authority to represent her in all dealings with the bank. An account for the investor for call money, offering an interest rate above the market rate, was linked to the deposit account. The bank and the firm agreed that the bank would pay the market rate of interest with the firm topping it up with a supplemental interest payment. The account terms stated that the bank only fulfilled the claimant’s orders and did not offer any advice. The authority document provided that the claimant’s only point of contact with the bank was via the firm who would also provide advisory services.
The investor suffered losses because the securities lost value. The investor claimed against the bank alleging breach of an advisory agreement and the account agreement. The appeal court had dismissed the claim. The Federal Supreme referred the case back to the appeal court to determine further facts.
No advisory agreement
The Federal Supreme Court confirmed that there was no advisory agreement between the claimant and the bank. Although such an agreement can be implied as soon as an investor asks a bank for investment advice or such advice is given, in this case the bank had not given any advice. On the contrary, it had expressly only offered execution-only services.
No attribution of liability from firm to the bank
Any incorrect advice by the firm could not be attributed to the direct bank. The court dismissed the claimant’s argument that the services provided by the bank and the firm were effectively one service provided by both institutions in cooperation. The court pointed out that the documentation stated the contrary: the firm provided advisory services, the bank only fulfilled orders to buy or sell securities, and the firm was not a representative of the bank.
Possible breach of the account agreement if the bank has sufficient knowledge
The court found, however, that a breach of duty by the bank arising from the account agreement could not entirely be excluded. The claimant had asserted that the firm had systematically and wilfully given incorrect advice to investors, by first attracting them with high interest call money accounts and then offering investments which were incompatible with their aims and only profitable for the firm. The claimant had contended, offering witness evidence, that the bank knew this.
The court stated that a direct bank is normally not obliged to supervise a financial services provider who has direct contact with an investor. If several providers of financial services are engaged in a graded way, only the institution closest to the investor has a duty to enquire as to an investor’s experience, knowledge, aims of investment and financial situation. The bank may rely on this service provider having provided advice according to legal requirements. However, a direct bank may have, as a secondary obligation under the account agreement, a duty to warn a customer. This is the case if a bank is aware of actual incorrect advice being provided or ought to have known this.
In order to establish liability against the bank, an investor must prove that the direct bank knew, or ought to have known, about an actual advisory error. The court refused to apply the rebuttable presumption of the bank’s knowledge of wilful deceit which has previously been applied in cases of “institutionalised cooperation” with an issuer or agent. The Supreme Court stated that this only applies to banks which finance an investor’s acquisition, whereas in this case the investor was buying shares with her own funds.
However, the Federal Supreme Court asked the appeal court to question a specific witness about the bank’ s knowledge of the firm’s conduct. The court did not find the claimant’s assertions speculative as she had shown sufficient factors which, overall, indicated that the bank may have had the requisite knowledge. The witness was both an authorised officer (Prokurist) of the bank as well as a member of the supervisory board of the firm. Further, a report issued by a leading accounting firm relating to the time of the witness’ employment, stated that none of the examined contractual relationships with customers of the firm had been correctly processed. The firm had also often offered to investors securities issued by its affiliate companies.
Comment
A bank providing execution-only services expressly offers no advice to customers, therefore wishes to have no influence on a customer’s investment decisions, and consequently does not want to be liable for any loss resulting from such decisions. The Federal Supreme Court’s decision is supportive of this in typical cases. A direct bank may be liable only in exceptional situations where it knew or ought to have known that a customer’s fund manager was systematically acting against the customer’s interest. For such a claim to be successful the claimant customer must be able to show sufficient evidence of the bank’s knowledge or circumstances that should have given rise to suspicion.
The court’s statement that the case law on “institutionalised cooperation” does not apply in these cases is also useful. The court had developed this in cases where an investor had bought real estate, financed by a bank, and sought to rescind the loan agreement. The rescission had failed as the provisions on linked transactions under consumer credit rules did not apply to acquisitions of real estate. To help investors in these cases, the Federal Supreme Court had developed a rebuttable presumption that the bank knew about a wilful deceit of the customer by an issuer or agent about an investment. This presumption was based on an intense cooperation between the bank and the issuer or agent. Investors have tried to rely on this presumption in other misselling cases as well. The Federal Supreme Court has now confirmed that they cannot utilise this presumption in claims against a bank providing execution-only services where another firm provides investment advice.
Further information
This case summary is part of the Allen & Overy Litigation Review, a monthly update on interesting new cases and legislation in commercial dispute resolution. For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 (0)20 3088 3710.