Contractual estoppel, misselling and COBS classification

Flaux J’s judgment also contains a useful analysis of the classification provisions of the FSA Conduct of Business Sourcebook (COBS). Client categorisation no longer requires “reasonable steps” to be taken in categorising a client as an intermediate customer (now an EPC). Instead, a client must satisfy a qualitative and quantitative test. Once that test has been satisfied, there is no longer a requirement under COBS for an annual review of the client’s categorisation.

Linda Wachner (Wachner) was a successful US businesswoman who since 2003 traded foreign exchange options with Bank Leumi (USA) (BLUSA) on an execution only basis. In 2005, Wachner set up another foreign exchange trading facility with Bank Leumi (UK) (BLUK), an affiliate of BLUSA, again on an execution only basis. Pursuant to the Financial Services Authority’s (FSA) Code of Business Rules (COB), BLUK classified her as an “intermediate customer” rather than a “private customer”, which meant Wachner could gain direct access to the dealers in BLUK’s dealing room.

Wachner signed BLUK’s terms of business (the BLUK Terms), the relevant terms were:

Clause 6.16 Suitability:

Unless BLUK enters into a specific agreement with you to do so, BLUK shall not owe you any duty to advise on the merits or suitability of any investment entered into or contemplated by you. You agree that you will rely on your own judgement for all trading decisions.

Clause 6.17 Advice:

Furthermore, any trading recommendation, market or other information communicated to you is incidental to the provision of services by BLUK under these Terms, and BLUK gives no representation, warranty or guarantee as to its accuracy or completeness or as to the taxation consequences of any investment.

In July 2007, Wachner agreed to a letter amending her original BLUSA facility (the Agency Agreement), so that she could trade her US facility during London hours through the dealing room at BLUK. The Agency Agreement stated: “… trading through BLUK for your account with us will be upon the same terms as if such trading were directly through us”. In March 2008, Wachner traded her first of many “reverse knock-in” options (RKIs) under the Agency Agreement.

During a period of unprecedented volatility in world markets Wachner’s suffered huge losses, which resulted in her owing €13.4 million to BLUK.

Proceedings were issued by BLUK to recover that sum, together with interest, on the grounds that under both the BLUK Terms and the terms of the June 2008 facility Wachner was liable to make good that loss. That claim was admitted, subject to Wachner’s counterclaim. The counterclaim alleged three causes of action: misrepresentation, breach of a duty of care, and breach of a statutory duty, all of which were dismissed by Flaux J.

Misrepresentation counterclaim estopped by the BLUK Terms

Wachner alleged that BLUK, through its traders Mr Leslie and Mr Gabb, had made a series of misrepresentations to her about the risks related to RKIs and how she would be allowed to trade them, and as a consequence, induced her to enter into the various options. Wachner claimed that, as a result, she was entitled to damages for misrepresentation under s2(1) of the Misrepresentation Act 1967.

Flaux J decided that, in the circumstances, Mr Leslie and Mr Gabb had not made any actionable misrepresentations to Wachner (in terms of there being no misrepresentation and/or reliance). Even if they had done so, clauses 6.16 and 6.17 of the BLUK Terms would have acted as an estoppel by contract to prevent Wachner from arguing that, in reliance on these representations, she had been induced by BLUK to enter into the particular transactions or types of transactions such as RKIs. Peekay Intermark Ltd v Australia and New Zealand Banking Group Ltd [2006] EWCA Civ 386 (Peekay) and JP Morgan Chase Bank v Springwell Navigation Corp [2010] EWCA Civ 1221 (Springwell) were applied.

Breach of duty of care counterclaim estopped by the BLUK Terms

Wachner alleged that in breach of a duty of care (arising out of a Hedley Byrne v Heller [1964] AC 465 / Henderson v Merrett Syndicates [1995] 2 AC 145 assumption of responsibility) owed to her by BLUK, BLUK had given her negligent advice about the RKI options.

Flaux J decided that, in the absence of any “specific agreement” to provide advice, as required under clause 6.16 of the BLUK Terms, Wachner’s counterclaim in negligence was excluded. On the evidence, Wachner could not establish that such an agreement had been made.

Considering Springwell, Flaux J added that even if such a duty was assumed, the level of advice provided by BLUK was at the lower end of the “spectrum” of advice, amounting to “trading floor” opinion, giving rise to a lower level duty of care which was insufficient to establish the breach of duty contended.

Damages for breach of statutory duty under s150 FSMA

Wachner’s third counterclaim was for damages for breach of statutory duty under s150 of the Financial Securities and Markets Act 2000 (FSMA 2000). In particular, Wachner alleged that BLUK had failed properly to categorise or classify her under the FSA’s COB Rules and its successor, the Conduct of Business Sourcebook (COBS) (which came into force on 1 November 2007). Wachner argued that she should not have been classified as an “intermediate customer” under COB 4.1.4R and 4.1.9R, and that, had she not been so classified, she would not have traded RKIs.

Initial classification of the client under the COB Rules

Flaux J decided that, on their proper construction, the COB Rules as to classification did not require BLUK to arrive at an objectively correct classification of a client, but only to have taken reasonable steps to arrive at the correct classification before transacting with the client. Even if, objectively, Wachner did not in fact have sufficient experience and understanding to be an intermediate customer, COB 4.1.4R and 4.1.9R would only have been breached if BLUK failed to take reasonable steps and reasonable care in classifying her as an intermediate customer. Wilson v MF Global UK Limited [2011] EWHC 138 (QB) and Spreadex Ltd v Sekhon [2008] EWHC 1136 (Ch); [2009] BCLC 102 were considered. Flaux J held that BLUK’s initial classification was not in breach of the COB Rules.

Reclassification of the client as an elective professional

Under COB 4.1.15R, there was a further requirement to conduct an annual review of the status of an intermediate customer. Flaux J concluded that with reference to the trades carried out under the Agency Agreement, the COB rules did not apply at all. In all these transactions, Wachner remained the client of BLUSA and, although the trades were agreed on behalf of BLUSA by its agents in London (BLUK), they were essentially US trades regulated by US federal laws and not by FSMA 2000.

The system of annual reviews is not repeated in COBS. Instead, COBS 3.5.9R provides that, if a firm becomes aware that a client no longer fulfils the initial categorisation criteria, then it must take “appropriate action”, including re-categorising the client where appropriate.

Rule 1.2 of the COBS transitional provisions (COBS TP) provided for a “grandfathering” procedure whereby a client who was correctly categorised as an intermediate customer prior to 1 November 2007 could automatically be re-categorised as an elective professional client (EPC) under COBS. Wachner was re-classified as an EPC and, on the facts, Flaux J decided there was nothing prior to 1 November 2007 which called into question the appropriateness of the initial classification. As to the allegation of a breach of a statutory duty to reclassify a client under COBS 3.5.9R, Flaux J said it would need to be established that BLUK “was aware” that Wachner no longer fulfilled the initial conditions on the basis of which she had been classified as an intermediate customer in 2005. It was not enough that BLUK “ought to have been aware” of that, had it exercised reasonable care. On the facts, BLUK was not aware of any need to alter the initial classification.

Contributory negligence

In assessing claims under s150 of FSMA, s1(1) of the Law Reform (Contributory Negligence) Act 1945 would apply to reduce the level of damages awarded. Flaux J concluded that, had Wachner been successful in claiming breach of a statutory duty as required under s150 FSMA, damages would have been reduced by 75% owing to her contributory negligence.

Comment: Following the decisions in Springwell and Peekay, the case reinforces the fact that a firm wishing to exclude liability for misrepresentation and breaches of duties owed to a client should ensure that its standard terms and conditions contain a well-drafted non-reliance clause and provisions which make it clear that it is acting in a non-advisory role only. These contractual safeguards can create a contractual estoppel against clients who claim that they were misled or received negligent advice. Again, the client in this case was relatively sophisticated and a court may find ways to reach a different conclusion where an unsophisticated client is introduced (for example, by the application of the Unfair Contract Terms Act 1977 to circumvent protective clauses), but the court’s overall approach was very helpful from a bank perspective.

The High Court’s decision also clarifies aspects of the application of the COB Rules and COBS. Under COBS, client categorisation no longer requires “reasonable steps” to be taken in categorising a client as an intermediate customer (now an EPC). Instead, a client must satisfy a qualitative and quantitative test. Once that test has been satisfied, there is no longer a requirement under COBS for an annual review of the client’s categorisation. The “grandfathering” procedure provided under COBS TP means that a client who is correctly classified as an intermediate customer under the COB Rules could qualify as an EPC under COBS without passing the qualitative and quantative tests and under COBS, unless a firm becomes actually aware of a need to change the classification (which is a higher threshold than if it merely ought to have been aware); the client will not benefit from the protections provided to somebody classified as a retail client.

One area of potential criticism of Flaux J’s decision relates to exclusion of the arrangements under the Agency Agreement from the UK regulatory regime as the definition of “client” under COBS 3.2.1 captures a person to whom a firm provides a service “in the course of” carrying on a regulated activity. Arguably Wachner did have a service provided to her by BLUK “in the course of” the regulated activity in question and therefore came within this definition of “client”.

This article first appeared on www.practicallaw.com.

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, Calum Burnett or tel +44 (0)20 3088 3710.