A recent case in London's Commercial Court, Peekay Intermark v Australia and New Zealand Banking Group, highlights what can go wrong if a salesman misrepresents the nature of a product to an investor, even a sophisticated investor. On the facts of the case, this was because the bank's salesman did not understand the product which the originator had structured. There was no suggestion of a deliberate attempt at misselling.
Key Points
Legal transaction documents such as contracts and risk disclosure statements are seldom seriously challenged in the context of the sale of structured products to sophisticated investors. Instead, investors seeking to avoid trading losses generally try to get round the contractual documents, and the legal protection they provide, by alleging misrepresentation, breaches of duties of care and so on.
This was illustrated by the Peekay litigation. Even where the legal documentation is all properly completed and signed, the court will not let the bank escape liability if it has described in its marketing process a different product from that which it actually sells. The case highlights the importance of consistency, and effective operational procedures, throughout the entire product cycle--from the origination and structuring of a product, through the marketing stages, to the legal conclusion of a trade.
Peekay is a classic example where a firm might have thought its legal terms and conditions and generic risk disclosure would extinguish misrepresentation claims. In other words, any imperfections or shortcomings in the marketing and sales process would be perfected by rock solid 'legals'. This was not the case. The Court found the firm had created and marketed an apple, while in fact selling an orange. And obtaining signed contractual documents relating to the orange did not help the bank.
Facts, Main Arguments And Judgment
The question in Peekay was whether a pre-contractual oral misrepresentation of the product's fundamental nature was overridden by the actual written contractual terms. Peekay bought a structured investment product originated by ANZ's structured products group, and marketed and sold through ANZ's private bank. The decision to invest was taken on behalf of the company by Peekay's director and controlling shareholder, Harish Pawani. The investor argued that:
* The decision to invest was taken on the basis of a misrepresentation made by a representative of the bank;
* The misrepresentation induced Pawani to make the investment on behalf of Peekay;
* Any divergence between what was verbally explained to him and what was in the Final Terms and Conditions should have been specifically drawn to his attention;
* The misrepresentation continued despite the signing of the FTCs; and
* Had he been aware of the true nature of the product, Pawani would not have bought it.
The bank denied the alleged misrepresentations and argued the product had been correctly described in the FTCs which had been sent to Pawani together with a generic emerging markets risks disclosure statement. Pawani--who was on any view a sophisticated investor--had initialled every page of the FTCs and the disclosure statement and had signed the disclosure statement. The bank argued these documents formed part of the investment contract and, in light of the contents, the claimants were not entitled to rely on any alleged pre-contractual representation which may have described the product differently.
The FTCs included:
"It is an express term.....that you are not relying on any communication (written or oral) made by ANZ as constituting either investment advice or a recommendation to enter into this transaction."
The risk disclosure statement said:
Before making any investment in an emerging markets instrument, you should...ensure that you fully understand the nature of the transaction and contractual relationship into which you are entering and the nature and extent of your exposure to risk of loss."
The alleged misrepresentation itself concerned the interest to be acquired by the company in a rouble denominated zero-coupon bond issued by the Russian Treasury, known as a GKO.
Pawani had been invited to invest in the product by a representative of the bank who told him orally that the bank would hold the GKO "on behalf of the company" which would therefore have a beneficial interest in it. An indicative term sheet sent to Pawani was not inconsistent with this explanation. The term sheet actually related to a different product, being a note product rather than the structured deposit product to which Peekay's investment was in fact booked.
In fact, the product was a derivative linked to a GKO as a reference obligation. It was structured as a U.S. dollar deposit, the performance of which was linked to returns on, and performance of, the GKO. The FTCs disclosed that the investment gave Peekay no interest in the underlying GKO. So, Peekay did not have any control over the liquidation of the investment in the event of sovereign default, and no opportunity to participate in any restructuring option.
The Russian Government defaulted in making repayment of the GKO. ANZ went through the cash settlement process and Peekay got back about 2.5% or USD5,000 of its initial USD250,000 investment.
The two main issues that the court had to decide were:
1) What was said by the salesperson as to the nature and characteristics of the investment product in question, and what was the investor reasonably entitled to understand based on what he was told?
2) Were any misrepresentations as to the nature of the product nullified or superseded by the initialled/signed FTCs and the risk disclosure statement?
On 1, the Judge concluded that, on the facts, the nature of the product was misrepresented to Pawani in a "fundamental respect" and that he reasonably understood from what he had been told, and had read, that his company would be acquiring an interest in the underlying bond. On 2, it was clear from the evidence Pawani did not read the FTCs or the disclosure statement before signing them. The Judge said the investor was "unwise" not to do so and added "nothing in this judgment should be taken as an encouragement to investors to ignore written terms and conditions applicable to their investments." He found Pawani had no reason to think the terms and conditions would relate to a fundamentally different product from that described to him. Pawani's signature of these documents did not show he was content to contract on the terms of the FTCs irrespective of any prior misrepresentation.
The court put considerable emphasis on the fact Pawani clearly placed much confidence in ANZ as his private bankers and had evidently had no prior cause to consider that the FTCs would contain any nasty surprises. Although the judge was not required to determine what would have nullified the misrepresentation, he indicated an accurate description by the bank's representative of the nature of the product before Pawani committed funds would have sufficed. He noted the problem would not have arisen at all had the product been properly explained to the bank's representative in the first place and if the indicative term sheet for a different product had not been provided.
The Judge also took the view there was no documentation correctly recording the terms of the investment and was critical of the bank for that. So Peekay succeeded. The measure of compensation was the difference between the amount invested and the amount subsequently realised on the liquidation of the investment.
Comment
Institutions will be exposed if their practices and procedures in the process from origination, through marketing, to sale are inconsistent. That process needs to be looked at from a legal, compliance and operational risk perspective to ensure consistency and control. This is all the more important where the pace and range of product origination and development is increasing, and there will be inevitable attempts to commoditise the process by, for example, using generalised distribution channels that may be detached or distant from product origination.
This issue will be a lot more acute where the investor targets are retail/non-sophisticated. Courts will be much less sympathetic to institutions. That is one reason why this is quite rightly at the top of many institutional agendas at present. Another is that the regulators will be equally unsympathetic, as the Financial Services Authority has repeatedly warned.
This week's Learning Curve was written by Jonathan Kelly, head of financial markets litigation, and Richard Bunce, senior associate in financial markets litigation, at Simmons & Simmonsin London.
