SALE OF STRUCTURED PRODUCTS TO RETAIL INVESTORS – SOME IMPORTANT ISSUES FOR CONSIDERATION

It has been reported that thousands of investors in Singapore may have lost most if not all of the approximately $500 million which they had collectively invested in structured financial products as a result of the sudden collapse of Lehman Brothers in September 2008. Many retail investors, some of whom are regarded as ‘vulnerable’ customers (i.e. senior citizens and/or with only primary school education), claim to have been mis-sold these structured financial products by financial institutions. In response, the Monetary Authority of Singapore (“MAS”) has reportedly urged the financial institutions involved to take responsibility where the product in question was mis-sold or was clearly inappropriate given the investor’s profile and circumstances. The investigations into mis-selling are still ongoing and MAS is closely monitoring the situation. At the time of publication of this note, a small number of the retail investors, believed to be some of the socalled vulnerable investors, have been told they will receive 100% compensation. This note sets out some of the legal issues that are likely to be raised should disputes between retail investors and financial institutions proceed to litigation in our courts. CLAIMS IN CONTRACT / TORT Some investors allege that the financial advisers who sold them the products did not alert them to the risks of the investment and that they promised that the principal sum was guaranteed. Also, many investors have claimed that they simply did not understand the contractual documentation in the first place. In the circumstances, the financial institutions may face claims of negligent or fraudulent misrepresentation, undue influence or non est factum. In turn, the financial institutions would be expected to rely heavily on the material contractual documentation which makes extensive and repeated reference to the risks involved in these investment products as well as the fact that the principal sum is not guaranteed. Further, material contractual documentation in which it is stated that the investor expressly warrants that he has relied

only on the information in the contractual documents (i.e. and not on any representations given by the financial adviser, for example) would be clearly favourable to the financial institutions. Retail investors have reportedly complained that the prospectuses / pricing statements are lengthy and too difficult to understand. One possible response to that is that the risks are clearly stated in bold type-face on the cover page of the pricing statement and prospectus. Even if the investor did not fully understand what the particular financial product was all about, it is difficult to fathom how anyone who is able to speak basic English could think that these products are low-risk or no-risk. An investor simply had to read the bold-type face print on the cover page of such documents (or ask someone with some knowledge of the English language to explain it to them) to know that was not the case. It appears that there are investors who claim they were given copies of either the pricing statement or prospectus only after the contract was entered into. There is also the possibility that some investors received neither the pricing statement nor prospectus at the time the contract was entered into and signed by him. As a general proposition, if purported terms of contract are not made available to the counterparty either before or at the time the contract is entered into, they should not in principle form part of the contract between the parties. On the other hand, if contractual documentation signed by the investor makes express reference to another document that is intended to form part of the contract (e.g. the pricing statement), it can be argued that that other document is incorporated by express reference into the contract. Applying this proposition, if the pricing statement and/or prospectus were not given to investors before or at the time of the signing of the contract, but the signed contractual documentation cross-refers to those other documents in an appropriate and clear manner, then there may be scope for the financial institutions to argue that the pricing statement and/or prospectus have been incorporated by express reference. On the other hand, there is a common law rule that where terms in that other document are particularly onerous, additional steps must be taken to bring those terms to the attention of the counterparty. However, in the case of Press Automation Technology Pte Ltd v Trans-Link Exhibition Forwarding Pte Ltd [2003] 1 SLR 712, the Singapore High Court held that this common law rule does not apply where the contract is in fact signed by the party to be bound by this ‘onerous’ clause. In other words, if the contract cross-refers to another document and an investor signs that contract, he cannot later complain that the document was never given to him and that he never read it. Other recent case-law of the Singapore Court of Appeal tends to suggest that the retail investors may face an uphill task if they bring legal proceedings against the financial institutions.

In Orient Centre Investments v Societe General [2007] 3 SLR 566, the plaintiff alleged inter alia misrepresentation by a bank in relation to investments in a range of structured products. The Court of Appeal held that the terms and conditions – which included warranties by the plaintiff that it had not relied on any representation by the bank’s employees – constituted “an insuperable obstacle” for the plaintiff. The claim was struck out. There are also dicta in the case that suggest that the Court is not concerned with whether or not the plaintiff had taken the trouble to read the contractual documents before signing them. In general terms, it appears that the Court takes a hands-off approach to standard form written commercial contracts. For example, in Zurich Insurance (Singapore) Pte Ltd v B-Gold Interior Design & Construction Pte Ltd [2008] 3 SLR 1029, the Court of Appeal held that for such commercial contracts the presumption is that all the terms of the agreement between the parties are contained in the contract and that this presumption will be “almost impossible” to rebut. Similarly, in Orient Centre Investments, the Court held that where the plaintiff had warranted that it had not relied on any representations by the bank’s employees, it was precluded from bringing a claim based on those precontractual representations. The indications are that the Court in such cases will regard evidence of pre-contractual oral representations as inadmissible. However, in appropriate cases the plea of non est factum may succeed. For those who are elderly and not literate in English, they may stand some chance of persuading the Court that the contracts they signed were significantly different from what they intended to enter into.

They would need to

also show that they were not negligent in signing the contracts. It has been pithily observed in one Singapore legal textbook that for a plea of non est factum to succeed, “it helps to be old, illiterate and half-blind”. Bearing in mind the possibility of a plea of non est factum, it is noteworthy that the financial institutions are paying particular attention to the claims of mis-selling made by senior citizens with little education. It is arguable that in any litigation going forward, this group would appear best placed to mount claims of non est factum against the financial institutions. FIDUCIARY DUTY The investors affected by the collapse of Lehman Brothers may also bring claims for breach of fiduciary duty by the relevant financial adviser. There is authority for the proposition that a banker who advises a customer on investments is acting in a fiduciary relationship with that customer. However, it is settled law that fiduciary duties can be amended or excluded altogether by contract. Therefore, based on what has been stated above in relation to limiting the scope for an action in

contract, liability for breach of fiduciary duty may also be excluded by appropriate wording in the material contractual documentation. In Orient Centre Investments, the Court held that the plaintiff could not recover for breach of fiduciary duty given the terms of the written agreements entered into by the parties. STATUTORY DUTIES Under the Securities and Futures Act (Cap 289) (“SFA”) and Financial Advisers Act (Cap 110) (“FAA”), Parliament has regulated, amongst other things, the prospectus requirements for structured products as well as set down what are in effect minimum professional standards for the financial advisers’ profession. Sections 253 and 254 of the SFA create criminal and civil remedies for false or misleading statements in the prospectus. It has been suggested that many of the types of structured products which the 10,000 or so investors bought were not suitable for the retail market.

In response, it should be pointed out that these

products were lawfully sold in Singapore. In fact, the Lehman MiniBond Programme, DBS High Notes 5 and Merrill Lynch Jubilee Series 3 LinkEarner Notes all met the requirements for registration under the SFA and MAS registered the relevant prospectuses after being satisfied by the information in the prospectus. However, it must be noted that in registering the prospectus, MAS asserts (and rightly so) that it does not judge the merits of the investment. Of particular concern to a financial institution will likely be the obligations placed on a financial adviser under the FAA, in particular sections 25 to 27 thereof. Section 25 relates to product disclosure and, in particular, disclosure of the risks which may arise from the product, while section 26 deals with false or misleading statements made by the financial adviser. Both sections are enforced through criminal penalties, being fines and/or imprisonment or both. On the other hand, section 27(1) of the FAA requires a financial adviser to have a reasonable basis for making a recommendation to a person who may reasonably be expected to rely on the recommendation with respect to an investment product. In considering this, the financial adviser must consider the investment objectives, financial situation and needs of the particular investor. An investor who acted in reliance on the recommendation and suffers loss or damage has a right of action against the financial adviser for damages if Section 27(1) is contravened by the financial adviser. From the perspective of the financial institutions, it is useful to note section 27 only grants a remedy to an investor “who may reasonably be expected to rely on the recommendation” of the financial adviser.

Therefore, in the case of many institutional investors and experienced or sophisticated retail investors, an argument could certainly be mounted that they do not fall within the category of persons who are reasonably expected to rely on the relevant recommendation. MAS has published ‘Notices’ under the FAA which flesh out the obligations on a financial adviser. It is stated that any breach of these Notices is subject to criminal sanctions. In our view, it is unlikely (but not inconceivable) that the Court will permit the investors to sue the financial institutions for civil remedies under sections 25 and 26 of the FAA as well as the relevant Notices issued by MAS, the main reason being that a breach of these particular provisions is expressly punished by criminal penalties in the first place. However, if the financial institutions have breached these provisions, they may of course face criminal proceedings in respect of such breaches. Finally, it would probably be difficult for a financial adviser to rely on contractual documentation purporting to exclude liability for breaches of statutory duties imposed on the financial adviser under the FAA as duties imposed by statute should be observed and complied with and parties should not, by use of contract, be permitted to exclude liability for breaches of statutory duty. CONCLUSION The sale of structured financial products to the retail market raises some important legal issues. At the risk of stating the obvious, each case will turn on its own particular facts and circumstances. At the time of writing this note, it appears that no legal action has been commenced in the courts in respect of DBS High Notes 5 or Lehman Minibonds. Contributed by: Litigation & Dispute Resolution Department

Contact: Chan Kia Pheng, Partner, Litigation & Dispute Resolution Department Tel: (65) 6238 3303; Fax: (65) 6535 1030; Email: [email protected] Ng Yeow Khoon, Partner, Litigation & Dispute Resolution Department Tel: (65) 6238 3211; Fax: (65) 6535 1030; Email: [email protected] Chua Beng Chye, Partner, Litigation & Dispute Resolution Department Tel: (65) 6238 3204; Fax (65) 6535 1030; Email: [email protected]