Landmark decision of the DIFC Courts on mis-selling
On 21 August 2014, the DIFC Court of First Instance issued its long-awaited judgment in Al Khorafi & ors v Bank Sarasin-Alpen (ME) Ltd and Bank Sarasin & Co Ltd, CFI 026/2009 (the Judgment).
The case involved mis-selling claims by three members of a prominent Kuwaiti family against a Swiss bank and its joint venture company in the Dubai International Financial Centre (the DIFC).
The Judgment has attracted a lot of attention from financial service providers in the Middle East as it demonstrates the serious implications of regulatory breaches in the DIFC and provides an example of how international financial service providers may come within the scope of the regulatory framework of the Dubai Financial Services Authority (the DFSA). The Judgment also has the potential to become a reference point for future mis-selling claims in the wider Middle East.
The Judgment was given by one of the most senior judges of the DIFC Courts, Deputy Chief Justice Sir John Chadwick, and held that Bank Sarasin & Co. Ltd (Bank Sarasin), a Swiss bank, and its joint venture company in the DIFC, Bank Sarasin-Alpen (ME) Ltd (Sarasin-Alpen), had mis-sold USD200 million of structured financial products to the three Kuwaiti investors.
The judge rejected an argument that losses sustained were simply the result of a market downturn:
"I am satisfied that the present is a clear case of mis-selling unsuitable investments to an unsophisticated investor, and to his equally unsophisticated wife and mother."
Bank Sarasin was not authorised to provide financial services in the DIFC, but it held a 60% shareholding in Sarasin-Alpen, which is licensed and regulated by the DFSA to carry out certain financial services in and from the DIFC.
Bank Sarasin adopted a business model whereby Sarasin-Alpen would market Bank Sarasin's financial products and act as agent for Bank Sarasin to complete account opening procedures. Bank Sarasin would serve the customers who were introduced by Sarasin-Alpen.
The Judge considered the detail of how the Bank Sarasin and Sarasin-Alpen business model operated in practice and held that:
(a) the structured financial products had been mis-sold to the investors because Sarasin-Alpen had failed to carry out sufficient investigations to satisfy itself that the investors met the necessary client classification criteria for acceptance as a client under the DFSA Conduct of Business Rules. In particular:
- Sarasin-Alpen had failed to take necessary steps to determine whether the investors had the threshold sum of liquid assets and sufficient financial experience and understanding to participate in financial markets; and
- Sarasin-Alpen had failed to consider whether the structured financial products were suitable for the investors; and
(b) Bank Sarasin had, by its own conduct and through the conduct of employees of Sarasin-Alpen, carried out financial services in or from the DIFC without DFSA authorisation and, therefore, in breach of the DIFC Regulatory Law.
The result of the Judgment is that both Sarasin-Alpen and Bank Sarasin are liable to compensate the investors for their losses.
The findings in the Judgment against Sarasin-Alpen are based on failures by Sarasin-Alpen to comply properly and in substance with DFSA Conduct of Business Rules and its own client due-diligence and on-boarding procedures. The Judgment is therefore an illustration of how important it is for financial service providers in the DIFC to be familiar with the scope and detail of the DFSA regulatory framework in the course of their day-to-day operations.
In recent years, the DIFC has seen the transformation from a strictly wholesale regime to a regime that also allows retail clients, while placing more emphasis on retail protection. In addition, the DFSA has taken public action against firms that have not (properly) on-boarded/classified their clients. Against that background, and based on the facts set out in the Judgment, the findings against Sarasin-Alpen are not surprising.
The facts considered in the Judgment with respect to Bank Sarasin will be of interest to international financial service providers with connections to the DIFC as an example of how it is possible to come within the scope of the DFSA regulatory framework (ie as an unlicensed financial services provider) with disastrous results. The following extract from the Judgment contains the key finding of fact against Bank Sarasin:
"I hold that, whatever may have been the intentions of those responsible for setting up the joint venture through Sarasin-Alpen, the evidence before the Court leads to the conclusion that, in practice, Bank Sarasin dealt with the Claimants through Mr Blonde as its own Client Relationship Manager. It was immaterial that Mr Blonde was employed by Sarasin-Alpen; his role, vis a vis Bank Sarasin, was indistinguishable from what it would have been if he had been employed by Bank Sarasin. That conclusion, as it seems to me, makes it impossible for Bank Sarasin to maintain that, in its dealing with the Claimants, it was not carrying on activities which constituted a Financial Service in or from the DIFC; and impossible for it to maintain that it was not doing so in breach of the Financial Service Prohibition."
We anticipate that the Judgment will lead financial service providers to conduct a detailed review of the structure of their business models in relation to the DIFC and how those business models operate in practice. Such reviews will likely involve a review of the attribution of specific client business to DIFC entities and entities outside the DIFC, as well as a review of client on-boarding processes in the DIFC.