The mis-information epidemic

The commercial practices of the UK's major banks have been coming under increasing scrutiny, with banks setting aside billions in compensation for their mis-selling of payment protection insurance and over-the-counter derivative products.

The recent Court of Appeal decision in Rubenstein v HSBC PLC ([2012] EWCA Civ 1184) illustrates how customers may have a remedy where they took up complicated investment products which they did not properly understand, or which were inappropriate for their needs. Many found themselves suffering unexpected losses when the financial crisis hit.

In 2005, Mr Rubenstein approached HSBC looking for a safe place for the proceeds of the sale of his family home (£1.25m) pending the purchase of another property. He wanted to find an investment that provided a higher interest rate than a standard bank deposit, but he emphasised that he could not afford to risk his capital at all. The bank's financial adviser recommended a complex bond product issued by AIG, and assured him that it carried no risk of capital loss because it was the same as a cash deposit.

While in the normal course of events the AIG bond product was suitable for low risk investors looking for a good rate of return, it was inherently an investment in the market, and thus subject to market fluctuations. HSBC neglected to explain this to Mr Rubenstein fully.

Three years later, following the admin-istration of Lehman Brothers and the turmoil of the credit crunch, a run on AIG bonds meant that Mr Rubenstein did suffer a substantial loss to the capital which he had invested.

Editing the facts

The High Court held that HSBC was negligent in the advice it gave, and in breach of various statutory duties. In particular, the bank was liable for making a recommendation to Mr Rubenstein without taking reasonable steps to ensure that he understood the nature of the risks involved, and for communicating its advice in a misleading way.

However, the trial judge accepted the bank's argument that the concept of a run on AIG was so remote that no bank would have been required to point it out as posing a risk to capital, and that what happened to the fund in September 2008 and the period that followed was wholly outside the contemplation of any competent financial adviser. He held that Mr Rubenstein's loss had thus been unforeseeable and was too remote to be recoverable. Rather than being caused by the bank's negligent advice, in his judgment, these losses arose from the 'extraordinary and unprecedented financial turmoil' which surrounded the collapse of Lehman Brothers.

The Court of Appeal considered these questions of causation and foreseeability in detail. In particular it was noted that, as a matter of law, where a loss is of a type that is foreseeable it is not a defence to say that the scale of those losses could not have been expected.

In its judgment, the Court of Appeal held that, while the extent of the run on AIG may have been unforeseeable, it was not the run which caused Mr Rubenstein's loss. Ultimately it was the collapse in the value of marketable securities in which the AIG fund was invested which caused his loss. Further, given the features of the AIG bond, losses arising from market forces were eminently foreseeable, albeit that the way in which they came about and the extent of those losses were not. Lord Justice Rix stated: '...although the Lehman Brothers collapse was both a symptom and contributory cause of market turmoil, the underlying causes of that turmoil went infinitely beyond Lehman Brothers' difficulties. It stretched to a failure of confidence in marketable securities in which there had previously been greater confidence. And what is new about that?'

Mr Rubenstein was awarded damages in excess of £100,000, representing what he would have received if his money had been invested in a more capitally secure proposal.

In support of his view, Lord Justice Rix referred to a provisional decision by the Financial Ombudsman Service (FOS) in February 2012 which upheld a mis-selling complaint by other consumers who had had a similar experience with the AIG bonds to Mr Rubenstein. The FOS noted that 'extreme market conditions are an established risk of all investments', and concluded that the consumers were entitled to compensation for their losses.

Mr Rubenstein's experience with his bank may well resonate with other consumers. In the years leading up to Lehman's collapse, the complexity of investment offerings grew considerably, such that the precise mechanics of particular investments, and the risks involved, were often completely opaque to the unsophisticated investor. To many, the magnitude of losses they then suffered during the financial crisis was wholly unexpected.

It is well established that banks have a duty to advise unsophisticated investors of the risks of a particular offering, and to ensure that the product is suitable. However, the decision in Rubenstein further assists consumers insofar as, where a bank has failed to discharge its duties, it may no longer be able to avoid liability on the basis that the financial crisis was so unforeseen and extreme. Rubenstein therefore provides a welcome finding for those who suffered in the market turmoil of the late 2000s.