"Investment Advisor' Legal Duties and Regulatory Obligations in
Selling Investment Products"
INTRODUCTION
After the Lehman incident, the regulatory regime in Hong Kong has been undergoing
substantial changes toward "over regulated" while the investment sentiment remain
weak. The HKMA and SFC after the extensive research have issued some very
restrictive (unreasonable to some extent) "recommendations" in Jan 2009 to the bank
and brokers to follow without any consultation, while in Singapore, MAS have taken
a more sensible approach. All in all, there is an increased customer awareness of
banker duty of investment advice, strict obligations from the regulators and upcoming
litigation cases on mis-selling on Mini-bonds are shaping the new landscape of the
selling of investment products in this Asian Financial Centre.
In this paper, I will review common law duties of investment advisor including the
recent leading mis-selling cases of JP Morgan Chase Bank v Springwell Navigation
Corporation and Field v Barbar Asia Ltd. I will compare the regulatory framework of
Hong Kong with e.g. UK' FSA, EU' MiFID and Basel Committee' international
standard and the various regulatory obligations of investment advisor in selling of
investment product to retail customers. I will also evaluate the recommendations
issued, after the Lehman Minibonds incident, by SFC and HKMA and compare them
with other jurisdictions like Singapore MAS. Last but not least, I will analyze as to
why it is felt that current laws and regulations are insufficient to protect the consumer
(is it a question of enforcement or supervision?) and to outline the new regulatory
landscape post Lehman incident.
DUTY AND STANDARD OF CARE – AN OVERVIEW
The duties and standards of care to which investment advisor are accountable depend
largely on the legal nature of the relationship with the client. They could be:
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Fiduciary obligations pursuant to the statutory requirement (e.g. Investment
Advisers Act in US) or specific contractual relationship (e.g. the one typically
found in Discretionary Management Services)
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Contractual duties which take into account of the nature of services (range from
“Execution Only” Broker service to a fee-based Advisory Management Service)
and the terms and conditions stipulated in the client agreement
Tortious duties to act with reasonable skill and care as the circumstance required
(in the absence of express or implied contractual duties and usually articulated as
a negligence action)
Codes and guidelines issued by the financial regulators or self-regulated bodies
for the standards of conduct required (e.g. HK SFC’ Code of Conduct, US’
Investment Adviser Association’ Standard of Practice)
Fiduciary Relationship
In some jurisdictions like US, investment adviser, pursuant to Investment Advisers
Act, owe a fiduciary duty to their clients. As such, an investment adviser stands in a
special relationship of trust and confidence with its clients. As a fiduciary, an
investment adviser has an affirmative duty of care, loyalty, honesty, and good faith to
act in the best interests of its clients. The parameters of an investment adviser’s
fiduciary duty depend on the scope of the advisory relationship and generally include
the following duties:
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to have a reasonable basis for its investment advice;
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to make investment decisions consistent with any mutually agreed upon client
objectives, strategies, policies, guidelines, and restrictions; and
to make full and fair disclosure to clients of all material facts about the advisory
relationship, particularly regarding conflicts of interest1;
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In relation to the selling of investment products, if there is no such law or status,
fiduciary duty is usually established on the facts of each case. In these circumstances
the plaintiff must prove the defendant is a fiduciary for the purposes of the
relationship. There is significant evidence to suggest that investment advisers would
be held to be in a fiduciary relationship with clients, in the provision of financial
advice to clients2
Contractual Relationship
For fee-based Advisory Management Services (which is not common in Hong Kong
“What is Investment Adviser”, Investment Adviser Association , see
http://www.investmentadviser.org/eweb/dynamicpage.aspx?webcode=WhatisIA#
2
See June Smith “ A Duty of Care” Argyle Partnership Lawyers, Newsletter June 2007
1
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either in retail or private banks), specific terms and conditions in the client agreement
should clearly spell out the scope of services investment adviser are provided and the
additional fees which the advisory firm or bank levies in return for the advisory
service. However, most banks in Hong Kong do not offer fee-based advisory
services to their clients, rather they provide access to or introduce clients to
investment products which are available in the market i.e. act as a salesman or
distributor of SFC-authorized investment products. The agreements generally make it
clear that it is for the client to make its own investment decision and that the bank
does not accept any responsibility for suitability. Similar contractual relationship also
found in the broker industry. As a broker's agency function is to execute orders given
to him, he is under no duty to give advice to his client, but if he does give advice a
cause of action in tort may arise if that advice is given negligently3.
Tortious Duty of Care and Regulatory Obligations
Even in the absence of express or implied contractual duties to advise a client on its
investments, investment advisers owe clients a duty of care in tort to act with
reasonable skill and care in situations where advice is provided. Also, investment
advisers, as licensed persons, must comply with the Code of Conduct for Persons
Licensed by or Registered with the Securities and Futures Commission (“Code of
Conduct”) as well as related guidance notes and circulars. Breach of the Code of
Conduct would not in and of itself found a civil claim for damages by an affected
investor, although it could result in regulatory sanctions (including the imposition of
fines, and/or suspension or revocation of licenses). The remaining sections of this
paper deal comprehensively with these duties and obligations.
TORTIOUS DUTY OF CARE
Recognition of Liability for Negligent Statement
The tort of negligent misstatement, spoken or written, imposing liability for causing a
pure economic loss4 was firstly recognized in English leading case of Hedley Byrne
& Co Ltd v Heller & Partners Ltd5. Before that the traditional position in negligence
law was that no duty of care is owned for such losses, even where the loss is
3
Investors Compensation Scheme Ltd v West Bromwich Building Society ( No 2 ) [1999] Lloyd's Rep PN 496
Pure economic loss means a purely financial loss, independent from and not consequent upon any
physical damage to the claimant or the claimant’ property
5
[1963] 2 All ER 575
4
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reasonably foreseeable. The reason for denying claims for losses caused by negligent
statements was plainly stated by Bowen LJ in Le Lievre v Gould6 “The law of
England does not consider that what a man writes on paper is, like a gun or other
dangerous instrument.” It was decided in that case, the defendant owned no duty to
make a careless statement7. Similarly, in Derry v Peek8, the House of Lords refused to
impose liability for a negligent statement for a policy reason of potential flood of
claim. Prior to Hedley Byrne, in order claim damages in tort, the plaintiff had to prove
fraud on the part of the defendant.
Hedley Byrne Principle
In Hedley Byrne, the House of Lords for the first time laid down that a negligent
statement, though honest, misrepresentation, spoken or written, may give rise to an
action for damages for financial loss caused by, apart from any contract or fiduciary
relationship. A duty of care will be implied when a party seeking information from a
party possessed of a special skill or knowledge trusts him to exercise due care and that
party knew or ought to have known that reliance was being placed on his skill and
judgment.
The plaintiff, Hedley Byrne & Co Ltd, an advertising agent was, doubtful of the
financial position of its customer, Easipower Ltd and asked its banker to obtain a bank
reference from Easipower’ banker, Heller & Partners Ltd, the defendant. The
defendant, over the phone, told plaintiff’ bank that Easipower believed to be
respectably constituted and considered good for its normal business engagements that
the company would not undertake any commitments they are unable to fulfill. A
further written inquiry made to the defendant asking for the financial structure, the
status of Easipower and their advice whether the company was trustworthy, in the way
of business, to the extent of ￡100,000 per annum advertising contract. The
defendant replied in a letter headed “CONFIDENTIAL: For your private use and
without responsibility on the part of this bank or its officials”, the letter continued:
“Dear Sir, in reply to your inquiring letter 7th instant, we beg to advice: Re Easipower
Ltd. Respectably constituted company, considered good for its ordinary business
engagements. Your figures are larger than we accustomed to see.” The plaintiff relied
on these statements and as a result they lost ￡17,661 when Easipower went into
6
[1893] 1 QB 491
A certificate negligently prepared by an architect showing satisfactory progress of the building at
different stages of construction. There is not contractual relationship between the claimant and
defendant architect
8
(1889) 14 App Cas 337
7
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liquidation. The plaintiff claimed the loss as damages from the defendant on the
ground that their advice was given negligently and in breach of defendant’ duty to
exercise care in giving it. The House of Lords decided there was a duty of not to make
negligent statement in the circumstances of the case but the defendant was not held
liable because the advice was given under a clear disclaimers of liability. Derived
from the principles in Hedley Byrne, a duty of care arises in the following
circumstances9:
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a special relationship exists between the plaintiff and the defendant of which “the
party seeking information or advice was trusting the other to exercise such a
degree of care as the circumstances required”10;
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the reason one party trusting the other is because the other party possess a special
skill or knowledge;
when giving advice the knowledgeable party know or ought to have known the
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other party is relying on him;
the knowledgeable party voluntarily assumed the responsibility for his advice i.e.
there is no contractual obligation for him to do so;
the advice is given negligently by the knowledgeable party; and
the advice receiving party act in reliance on the advice and suffered a financial
loss as a result
The Hedley Byrne duty of care principle was reconfirmed subsequently by Privy
Council in Mutual Life and Citizens Assurance Co Ltd v Evatt11 which expanded the
scope of such duty to the professional advisors and to those who held themselves out
as possessing professional skills. The duty of care of not giving negligent advice or
information by the professionals including investment advisors was since then firmly
established in the common law jurisdiction. We should now look at how the Court
determining whether an investment advisor has exercised his duty of care duly and
what standard of care required by the investment advisor.
Standard of Care in Advising
9
See also DK Srivastava, The Law of Tort in Hong Kong, 2nd Edition 2005, Lexis Nexis Butterworths
p252
10
See Lord Reid at p486 in Hedley Byrne & Co Ltd v Heller & Partners Ltd [1963] 2 All ER 575
11
[1971] 1 All ER 150
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Lord Bridge in the classic negligent case of Caparo Industries PLC v Dickman12 said
that
“In advising the client who employs him, a professional man owes a duty to exercise
that standard of skill and care appropriate to his professional status and will be liable
in contract and in tort for all losses which his client may suffer by reason of any
breach of that duty”
An appropriateness test, with reference to members of that profession and the
professional status of that particular individual is used by the Court to determine the
required standard of skill and care in each particular case. If such standards or
industry practice are too low to provide the necessary protection for the plaintiff client,
the Court will critically assess whether or not the current practice of that profession is
sufficient to negate liability for negligence and decide the standard of care which the
Court considers the members of the profession ought to achieve13. A leading case
from Hong Kong and another recent one from UK illustrate how the Court determine
the standard of care required by the investment advisors under two different scenario,
namely, for the inexperienced investors and for the sophisticated investors.
Field v Barber Asia Ltd
This an interesting case that no action had been taken by Securities Futures
Commission against the defendant, a SFC-licensed independent investment advisor
Mr. Andrew Barber (Barber) of Barber Asia Ltd (BAL), when the complaint was
initially brought to them by the plaintiff in Oct 1999. The defendant, believing that
having followed all relevant regulatory requirements and code of practices and with
the risk disclosure statement properly signed by the plaintiff owed no further duties to
the plaintiff, appealed twice to the Court of Appeal. The first one was against the
Court of First Instance’ decision that negligent advice had been provided causing the
financial loss of the plaintiff and the second one was against the Securities and
Futures Appeals Tribunal (SFAT)’ decision for his license suspension. The suspension
sanction was decided upon the Court of Appeal’ decision that the negligent advice
Barber had been given to his client which called into question his fitness and
properness as a licensed person. It is also admitted by the SFAT in their
12
[1990] 1 All ER 568 575
See also Ian De Witt “Responsibilities Beyond Regulations: Mis-selling: Civil Liability for
Negligence and for giving Negligent Advice”, Hong Kong Confederation of Insurance Brokers Annual
Conference 2008
13
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Determination14 that “this case is somewhat out of ordinary in that action of the SFC
has been taken upon the basis of that which happened in the civil courts of Hong
Kong, and absent independent investigation on part of the SFC.”15 Nevertheless,
Field v Barber Asia Ltd is the Hong Kong leading case related to the standard of duty
expected from an investment advisor. It has the far reaching effect on the subsequent
regulatory formation of the standards of conduct of the suitability obligations16. To
determine whether the investment advisor has exercised the expected degree of care
as the circumstances required, it is necessary to look the circumstances i.e. detailed
facts and evidences presented in the case.
Background and Essential Facts
Ms Field, a single lady in her early 40s, was an expert in her own disciplines but did
not have much experience in investment. Ms Field had accumulated HK$3 million
which she was aiming to invest in capital growth but conservative risk investments.
After friendship and trust formed with Mr. Barber, Ms Field invested USD300,000 in
a life assurance product offered by Old Mutual Hong Kong which consisted of
investment in a portfolio of conservative and relatively low risk overseas funds. Few
months later, in response to Ms Field desire for higher returns (Ms Field told Mr.
Barber she wanted to “make her money work harder” in order to return to UK earlier
than plan. This, to Mr Barber, means the Ms Field wished to move to a higher risk
strategy with a view to achieve higher returns), Mr. Barber introduced the emerging
South American stock market funds and recommended to Ms Field to switch her
underlying investments in Old Mutual Plan to narrow “sector funds” for potentially
higher returns. When he pointed out the volatility in these markets, Ms Field had
rejected these options and had asked for other alternatives to maximize her
investments. Mr. Barber then recommended an investment structure called the Loan
and Guarantee Scheme ('the Scheme') offered by N M Rothschild & Sons (C.I.) Ltd
('Rothschild'), a part of well-known investment house in UK. The Scheme was a
5-year loan gearing facility involved borrowing in Yen from Rothschild at a low
interest rate, converting the Yen into Sterling and investing those funds in
Sterling-denominated investments (e.g. a 100% capital protected fund) producing a
higher return. Both existing investment with Old Mutual and Sterling-denominated
investments were assigned to Rothschild as security for the loan. Resulting from
14
Andrew Nicholas Barber v SFC, the Securities and Futures Appeals Tribunal, Application no 12 of
2004
15
I bid, para 4
16
SFC issued “Questions and Answers on Suitability Obligations” on 8 May 2007 to fill up the gap of
lacking the expected standards of conduct stipulated in paragraph 5.2 of the Code of Conduct
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considerable appreciation of Yen, the Sterling equivalent of the loan had rapidly
increased in few months time. With the consequence that the value of the collateral
cover was short of the minimum cover required under the Scheme. It triggered the
margin calls of which Ms Field was unable to meet for the second time, forced the
liquidation of Sterling investment and resulted 3/4 loss of the original capital.
Court Decision and the Rationales
Applying the well-established Hedley Byrne principles, the Deputy High Court Judge
Barma SC concluded that Mr. Barber owed Ms Field a duty of care for the reasons17:
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There was the necessary voluntary assumption of responsibility by Barber Asia;
There can be no doubt that Barber Asia, as professional investment advisers, were
in possession of special skills or knowledge which Ms Field, a wholly
inexperienced investor, did not have;
The advice was clearly provided as part of their business and it is clearly in Barber
Asia's contemplation that it would be rewarded for those services, although not by
Ms Field, by being put in a position to earn fees and commissions from the
investment products which Ms Field would acquire as a result of following its
advice; and
It is clear that Barber Asia realised, or must have realised, that Ms Field would
rely on its advice;
Judge Barma SC also decided that, on the facts of this case, that duty has been
breached as Barber Asia did fall short of the standard of care which is to be expected
of a reasonably competent financial adviser and specifically pointed out:
1. the inappropriateness of recommended a gearing investment strategy, which could
give rise a significant risk of loss the capital, to an inexperienced and conservative
Ms Field and used up her entire capital. In the Judge’ words “I cannot see any
basis on which a reasonably competent investment adviser could properly give
advice which was or should have been known to be inconsistent with an advisee's
stated esires or objectives”18; and
2. the insufficiency of disclose/giving warning to Ms Field of the existence and
nature of the risk of the Scheme resulted from the gearing and currency mismatch.
Again, as expressed by the Judge, “I do not think that this was sufficient to bring
17
18
Field v Barber Asia Ltd [2003] WL 1953774 (CFI), [2003] HKEC 727, 157-158
I bid ,166
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to Ms Field's attention the risks associated with the currency mismatch, which it
was incumbent on Mr Barber to do if he were to deviate (as he did) from Ms
Field's instructions to provide her with a conservative or conservative/medium
risk investment strategy. The obligation to warn of particular risks is, I think one
which a reasonably prudent investment advisor would be expected to comply
with...”19
The Judge go further in his decision the losses which Ms Field suffered were caused
by such breaches of duty of Mr Barber and they were not attributable (in whole or in
part) to Ms Field's own actions and awarded Ms Field of the damages of loss suffered
together with the interest occurred. On the appeal, the counsel for Mr. Barber argued
that “the level of service selected by Ms. Field was the execution basis service, Barber
Asia had discharged its duty by ensuring that Ms. Field was aware of the overall
nature of the scheme. Reliance was also placed on the warning notice which
recommended that she seek independent legal advice”20. The Court of Appeal
reconfirmed that “The basis of Barber Asia's liability was the voluntary assumption of
responsibility which gave rise to a duty of care to Ms.Field. It is a question of fact in
each case whether there was such a voluntary assumption of responsibility. The
different services offered by Barber Asia were irrelevant. What mattered was whether
irrespective of the level chosen, it proferred investment advice which gave rise to a
duty of care. Indisputably the advice rendered did not conform to the client's
request21”
Implications for Investment Advisors
Prior to Barber Asia case, it was common thought in the financial advising industry
(including sales/marketing professionals in retail and private banks) that as long as
financial adviser has complied with the applicable regulatory requirements , they
would not be liable for any loss suffered by investors who have relied on their advice.
The decisions from High Court, especially, the appeal against SFAT, clearly show
that obtaining a client's signature on a risk disclosure statement and merely giving a
general explanation of investment products to clients are far from enough. Financial
advisers must ensure that products recommended to clients are suitable and meeting
with their clients' investment objectives and that the nature of risks are clearly
explained to, and understood by, clients. The gap of lacking clear and elaborated
19
20
21
I bid, 169
Field v Barber Asia Ltd [2004] 3 HKLRD 871, 26
I bid, 27
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guideline to comply the suitability obligations stipulated in section 5.2 of SFC Code
of Conduct has closed by SFC issuance of a specific and detailed guideline in May
2007 which will be discussed in the subsequent section. Prior to discussing the
regulatory obligation, it is worth to briefly review the expected standard of duty for an
experienced and sophisticated investor. We now turn to the recent UK leading case of
JP Morgan Chase Bank and others v Springwell Navigation Corporation22
(“Springwell”). Its decision is persuasive to subsequent cases in Hong Kong if the
facts and circumstances surrounding the client relationship are similar.
JP Morgan Chase Bank and others v Springwell Navigation Corporation Background and Essential Facts
Springwell was an investment vehicle for a family which owned and operated a large
Greek shipping fleet. The business was run by two brothers, Mr. Spiros Polemis ("SP")
and Mr. Adamandios Polemis ("AP"). Springwell had invested heavily in emerging
markets acquiring, through JP Morgan Chase Group (“Chase”), an USD700 million
portfolio of debt instruments including "GKO-linked notes" which were derivative
instruments referenced to bonds issued by the Russian Federation, known as GKOs.
Springwell had invested profitably in such notes but when Russia, as financial crisis,
defaulted on certain of its financial obligations in August 1998, the value of these
investment were marked down heavily and effectively the portfolio collapsed. In
respect of the loss of the value of the investment portfolio acquired through its
dealings with Chase, Springwell claims damages or equitable compensation for
breach of contract, negligence, breach of fiduciary duty, negligent mis-statement
and/or under section 2 of the Misrepresentation Act 1967.
The very key issue to be decided was “Did Chase owe a contractual and/or tortious
duty of care to Springwell to advise it as to appropriate investments? If so, what was
the extent of such duty?” Alleged by Springwell, the "advisory role" given rise to a
duty of care which had numerous necessary incidents includes:
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22
to establish in discussion with AP Springwell's investment expertise, investment
objectives and attitude to risk having regard to Springwell's strategic function;
to ensure that their understanding of Springwell's investment expertise, investment
objectives and attitude to risk was recorded accurately in writing and
communicated to AP as Springwell's principal and confirmed by him as being
[2008] EWHC 1186
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correct;
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at regular intervals to review Springwell's portfolio against what had been
established as its investment objectives and to take reasonable care to advise
Springwell of the results of such review and of any steps necessary to render
Springwell's portfolio consistent with those investment objectives;
to take reasonable care in advising Springwell that the portfolio as a whole and in
respect of particular investments was appropriate having regard to what had been
established as being Springwell's investment objectives and attitude to risk; and
to give adequate explanations to AP so as to enable him to understand the risks
inherent in particular investments, and to understand the balance of risk inherent
in the portfolio as a whole;
In other words, what is alleged is that, because there was an "advisory relationship",
every time that Justin Atkinson (“JA”), emerging market bond trader/salesman,
offered an investment for sale to Springwell, he was obliged to give, and was
implicitly giving, advice as to the suitability and risk characteristics of that investment,
both on its own and as part of Springwell's overall portfolio23. The damages are
sought for a failure to advise Springwell to sell investments, at its highest, is that JA
was obliged to give, and implicitly gave, ongoing and updated advice as to the merits
of retaining every investment which Springwell had previously purchased. Judge
found that the duties of care, which Springwell alleged that Chase owed are of “a very
wide-ranging and onerous nature”.
Court Decision and the Rationales
To determine as to whether an advisory duty existed, the Judge Gloster started with
the principles laid down in Hedley Byrne and the three tests which had been used by
the House of Lords in Commissioners of Customs & Excise v Barclays Bank24,
namely,
- the assumption of responsibility test, coupled with reliance;
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the "three-fold-test" (whether the loss was reasonably foreseeable, whether the
relationship between the parties was of sufficient proximity and whether in all the
circumstances it is fair just and reasonable to impose such a duty); and
the incremental test
The Judge agreed with their Lordships that there was no single common denominator,
23
24
JP Morgan Chase Bank and others v Springwell Navigation Corporation [2008] EWHC 1186, at 44
[2007] 1 AC 181
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with all of the tests operating at a high level of abstraction and what each test
emphasised was the need to take into account all the relevant facts in the overall
determination25. She advocated the need for a practical approach to the question
whether a duty of care exists and the evolution of "lower level principles" as a more
useful guide than "high abstractions" and concluded that “whatever the formulation of
the test, it requires an objective ascertainment of the relevant facts, the primary focus
being on exchanges between the parties”26. She then listed the relevant "lower level"
factors that serve as indicators of the existence (or otherwise) of a contractual or
tortious duty of care as following:
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the contractual context (including the terms of the relevant contractual documents
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and disclaimers, and the absence of any written advisory agreement);
what, if anything, was said to AP by Chase representatives when he was
introduced to JA;
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the actual role played by JA (including the purpose for which he was giving AP
recommendations or advice over the relevant period);
the extent of AP's financial experience or sophistication;
the extent of AP's reliance on JA and related Chase entities (including the extent
to which it was foreseeable that he would rely upon them for the investment
advice Springwell alleges it should have been given); and
the regulatory background27
Based upon “the parties specifically contracted upon the basis of a trading and
banking relationship which negated any possibility of a general or specific advisory
duty coming into existence” and the fact a large volume of consistent documentation
with consistent “non-reliance” and “non-advisory” language agreed by equal
bargaining power parties (which were nothing intrinsically unfair and unusual), the
Judge concluded, following the IFE Fund v Goldman Sachs International28, that the
effect of the contractual documentation was to define the relationship between the
parties so as to “exclude any parallel or free-standing common law duties of care”.
While the Judge did find as a fact that JA made recommendations and in that sense
advised AP what to buy, it was concluded that right from the beginning, JA was
understood by AP to be a salesman of bond trades. At all times AP retained control
over the decision making, and all decisions as to whether to initiate trades were taken
by him on Springwell's behalf.
25
26
27
28
I bid, at 49
1 bid, at 51
I bid, at 53
[2006] EWHC 2887
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The Judge found Springwell was a highly sophisticated investor and AP is a
commercially astute, clever businessman, a hugely experienced and sophisticated
emerging markets investor that in search of higher returns, he was comfortable with a
commensurate degree of risk.
Although AP "relied upon" JA to a considerable extent and clearly valued JA's views
and opinions, however, AP also ignored JA's views on many occasions and made
decisions which went against JA's views. As such, the Judge considered this did not
amount to an assumption of the responsibility to give Springwell wide-ranging
investment advice as to the structure of its portfolio, the need for diversification or
asset allocation.
The Judge found that the wording of the contractual documentation was an attempt by
Chase to comply with the relevant SFA rules applicable at the time. The fact that
Springwell was classified as a non-private customer under SFA rules, contracted out
of the regulatory protection otherwise afforded to private customers to advise on
suitability. As such, both the contractual and regulatory contexts showed there was no
duty of care on the part of Chase to advise.
Based upon the entirety of the evidence. the conclusions of above “low level” factors
pointing to or against the existence of a duty to advise, and the arguments raised by
the parties (in particular, great detail the facts relating to the relationship between
Springwell and Chase during the period 1990 to 1998), the Judge concluded that
Chase owed no contractual or tortious obligations to Springwell to advise it as to
appropriate investments or as to the structure of its portfolio, either in the wide terms
alleged or otherwise.
Implications for Investment Advisors
What is the real comfort of the leading decision give the banks and/or investment
advisor, is not that duty of care and obligations could never salesman arise when a
salesperson made recommendation (it was indeed in the circumstances of this case that
the bond trader, in his capacity as a salesman, did not amount to an assumption of
responsibility so as to bring into play the full range of obligations of an investment
advisor, as contended by plaintiff), it is the Court's attitude to the contractual framework
and recognition that this could and should govern the parties' relationship. It is
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therefore important for banks to put robust contractual documentation in place setting
out the agreed basis of the dealings between the parties.
The decision also show the Court will be reluctant to impose general advisory
obligations on investment advisors and/or banks where the investors, to the extent as
sophisticated as in this case, are involved. Although Springwell was a heavily fact
dependent case, as this type of dispute will inevitably be, it remains, an important
decision and one which is bound to be cited frequently.
REGULATION OBLIGATIONS ON INVESTMENT ADVISOR – HONG
KONG PERSPECTIVE
Like many other jurisdictions, provision of financial planning and advising services,
managing other assets or dealing with securities in Hong Kong subject to a licensing
regime. Corporations and staff employed to carry on regulated activities29 must firstly
satisfy licensing criteria before dealing in securities or futures or giving investment
advice. Their business conduct must then comply with relevant requirement stipulated
in codes and guidelines issued by the SFC and/or the HKMA. The regulatory
regime for sales of investment products in Hong Kong rests on two important pillars30,
namely:
1) the authorization of product documentation that is principally directed at ensuring
the adequacy (“disclosure” pillar); and
2) a requirement on the persons recommending or soliciting a product to ensure
suitability of the product for particular investor (“suitability” pillar).
The two pillars are supported by regulatory enforcement against cases of
non-compliance with requirements. These non-compliance cases are usually
unrevealed from customer complaints, during on-site inspections by the regulators
and in a rare situation from the Civil Court decision (e.g. like Barber Asia Ltd case).
There are explicit requirements in the Code of Conduct that
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“In conducting its business activities, a licensed or registered person should act
honestly, fairly, and in the best interests of its clients and the integrity of the
market.” (General Principle 2)
29
Schedule 5 of SFO listed 9 types of regulated activities
See “Issues raised by the Lehman Minibonds crisis Report to the Financial Secretary”, SFC, Dec
2008, p15
30
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“When providing advice to a client a licensed or registered person should act
diligently and carefully in providing the advice and ensure that its advice and
recommendations are based on thorough analysis and take into account available
alternatives” (Section 3.4 Advice To Clients: Due Skill, Care and Diligence)
“A licensed or registered person should take all reasonable steps to establish the
true and full identity of each of its clients, and of each client’s financial situation,
investment experience, and investment objectives.” (Section 5.1 Know Your
Client: In General)
“Having regard to information about the client of which the licensed or registered
person is or should be aware through the exercise of due diligence, the licensed or
registered person should, when making a recommendation or solicitation, ensure
the suitability of the recommendation or solicitation for that client is reasonable in
all the circumstances.” (Section 5.2 Know Your Client: Reasonable Advice)
“A licensed or registered person providing services to a client in derivative
products, including futures contracts or options, or any leveraged transaction
should assure itself that the client understands the nature and risks of the products
and has sufficient net worth to be able to assume the risks and bear the potential
losses of trading in the products” (Section 5.3 Know Your Client: Derivative
Products).
One important supplement has been issued by SFC on Suitability obligations. The
SFC “Circular to All Licensed Corporations, Questions and Answers on Suitability
Obligations” (the “SFC Circular”) dated 8 May 2007 provides further detail as to
how investment advisors are expected to comply with the suitability obligation in
paragraph 5.2 of the Code of Conduct. The SFC Circular states that investment
advisers must “match the risk return profile of each recommended investment product
with each client’s personal circumstances”, and “use their professional judgement to
assess diligently whether the characteristics and risk exposures of each recommended
investment product …are actually suitable for the client and are in the best interests of
the client, taking into account the client’s investment objectives, investment horizon,
risk tolerance, financial circumstances, etc.”
The SFC Circular also states that investment advisers must provide clients with
prospectuses and offering material for the investments. However, it is not sufficient to
merely provide this material, they “should help each client make informed decisions
by giving the client proper explanations of why recommended investment products are
suitable for the client and the nature and extent of risks the investment products bear”.
Investment advisers should “always present balanced views, drawing the client’s
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attention to the disadvantages and downside risks as well”. The explanations must be
in plain English, be fair and not be misleading.
The SFC Circular states that investment advisors should document and retain the
reasons for each product recommendation made to each client. A copy of the
rationale underlying each investment recommendation should also be provided to the
client. To demonstrate compliance with the regulatory requirements, investment
advisors should document and record contemporaneously the information given to
each client and any material queries raised by the client and the responses given by
the investment advisor. Investment advisors should also keep sufficient
documentation on all client transactions including orders placed to product providers.
Together enforcement with on-site inspections, both HKMA and SFC, compared with
international standards, the regulators considered the current regulations are generally
sufficient.
REGULATORY OBLIGATIONS ON INVESTMENT ADVISOR – OVERSEAS
PRACTICES
For comparison purpose, I will discuss, on higher level basis, the regulatory regime of
suitability and disclosure for sales of investment products in the overseas.
When and if a suitability determination must be made
Generally, there is a requirement in major financial centers that a determination must
be made as to whether a product is suitable for a retail customer at the time of
solicitation (recommendation) and that a recommendation must be made in order for
the obligation to arise (e.g. United States, European Union). In the European Union,
MiFID will require firms to assess the "suitability" of a service or transaction when
providing services that entail an element of recommendation on the part of the firm (ie
investment advice and portfolio management)31. Suitability obligations generally
apply when a recommendation has been made, but there are nuances related to the
applicability of such an obligation in some jurisdictions32:
- Does not apply to “general” (versus “personal”) advice in European Union under
MiFID
The Joint Forum “Customer suitability in the retail sale of financial products and services”, Bank for
International Settlement, April 2008, at 50 and 53
32
I bid, at 61
31
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-
-
In the European Union under MiFID, a less rigorous suitability requirement
applies where products are sold to professional clients, taking into account the
client’s experience, knowledge, and financial resources;
Further, under MiFID, in the case of execution only services (but in non-complex
products only) the “appropriateness” test is not applied, provided that the service
is provided at the initiative of the client, that the client has been clearly informed
that the firm is not required to assess the suitability or appropriateness of the
instrument or service offered and accordingly that the client will not have the
benefits that would otherwise be provided by suitability and appropriateness
determinations
Similarity, in Hong Kong, under the Code of Conduct, suitability obligation could be
exempted for Professional Investor (“PI”) provided that certain criteria (financial and
knowledge assessment) and formality requirements (explanation of consequence
being treated as PI given and a written consent obtained). The PI regulatory regime is
currently under reviewed addressing the concern that investment knowledge and
experience are more crucial than wealth (currently HKD8 million) to be treated as PI.
Information that must be obtained from customers
In the most jurisdictions like Hong Kong, banks or films in accordance with
regulations or supervisory guidance obtain certain types of information on the basis of
which the bank has to determine the appropriateness or the suitability of a particular
investment. This information generally includes the client’s financial situation
(regular income, assets, etc.) and his investment objectives (risk profile, including risk
taking preferences, etc.) and/or level of knowledge/experience in the investment field
(types of services, nature, volume and frequency of transactions, etc.).
Recordkeeping Requirements relating to Suitability Determinations
According to survey by Joint Forum33, except in the European Union (the Committee
of European Securities Regulators has recommended to its members that under
MiFID, the competent authorities should require that a record be made of the fact that
investment advice has been rendered to a retail client, as well as of the financial
instrument that was recommended), Most other jurisdictions do not have a specific
documentation requirement for suitability determinations, but have general
The Joint Forum “Customer suitability in the retail sale of financial products and services”, Bank for
International Settlement, April 2008, at 66
33
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recordkeeping requirements that would cause the firm to document the basis for any
suitability determinations. The HKMA and SFC in Hong Kong is probably the first
regulator and so far only specifically make and enforce such requirement.
SFC AND HKMA RECOMMENDATIONS ON SELLING OF INVESTMENT
PRODUCTS
As a result of the global financial crisis and the unexpected collapse of Lehman
Brothers (the 4th largest investment bank in the US) in Sep 2008, more than 30,000
retails investors in Hong Kong who have invested over USD 2 billion in Lehman
Minibonds and the banking industry as a whole have been adversely affected by such
crisis.
The HKMA, up to 25 June 2009, received 21,343 complaints concerning the Lehman
Brothers-related products. After preliminary assessment, 816 cases lacking
insufficient prima facie evidence to proceed and 13,727 cases are seeking further
information either the complainants and/or the banks. A significant portion of them
(3,679 cases) has proved impossible to obtain or more types of necessary information
from the complainants. So far, only 482 cases involving 16 banks referred to SFC for
disciplinary consideration. These are the cases which the banks and/or their staff
breach the relevant Code of Conduct in the selling process and a number of cases are
at a very advanced stage of the enforcement process. What going on the regulators are
indeed “persuading” the banks to buy back the Minibonds as the “alternative” for
enforcement through public announcement. For the brokers, Sun Hung Kai
Investment Services agreed in 22 Jan 2008 to repurchase Minibonds from its client at
original values without admitting any liability or wrongdoing arising from these
matters. For banks, Bank of China announced, on 23 June 2009, that they will buy
back Lehman mini-bonds from customers at 60 percent of their original cost. Along
this backdrop, both SFC and HKMA are progressively enforcing the
recommendations issued in Jan 2009 to:
-
attach “health warnings” to retails derivatives products
requires investment products to have concise and easily understood key facts
statement
strengthen the assessment of a customer’s risk profiling process including the
mandatory requirement to audio tape the process
for product and client mismatch, record and retain completion documentation and
- 18 -
the sales process audio-recorded
-
physically segregate the retail securities business form their ordinary banking
business and complete information separation to prohibit the making use of
deposit-related information to target and channel retail customers into investment
activities
Compared with approach adopted MAS Singapore (they have issued a consultation
paper in March 2009 making some proposals to 1) enhance regulatory regime for
investment products 2) promote more effective disclosure and 3) strengthen fair
dealing in the sale and advisory process, and on 3 Apr 2009 issued the “Guidelines on
Fair Dealing” with the aim to moving beyond mere compliance with rules on
processes and by placing emphasis on achieving fair dealing outcomes for customers),
the regulators in Hong Kong, take a more dramatic and aggressive approach to deal
with banks, for example, the next day after the issued the Report34, without any
discussion or consultation with the banking industry, promulgated the
recommendations for their immediate actions. This is an unwelcome surprise by the
banking industry, a Retail Banking Taskforce on Sale of Investment Products was
formed by the Hong Kong Association of Bank to negotiate the HKMA. Through
several around tough give-and-take negotiations, implementation details for these
recommendations have been agreed and set forth a full implementation by end of June.
Among the strict requirements audio recording of the sales process and non-sales
bank staff verification of customer risk assessment at the point of sales, any customer
after reading the marketing material of investment products placed in the bank
counter/hall, will be invited to discuss the matter in the investment corner. This will
immediately trigger the requirements of Code of Conduct 5.1 and 5.2 and FAQ on
Suitability Obligation and the burden of proof rest with the bank/licensed persons. In
the field, basically, no staff will make any recommendation of his/her own when
explaining the investment products to the client. Unless the customers are very keen
to buy the products, no deal made from these investment corners established under
this new regulatory scheme. Meanwhile, no new product launch to the market. HSBC
Chief Executive, Peter Wong, publicly commented that it take more than 9 months to
approve
NEW REGULATORY LANDSCAPE
“Report of the Hong Kong Monetary Authority on Issues concerning the Distribution of Structured
Products connected to Lehman Group Companies”, the HKMA, 8 Jan 2009
34
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While the G20 Summit on Financial Market has laid a foundation35 for reforming the
international financial markets and the Action Plan detailing immediate and
medium-term actions to be taken by national and regional authorities, the correct
approach for Hong Kong, as suggested by Joseph Yam, is to keep a close watch,
rather than jumping onto any bandwagons. Now is not the time to emulate others
blindly. As such, “well-planned, pre-emptive reforms are often more effective than
reforms introduced in the heat of a crisis” 36.
As such, no major regulatory reform (for adopting a “Twin Peak” rather than
continual with Institutional Approach) is expected to be taken place “in the heat of a
crisis”, the key consultations in the pipeline are:
-
-
the feasibility of a “cooling off” period, mandatory of key facts statement, PI
definition
to explore requiring intermediaries to adopt suitable criteria for characterizing
investors to help ensure that investment advice and products offered are suitable
for investors
without swift from the disclosure regime, a review whether some complicated
products should be restricted from selling to retail customer, if yes, what are
criteria
Meanwhile, the Administration (Financial Services and the Treasury Bureau) have
been asked to review the regulatory framework that would need to be implemented
through primary legislation e.g.
- whether the two public offering regimes under the Companies Ordinance and the
Securities and Futures Ordinance should be retained;
- whether a financial services ombudsman should be established by statute;
- whether it is necessary to adjust the regulatory framework regulating the securities
business of banks; and
-
whether a cross-sector Investor Education Council should be established by
statute.
CONCLUSION
35
Five Principles agreed in the G20 Summit on Financial Markets and the World Economy held in
Washington, DC on 15 November 2008 are 1) Strengthening transparency and accountability 2)
Enhancing sound regulation 3) Promoting integrity in financial markets 4) Reinforcing international
cooperation and 5) Reforming international financial institution
36
Joseph Yam “Reforms in the monetary and financial systems
- 20 -
While the principles relating to duty of care are well established, in their application it
may be difficult to precisely determine: (a) the existence of the duty of care; (b) what
duties are owed to whom; and (c) to what extent the duties have been fulfilled or
breached..
The Court experience with the suitability claims, as indicated in Springwell and
Barber Asia cases, are heavily fact based. Whether sophisticated and aggressive risk
taking customers have any claim on Minibonds are yet to see. The fact that what the
SFC Circular does not provide further detail on is when the suitability obligation is
triggered. The wording of Paragraph 5.2 of the Code of Conduct states that the
obligation is triggered when a firm makes any “recommendation or solicitation” in
respect of an investment to a client. The SFC acknowledged in its report to the
Financial Secretary in December 2008 entitled “Issues raised by the Lehmans
Minibonds crisis”, that the term “recommendation or solicitation” is very broad and
will apply to most situations where a financial product is marketed directly or
indirectly to a client. The Code of Conduct is silent on the question of whether the
suitability obligation is triggered by general advice on product types (e.g. advice that
a person should invest in bonds rather than equities) or whether it only applies where
a specific product recommendation is made.
As the comprehensive report produced by Asian Institute of International Financial
Law, Hong Kong University, without regulatory concessions37 (numerous waiver
from SFC disclosure and prospectus requirement under Company Ordinance) and the
effective supervision and enforcement on suitability obligations as per SFC Circular
issued in May 2007 (e.g. only two cases sanctioned by SFC prior to Minibonds
incident and none from the HKMA), perhaps, the likely results and the extent of the
impact would be considerably smaller.
While the results from the consultation and upcoming establishment of new
regulations and resolution/education bodies will definitely sharp the new regulatory
landscape, the immediate impacts on the business have been emerging and with
expected changes to existing inspection regime (in light of findings from the
investigations), the banking business profitability and operational efficiency would be
a big challenge ahead.
“The Global Financial Crisis and the Future of Financial in Hong Kong”, Asian Institute of
International Financial Law, Faculty of Law, The University of Hong Kong at 3.3.5
37
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Reference:
Articles:
Paul Lejot, “Dictum Non Meum pactum: Leham’s Minibond Transactions”, Hong
Kong Law Journal 2008
Jose Antonio Maurellet, Adrian Lai, “The Minibond Sago: Caveat Emptor or
Financial Adviser Beware?, Hong Kong Lawyer, April 2008
Ross M Y Yuen, “Minibond: High or Low Risk?, Hong Kong Lawyer, April 2009
Philip Smith, “Client Alert, Mayer Brown, November 2004
Ian De Witt, “Responsibilities Beyond Regulations : Misselling : Civil Liability for
Negligence and for giving Negligent Advice”, The Hong Kong Confederation of
Insurance Brokers Annual Conference 2008
Philip Smith, “Client Alert, Mayer Brown, November 2004
Grace Liu, “Survey Identifies Weaknesses in Selling Process”, The Asian Banker,
February 2009
Joanna Wood, “Extent of Bank’s Duty to Advise in Relation to Investment Portfolio”,
Allen & Overy, July 2008
Books
D K Srivastava, “The Law of Tort in Hong Kong”(Lexis Nexis, 2th ed, 2005)
Stephen D. Mau, “Hong Kong Legal Principles, Important Topics for Students and
Professionals”, (Hong Kong University Press 2006)
- 22 -
SFC/HKMA Report and Circulars
Report
“Review of the Regulatory Regime Governing the Sale and Marketing of Unlisted
Investment Products, March 2009
SFC Circular
“Equity-linked Instruments are subject to suitability and fair dealing requirements”, 1
April 2003
“Enforcement News – Towry Law (Asia) HK Limited Offers Ex-gratia Payments to
Investors in GDT and GOT – SFC Settles Disciplinary Proceedings with a Severe
Reprimand”, 17 August 2004
SFC Speech by Alexa Lam, “The Obligations and Duties of Investment Advisors
Licensed by the SFC”, 24 February 2005
“SFC Report on Selling Practices of Licensed Investment Advisers”, February 2005
“Enforcement News – SFC Suspends Andrew Nicholas Barber for Unsuitable
Investment Advice”, 4 July 2005
“Press Release – Best Practices on Selling, Compliance and the Implementation of
the Securities and Futures Ordinance”, 27 October 2005
“SFC Circular – Questions and Answers on Suitability Obligations”, 8 May 2007
“Issues Raised by the Lehmans Minibonds Crisis, Report to the Financial Secretary”,
December 2008
“Enforcement News – Sun Hung Kai Investment Services Ltd Agrees with SFC to
repurchase Minibonds from its clients at original value”, 22 January 2009
- 23 -
HKMA
Report
“Report of the Hong Kong Monetary Authority on Issues Concerning the Distribution
of Structured Products Connected to Lehman Group Companies| December 2008
“The Securities and Futures Commission’s Report (the Report) on Selling Practices of
Licensed Investment Advisers, 1 March 2005
“Retail Wealth Management (RWM) Business, 3 March 2006
“Thematic Examinations on Investment Advisory Activities, 1 March 2007
“Questions and Answers on Suitability Obligations Published by the Securities and
Futures Commission (SFC), 9 May 2007
“Circular Issued by the Securities and Futures Commission (SFC) Regarding
Risk-disclosure Duties of CLN Issuers, 23 June 2009
Submission to Legislative Council
“Submission to Legco Panel on Financail Affairs Special Meeting to be held on 30
December 2008”
“HKMA’s response to information requests of Legislative Council Panel on Financial
Affairs Follow-up to Special meeting on 23 February 2009”
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