Investor Beware? Hong Kong Court Confirmed Bank's Advisory Duty to Inexperienced Investors

08 September 2016

Richard Keady, James Wong

In the latest decision to emerge following the financial crisis on mis-selling of investment products, the Hong Kong High Court has ruled against the private banking unit of Oversea-Chinese Banking Corporation (the Bank), finding it to have been in breach of its advisory duty to two elderly customers despite clear non-reliance clauses in the contractual documentation. (Chang Pui Yin v Bank of Singapore Ltd HCCL 12/2013, 8 August 2016)

What happened in the case?

The plaintiffs were an elderly couple (Mr and Mrs Chang, who were about 90 and 80 years old respectively at the time of trial) and Mrs Chang's investment company, Nextday International Limited (Nextday). The couple led "uncomplicated lives" and had minimal investment knowledge or experience. In 1997, Mr Chang received a windfall of approximately HK$120 million. From 1997 to 2004, the Changs made only low to medium-risk investments such as time deposits, foreign currency and mutual funds.

In 2004, the Changs opened their accounts with the Bank, following Mrs Chang's relationship manager, Mrs Li, who had moved to the Bank. Since then, they started purchasing large amounts of high-risk investments, including equity linked notes, foreign currency options and accumulative forwards, knockout daily accumulators, foreign currency loans, high yield bonds and equity options. In the 2 years and 9 months following its inception, the investment portfolio lost over US$2.1 million.

The Changs complained to the Bank, but the Bank denied any wrongdoing. The Plaintiffs commenced court proceedings against the Bank in 2011.

The Court's decision

Mr Justice Bharwaney found that the Changs had trusted and relied on Li on how to conduct their investments. However, Li failed to give any proper explanation of the risks and disadvantages of the investment products that she had recommended. Despite her knowledge that the Plaintiffs were always medium risk investors, she had continually recommended high risk investments and sold high risk products to them since 2004.

Unsurprisingly, the Bank sought to rely on the usual express non-reliance clauses in its contractual documentation, to argue that the banking relationship was "non-advisory" and "execution only". However, the Judge held that the only proper construction of the agreement is that the Bank had contracted to provide an advisory service to the client. Li and the Bank breached the contractual advisory duty they owed to Plaintiffs (the Changs and Nextday). In particular, they failed to:

  1. exercise reasonable care and skill to ascertain and have regard to their investment objectives and risk appetite;
  2. exercise reasonable care and skill when offering products which were not suitable to their investment objectives and risk appetite; and
  3. exercise reasonable care and skill to warn of the risks inherent in the investments that were being offered to them.

Accordingly, the Judge entered judgment for the Plaintiffs, with damages to be assessed.

However, the Judge added that, if the banking relationship had been "non-advisory" and "execution only", then the Bank would have succeeded in its defence of contractual estoppel. In other words, if the parties had agreed in a contractual document (that the banking relationship was "non-advisory" and "execution only"), then neither party can subsequently deny this fact and the contract itself gives rise to a defence by way of estoppel. The Judge followed persuasive English Court of Appeal authority on the validity of this defence, and said that it could only be overturned by a higher court in Hong Kong.

Analysis and practical advice

In ascertaining the nature of the banking relationship and by construing the contractual documentation in place, which defined the scope of the Bank's duties and hence the outcome of the case, the Court paid detailed attention to the factual background of the case. This is in line with the modern approach to contractual interpretation. In particular, the Court noted that the plaintiff elderly couple were inexperienced and unsophisticated investors, who had placed trust and confidence in their relationship manager at the Bank in providing investment advice. Hence, despite the clear non-reliance clauses in the Bank's documentation, the Court found that the Bank had in fact contracted to provide an advisory service to the customers but had breached its duties.

It should be borne in mind that this case arose out of advice given and transactions entered into over a decade ago, before the onset of the global financial crisis. The private banking unit in question was owned by ING at the time, but was later sold to OCBC. Most institutions will have updated their procedures, controls and documentation since then. Nevertheless, the judgment serves as a timely reminder for institutions to make sure they keep their house in order:

  • When assessing the suitability of investments for clients, a relationship manager must record properly the background, financial situation, investment objectives and risk appetite of the client. All too often in cases like this, evidence emerges that the relationship manager has simply been "going through the motions" or keeping sloppy or inaccurate records just to get the green light to sell high risk products.
  • Financial institutions must continue to preserve and maintain proper documentation of the risk assessment exercise. These records can serve as crucial contemporaneous documents to support the bank's position and its employees' credibility in case of disputes with customers. Policies are too often honoured more in the breach than the observance. In the present case OCBC were not able to do this – all they could produce were various product brochures from 2007, none of which gave any indication of the degree of risk involved.
  • Before selling high risk products, clients should be informed of the nature of the investments and should be warned against the risks involved, particularly for inexperienced and unsophisticated investors. Here, Li claimed to have done so but there were no documents to support that and none of the telephone tape recordings from that period had been retained by the Bank.
  • Financial products, including those sold to retail customers, are increasingly complex and sophisticated. It is not only customers who may not understand them, relationship managers and other employees may not understand them either. Li was heavily criticised by the Judge for not understanding many of the products she had been selling to the Changs.
  • The SFC has already prompted financial institutions to include appropriate wording in client agreements (that the products are suitable for the customer) sooner rather than later, and before the expiry of the transitional period in June 2017. The decision in this case is another reason to ensure that this gets done.

Finally, some interesting lessons from a dispute resolution perspective also emerged from the case:-

  • The doctrine of contractual estoppel is not dead. OCBC's defence would have succeeded if it could have shown that it was operating on an execution only basis. But expect a greater readiness on the part of the Courts to construe contracts more widely such that the Bank is taken to have assumed a duty to advise. A clause which purported to disclaim liability for any advice given in respect of an account established on an advisory basis will likely be held not to apply, as was the case here.
  • Document retention policies remain crucial components of risk management. This may not be the most exciting of areas for in house legal and compliance teams to manage, but they can have a critical effect on the outcome of litigation. In this case important documents such as telephone conversations, which may have helped OCBC conduct its defence, had not been retained or had been destroyed.
  • The Judge placed significant reliance on transcripts of tape recorded telephone calls between the Changs and Li. There is nothing new in that, especially given the time during which the disputed transaction took place (2004-2008). Since then, social media apps have transformed the way in which business is transacted across all sectors. Expect future cases to feature evidence from WhatsApp and WeChat communications, nearly all of which will reside on an individual's personal device and not the institution's servers, and notwithstanding an institution's social media policy. This can lead to evidence emerging later in a case where a plaintiff can produce copies of messages which the institution was previously unaware of.
  • Both parties adduced expert evidence to support their respective positions, but from experts with very different profiles. The Judge preferred the evidence of the Changs' expert who he said had extensive practical knowledge to back up his theoretical knowledge. By contrast, the Judge felt that the Defendant's expert was essentially an academic and that his evidence was often not helpful. The message here is that Courts tend to prefer witnesses who have "hands on", real world experience, as opposed to academics steeped in theory rather than practicalities. 

Authors

Keady-Richard

Richard Keady

Partner
China and Hong Kong

Call me on: +852 2248 6000
Image of James Wong

James Wong

Associate
China and Hong Kong

Call me on: +852 2248 6000