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The FCA has recently published Finalised Guidance 15/1 (the Guidance), which promises to consolidate existing sources of guidance on retail investment advice, and to clarify what does and does not amount to advice or a personal recommendation in that context. The significance of that question is, of course, that when a bank makes a personal recommendation, it is obliged by COBS 9 to ensure that the product recommended is suitable.1
In mis-selling claims there is often a battle between claimant and defendant as to the proper role of regulation in determining whether the defendant bank is liable to pay damages. In this article we focus on claims relating to the sale of interest rate swaps, given the current volume of litigation about these products, but the principles apply to mis-selling claims more generally.
In this article we consider whether the publication of the Guidance can be seen as an intervention in this debate and, if so, whether it materially affects the position in relation to cases which have been or will soon be decided by the courts. We also consider whether the Guidance represents an increasingly clear divergence between the legal and regulatory approaches to these issues.
In a separate update, we will consider the detailed contents of the Guidance and its implications for sales of derivative products now.
All swaps cases have different specific facts, but there are frequently common features in relation to background and contractual framework. It is usually the case that a customer has approached a bank to ask for lending, which is then offered on terms which include the payment of interest at a floating rate. As part of discussions relating to the loan, the bank and the customer start to discuss interest rate hedging, which is sometimes a requirement of the loan agreement. Such discussions are often said by the customer to amount to investment advice. The practical effect of the hedge (whether it is a vanilla interest rate swap, a collar or some alternative) is usually to switch the customer's loan repayments onto a fixed rate or to fix the rate within a defined band. The hedge will have a fixed term, and if the customer wishes to terminate it early, breakage costs will be payable by either the customer or the bank depending on which of them is in the money at the time.
Before the hedge is sold, the customer will typically have signed general terms of business provided by the bank in a standard form, which generally say that the bank does not provide advice in relation to the products it sells (or sometimes that it does not usually provide advice, but may specifically agree to do so). The customer usually agrees to the trade by telephone, and then signs a further agreement in relation to it, which generally contains representations by the customer that no advice has been given in relation to the trade, and that the customer has the necessary knowledge and understanding to appreciate the risks of the transaction.
Should there be any dispute between bank and customer in relation to this sequence of events, there are two, largely separate ways of judging the bank's conduct. One is by reference to the law, and can be determined by a court. The other is by reference to the applicable regulatory system (particularly the COBS rules), but for many customers, there is no arena in which to fight on this front. The FOS will consider regulatory requirements, but the limits on its awards may not make it an attractive alternative for some complainants. Private persons (individuals, or companies not acting in the course of business) can claim for breach of statutory duty in relation to breaches of the COBS rules under s138D of FSMA, but in relation to swaps cases, such claimants are in a minority.
It is for that reason that some claimants in swaps cases have been ingenious in trying to work requirements to comply with COBS (and its predecessor COB) into common law claims which the court can determine. The sub-text to this (and it is not one which the Guidance does anything to dispel) is that the regulatory regime is more friendly to the aggrieved customer than is the law.
Claimants frequently plead both COBS 9 and COBS 10 (among other provisions) as relevant to their claims, even where there is no s138D claim. Their arguments for doing so have included the following:
In general, such arguments have not fared well. However, where a duty of care which arises at common law covers the ground occupied by a COBS rule, the content of the COBS rule may inform the court as to whether the bank has complied with that duty in some cases. So, for example, if a bank has a common law duty to advise in relation to an investment product, it may well be in breach of that duty if it does not comply with COBS 9, although that would need to be determined in each case. Similarly, if a bank followed procedures designed to enable it to comply with COBS 9, that might undermine an argument that it did not assume an advisory duty. Otherwise, the court has not generally treated as relevant the issues of whether a bank was obliged to comply with COBS 9 or COBS 10 in selling an interest rate swap, or whether it in fact did so.
The short answer to this question, in our view, is that it should not, save for in specific circumstances. Unless the law changes such that all customers can effectively claim damages for breach of the COBS rules, it is unlikely that the considerations in the Guidance as to whether and how COBS 9 applies have a significant effect on claims litigated. If judges do not tune in to the message the regulator is broadcasting, it really does not matter much to their decision-making what that message is.
The most obvious circumstance in which the Guidance will be directly relevant is where a claim is made under s138D of FSMA for breach of the FCA's rules. Where such a claim can be made, then the Guidance is likely to be considered by the court in some detail. Similarly, where the court finds the existence of a common law advisory duty, the Guidance might again be relevant to determining whether it has been discharged.
Notwithstanding what should, in our view, be a relatively small impact on cases litigated, it is still worthwhile for firms facing such complaints to consider the Guidance in detail. They will need to bear in mind in doing so that the Guidance relates to the COBS rules as they currently are, while some swaps cases may relate to sales made during the period before COBS was introduced. However, there are still common concepts (such as the personal recommendation).
One reason for firms to study the Guidance is that it is expressly stated to consolidate existing guidance in relation to retail investment advice, and the FCA views it as being the definitive source of non-Handbook guidance on the issue, subject only to any relevant provisions of PERG. The Guidance therefore sets out to interpret requirements which already exist, and for that reason it should in principle provide firms with a good yardstick to measure whether the FCA would view their sales of interest rate swaps as compliant or not.
This matters for two main reasons:
(a) even if a customer cannot directly claim damages in respect of a breach of the rules, the FCA can still take enforcement action in relation to non-compliant sales; and
(b) when dealing with new customer complaints, the firm will be obliged to consider whether it discharged its obligations at the point of sale.
As set out above, one of the main lessons to be learned from the judgments already handed down in swaps cases is that legal requirements and regulatory requirements are different things. Some aspects of the Guidance would tend to reinforce rather than reduce that difference. Our forthcoming update will set out some of the more detailed content of the Guidance, but for present purposes, there are three inter-linked areas where a comparison may be helpful.
There are similarities between the court's approach to determining whether advice has been given and the FCA's approach to determining whether a personal recommendation has been made. In either case, the mere provision of information is not enough, there must be an element of judgment brought to bear on the part of the bank, which steers the customer in a particular direction. There does not, in either case, need to be an explicit recommendation. The Guidance makes it clear that personal recommendations can be made implicitly (although the examples it provides are arguably almost explicit recommendations), while the judgment in Crestsign v. RBS refers to a selective choice of products for consideration by the customer.
The court and the regulator part company, however, in the analysis undertaken after that point. Legally, the fact of straying from information to advice does not necessarily make such advice actionable. For the purposes of COBS, once a personal recommendation is deemed to have been made, the firm making it is required to have complied with COBS 9 in doing so.
This makes it very important in the regulatory context to know whether or not a personal recommendation has been made at all. If the FCA deems that it has, then the firm will be obliged to show that it discharged its obligations under COBS 9, whether or not it intended to make a personal recommendation in the first place.
A court, on the other hand, will look at whether a reasonable person would objectively conclude that advice was being given for which the bank assumed legal responsibility. One striking feature of the Guidance is the FCA's reluctance to adopt a similarly objective test.
The Guidance notes that a court would consider whether a reasonable person in the customer's position would conclude that advice was being given, but does not adopt that test. Instead, it says that the customer's subjective view of what the firm is doing will be "very important", although it acknowledges that the customer might, on occasion, get it wrong. One might ask what objection the FCA has to the court's test as it describes it, and why it will not adopt it. As it is, it remains unclear what importance the regulator will attach to the customer's subjective belief, and how it is to be established evidentially after the fact.
The most likely practical example of why this causes a difficulty relates to implied recommendations. While a court will consider on an objective basis whether advice has been given, the FCA might well give much greater weight to a customer's subjective view as to whether a product was recommended or not. If, for example, a bank does not overtly recommend a product but says something about it which it characterises as informative, but which the customer unreasonably takes as advice, will the FCA conclude that a personal recommendation was made? Disputes as to the character of discussions between bank and customer are often central to swaps disputes, and it is clear from the Guidance that the FCA expressly does not adopt the court's approach.
One striking feature of judicial decisions in relation to interest rate swaps has been that banks' terms of business have generally withstood attack. In particular, banks have been successful in establishing that "no advice" clauses in their general terms of business are so-called "basis clauses", which define the basis on which the parties' dealings are conducted, rather than exclusion clauses. The existence of such clauses has been held to go to the reasonableness or otherwise of believing that the bank accepted liability for any advice actually given. In Crestsign for example, the judge said that the end result was one whereby the salesman should effectively have been understood to say: "I recommend one of these products as suitable, but the bank does not take responsibility for my recommendation".
The Guidance casts considerable doubt on whether contractual provisions could have a similar effect in terms of the regulatory position.
The Guidance contains a section headed "Disclaimers", which is worth considering in full. It states that: "It is important to remember that even a clear, prominent and understandable disclaimer stating that no advice or recommendation is being given is unlikely to be sufficient to avoid having presented a recommendation as suitable for the customer. For example, if a firm stated that its product would suit a particular customer's needs, including a disclaimer saying that this was not advice would not necessarily change the basic nature of a communication and it may still constitute a personal recommendation." This would suggest that the FCA will largely look only at how a firm presents products to potential investors in its communications, rather than at contractual language setting out the basis on which such communications are made.
In relation to examples such as the one provided by the FCA, that may be comprehensible for regulatory purposes. However, the Guidance does not address a situation where the relevant provision is not a "disclaimer", but a contractual agreement preceding the sale of the relevant product, whereby the firm makes clear that it does not provide advice. Would such a provision influence the FCA's interpretation of whether an implied recommendation had been made? It might well not, but the question remains unanswered in the Guidance.
This means that a single clause could be regarded by a court as a "basis clause", which set out in an acceptable way the parties' relationship, and by the FCA as something which had no effect on the duties owed by the firm under COBS.
The battle will doubtless continue to rage between claimants in mis-selling cases and defendant banks as to the relevance of the COBS rules to the claims asserted. The existence and content of the Guidance is likely to make little difference to the outcome of that battle in most cases, although it should not be ignored.
What it does serve to show however, in this context, is that there is a gulf between the way in which a court considers a misselling case where advice is alleged to have been given, and the way in which the FCA views such cases. The possibility of the same sale receiving different legal and regulatory treatment is high. It may be that this is a perfectly reasonable state of affairs: the two regimes are different. However, it does create something of a lottery of outcome for different types of complainant: those whose claims can be determined in full by the FOS and those which cannot; and those who can claim under s138D as compared with those who cannot.
These differences are unavoidable as matters stand. It remains to be seen whether they shrink in years to come, or become still more stark.
1In relation to sales of derivative products, even where a firm does not provide a personal recommendation, it is obliged to assess appropriateness under COBS 10
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