England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE QUEEN'S BENCH DIVISION
COMMERCIAL COURT
(MR JUSTICE TEARE)

		Royal Courts of Justice Strand, London, WC2A 2LL
		3 April 2012

Lord Justice Toulson:

1. On 4 October 2011 Teare J handed down a judgment dismissing a claim brought by the claimants against Credit Suisse for alleged mis-selling of financial products known as SCARPs (which is short for "Structured capital-at-risk products"). The claimants have appealed against this judgment, with leave given by Sir Mark Waller. The appeal is likely to be heard in June by a court which is almost certain to be differently constituted.
2. The matter comes before the court today on an application by the claimants for an order for disclosure under CPR 31.12 in advance of the hearing of the appeal. The claim relates to 10 SCARPs, or notes, which were sold to the claimants by CS between February 2007 and June 2008. They were all purchased with loans and so were leveraged. The purchasers were the late Mr Mohamed Zeid, his wife and daughters. Mr Zeid died at the age of 77 on 16 May 2010, after the action had been commenced but before he had made or prepared a witness statement. The action was continued on his behalf by his wife and daughters on their own behalf and as his personal representatives.
3. Mr Zeid was a successful and wealthy businessman. His major commercial activity was in the oil industry, but his interests and responsibilities extended into insurance, financial services and banking. He began to buy structured products from the CS Group in 2003. He also bought structured products from other banks. Prior to buying the ten notes which were the subject of the claim, Mr Zeid had bought around 30 structured products from CS. He acted on behalf of himself, his wife and daughters. They played no active part in his investment decisions. Mr Zeid entered into a written advisory agreement with CS in February 2005. The person who dealt with Mr Zeid on behalf of CS was a Mr Zaki, who was employed by CS as a relationship manager on the Middle East desk. Mr Zaki would receive commission on the sale of the products.
4. The relationship between the parties turned sour in October 2008 as a result of the failure of Lehman Brothers, the collapse of other banks and the seizing up of inter-bank lending. The Nikkei index plunged, wiping a significant amount off the value of the notes. CS issued a margin call, which Mr Zeid did not meet. It then liquidated some of the products, with a resulting loss to the claimants of nearly US $70 million. The claimants sued CS for the shortfall.
5. Their claims were put under a number of heads, but it was made clear in the claimants' written closing submissions that at its heart the claim was about breaches of statutory duty. The breaches alleged were breaches of the Conduct of Business Rules ("COB") and Conduct of Business Sourcebook Rules ("COBS"), issued by the FSA under the Financial Services and Markets Act 2000. One set of rules succeeded the other and for present purposes it is not necessary to distinguish between them. Section 150 of the Act provides that a contravention of the rules is actionable at the suit of a person who suffers loss as a result of the contravention, subject to the defences and other incidents applying to actions for breach of statutory duty.
6. The judge summarised the issues and the way in which the case was presented in paragraphs 3 and 4 of his judgment:

"3. Considerable forensic effort was expended by the Claimants in showing that certain aspects of CSUK's record keeping and the manner in which CSUK had classified Mr. Zeid and the Claimants pursuant to COB 4 and COBS 3 were unsatisfactory. Aspects of CSUK's record keeping and classification of the Claimants did not inspire confidence that CSUK gave proper attention to its statutory duties but they are not in truth the foundation of the claim. The foundation of the claim lay in CSUK's duty under COB 5 and COBS 9 to ensure, where it makes a personal recommendation concerning an investment, that its advice is suitable for the client. Reliance was also placed on a duty of CSUK under COB 7.9 not to arrange for the loan of money in connection with a proposed investment unless certain conditions were satisfied, in particular that the arrangements for the loan and the amount concerned were suitable for the type of investment proposed. There is no such duty under COBS but instead there is guidance (not a rule) that when considering the suitability of an investment which is linked to a loan the suitability of the overall transaction should be taken into account.


4. There was a factual dispute between the parties as to whether CSUK made a personal recommendation to Mr. Zeid to buy the structured products in question. If CSUK made such a recommendation then CSUK had a duty to ensure that its advice was suitable for Mr. Zeid pursuant to COB 5 and COBS 9. If no such recommendation had been made then no such duty arose. There was also a factual dispute as to whether CSUK (as opposed to another Credit Suisse entity) arranged for a loan. If it did, then it had a duty only to do so under COB 7.9 in certain circumstances. If it did not, then no such duty arose."

7. In relation to the claims under COB 5 and COBS 9 the judge found in favour of the claimants on the first question, which was whether a personal recommendation was made to Mr Zeid to buy the products in question. The next question was whether CS's advice was suitable for the clients. The judge found that notes 1 to 7 were suitable, having regard to Mr Zeid's investment objectives and his understanding of the risks which were entailed. He found that, notwithstanding Mr Zeid's appreciation of the risks and his ability to bear the consequences, by May to June 2008 the state of the market and the nature of Mr Zeid's portfolio were such that notes 8 to 10 were unsuitable. There was therefore a breach of COBS 9.2.1 in that CS, through Mr Zaki, recommended the purchase of notes 8 to 10 without taking reasonable steps to ensure that the recommendation was suitable for Mr Zeid.
8. However, the judge found that the claimants had failed to establish that they suffered any loss as a result of Mr Zaki's recommendations, because the judge was not persuaded that Mr Zeid relied on Mr Zaki's recommendations in deciding to purchase notes 8 to 10. At paragraph 133 of the judgment the judge said:

"133. ... In May/June 2008, at a time of great market volatility, Mr. Zeid made very large investments, involving substantial leveraging. He did so, notwithstanding that in January-April 2008 there had almost been a margin call and that he had promised to provide additional collateral. To invest in products linked to equity markets in May/June 2008 one had to have had a serious appetite for investing and to be bullish, brave and confident. Mr. Zeid was, it seems to me, all of those and was determined to get an enhanced return on his money. Mr. Zaki described Mr. Zeid as having an 'appetite for continuing to purchase…….He was a pro, he was bullish about the market and he wanted to take advantage.' In deciding to purchase notes 8-10 it is more likely than not that Mr. Zeid relied on his own judgment and not on advice from Mr. Zaki. If Mr. Zeid had not received advice on the merits from Mr. Zaki he would still have bought the notes and suffered loss when they were liquidated. Put another way, if Mr. Zaki had advised that notes 8-10 were unsuitable, it is more probable than not that Mr. Zeid would still have purchased them and suffered loss when they were liquidated.

9. As to the separate claim under COB 7.9, the judge explained at paragraph 121 that:

"121. ... Pursuant to COB 7.9 a firm which lends money or arranges for another person to do so must not do so unless, inter alia, it has made and recorded an assessment of the customer's financial standing and has taken reasonable steps to ensure that the arrangements for the loan and the amount concerned are suitable for the type of investment which the customer is likely to enter into. Under COBS 9.3.4 guidance was given that, when considering the suitability of a recommendation, which is linked to a loan, the firm should take into account the overall suitability of the overall transaction."

The judge dismissed that part of the claim for reasons which he set out at paragraph 123:

"123. In circumstances where an existing credit facility is drawn down I do not consider that COB 7.9 imposes an additional duty to consider the suitability of drawing down the loan. COB 7.9 appears to me to be dealing with the suitability of a loan or credit facility at an earlier stage, namely, when it is granted, not when it is drawn down. Thus the customer is required to give his 'prior written consent to both the maximum amount of the loan or credit and the amount or basis of any interest or fees.' The customer will surely do that when the loan or facility is granted, not when it is drawn down. Before granting the facility the firm must have taken reasonable steps to ensure that the arrangement for the loan or credit and the amount concerned are suitable 'for the type of investment agreed proposed or which the private customer is likely to enter into.' There was no suggestion in the present case that when the credit facility of US$100m. was arranged by CSFB in January 2005 or when CSUK arranged the Framework Credit Limit in September 2006 that such credit was unsuitable for Mr. Zeid. What was suggested was that when that credit was drawn down to purchase structured credit products, and in particular, the 10 which form the subject matter of this claim, those purchases, taking into account the substantial leverage, were unsuitable for him. In my judgment leverage was a relevant matter to take into account when assessing suitability, but that duty arose pursuant to COB 5.2.5 and COBS 9.2.1."

10. In the grounds of appeal the claimants have not sought to appeal against the judge's dismissal of the claims under COB 5 and COBS 9. In other words, they have not sought to appeal against his finding that notes 1 to 7 were suitable for Mr Zeid and that he did not rely on Credit Suisse's recommendation in deciding to buy notes 8 to 10. The grounds of appeal relate only to notes 1 to 7 and COB 7.9. The appellants submit that the judge's reasoning in paragraph 123 was wrong and that COB 7.9 applied when the credit facility was drawn down for the purchase of notes 8 to 10.
11. The claimants lodged their notice of appeal on 25 October 2011. On the same day the FSA published a final notice imposing a penalty of £5.95 million on CS for failing to take reasonable care to establish and maintain effective systems and controls in respect of the suitability of its advice regarding SCARPs to its private customers. The amount of the financial penalty was 30 per cent less than it would otherwise have been to give credit for what, in the language of other courts, would be termed an early guilty plea.
12. The FSA investigation followed from a routine visit by the FSA's supervision team in November 2009 when it performed a limited review of Credit Suisse's systems and control framework. In February 2010 the FSA decided to carry out a two-pronged investigation. It appointed an external firm to carry out a skilled person's report under section 166 of the Act to assess the adequacy of Credit Suisse's systems and controls and, through the FSA's own Conduct Risk Division, it also examined the files of 30 private clients who had bought SCARPs during the period from 2007 to 2009 inclusive. Those clients did not include the claimants but did include two other clients for whom Mr Zaki was the relationship manager.
13. Paragraph 2.3 of the FSA final notice identified in summary five failings. The FSA found that CS:

"2.3 ...

(1) failed to have in place adequate systems and controls in respect of the determination of Customers' attitudes to risk. ...

(2) failed to take reasonable care to adequately evidence that the SCARPs it recommended to its Customers were suitable, given the assets and investments held by those customers at the time. ...

(3) failed to have in place adequate systems and controls surrounding the recommendation of leverage to Customers. ...

(4) failed to have in place adequate systems and controls surrounding levels of issuer and investment concentration within Customers' portfolios. ...

(5) did not effectively monitor its staff to ensure that they took reasonable care to ensure the suitability of their advice. ..."

The FSA concluded at paragraph 2.4 that as a result of those failings Credit Suisse's customers were exposed to an unacceptable risk of being sold a SCARP which was unsuitable for them. The notice also stated:

"2.4 ... The FSA has not proceeded to examine whether any individual advised sales were in fact unsuitable."

14. By the present application the claimants seek an order that Credit Suisse should within 14 days provide to the appellants documents relating to the FSA's investigation (including documents relating to the skilled person's report) which resulted in the Final Notice dated 25 October 2011 and which documents adversely affect its own case (as it was put before Teare J) or support the claimants' case (as it was put before Teare J).
15. There is an argument whether any or all of those documents ought to have been disclosed in the course of the action. Credit Suisse say that they were not under any obligation to do so. They point out that the vast majority of the files examined by the FSA related to customers who had no connection with Mr Zaki; only two of the customers related to Mr Zaki; and the claimants were not themselves customers whose files were examined. The claimants say that this is not the point and that what really matters is that there was a striking similarity between criticisms made by them of Credit Suisse and the areas where the FSA found the system of monitoring and recording to be systemically defective.
16. If it had become known that the FSA investigation was going on prior to the trial and there had been an application by the claimants for specific disclosure, I can see that it would have been a heavily fought application and arguments of some merit could have been advanced either way. I do not consider that the outcome would have been open and shut. It would have been a matter for the judge's discretion, having regard to the overall shape of the case, and he might, for example, have ordered disclosure of the skilled person's report. But I do not consider it necessary to endeavour to conduct a hypothetical retrospective exercise of that kind for the purpose of determining the present application.
17. I would refuse the present application for these reasons. First, the documents sought have no relevance to the issues presently raised by the claimants' ground of appeal or by the Respondent's Notice in relation to that appeal. In his oral submissions Mr Robert Anderson QC did suggest that the documents sought have some potential relevance to the issues about COB 7.9, raised by the notice of appeal and by the Respondent's Notice, but when that point was explored in argument it did not bear analysis. The reality is that the claimants are seeking to find out whether they may have some other arguable grounds of appeal and for that purpose they are seeking wide disclosure of documents which, as I say, are not germane to the issues presently raised in the appeal. That factor may not be a fatal objection. I accept that this court has jurisdiction to consider whether the application ought to be granted on the merits, and that involves a discretion, but it is certainly right in these circumstances to approach the application with caution.
18. Secondly, the essence of the FSA's findings is that there was a systemic failure to maintain proper records and controls which put customers at risk of mis-selling because bad advice may have been given which should have been prevented or detected by proper monitoring and recording. It is, however, of the first importance to remember the ground on which the claim failed. This was the judge's assessment that Mr Zeid knew what he was doing, that notes 1 to 7 were consistent with his objectives and that he did not act on Credit Suisse's recommendations in buying notes 8 to 10. When considering the critical issue of the suitability of the notes, the judge said at paragraph 99:

"99. CSUK's approach to obtaining and recording information about Mr. Zeid therefore appears to have lacked the rigour and care which COB and COBS required. But, although detailed submissions were made about that approach and, in particular, as to the manner in which CSUK and its predecessor had classified Mr. Zeid, those submissions did not, in my judgment, ultimately assist the Claimants' case on suitability. It was accepted by CSUK that Mr. Zeid and his family had to be regarded as private clients. Mr. Zaki regarded Mr. Zeid as an "expert" private client but I am not persuaded that he was wrong to do so. Mr. Zeid plainly had a high level of interest in the market, formed views about the market and had confidence in his own views. Mr. Zaki could and should have made more enquiries as to Mr. Zeid's net worth but no evidence was adduced to suggest that Mr. Zeid could not bear the financial risks to which he was exposed by trading in CDIs. The important point, it seems to me, is whether the recommendations made by Mr. Zaki were suitable for Mr. Zeid. If they were not suitable then it adds nothing to enquire whether Mr. Zaki's approach to obtaining and recording information and classifying the Claimants lacked the required rigour and care. If they were suitable, then again it cannot matter whether his approach to obtaining and recording information and classification was adequate or not. Of course, if the recommendations were not suitable for Mr. Zeid the extent to which Mr. Zaki failed to exercise the required degree of rigour and care in obtaining information about Mr. Zeid may, depending upon the reasons why the recommendations were unsuitable, be relevant when assessing whether Mr. Zaki, and hence CSUK, took reasonable steps to ensure that the recommendations were suitable. In that sense regulatory failures in the information gathering exercise may evidence a breach of the duty to take reasonable steps to ensure that the recommendations were suitable but they do not, it seems to me, assist in showing that the recommendations were not suitable."

This is an important passage. What is also an important fact is that the claimants have not sought to suggest that the judge erred in principle in adopting that approach. There is no ground of appeal asserting that this was a misdirection by the judge. In those circumstances it is perhaps unnecessary to add (but I nevertheless do add) that the judge's approach was logically entirely correct.

19. Failures in the recording and monitoring system in relation to the claimants' investments may evidence a failure to take reasonable steps to ensure that the recommendations were suitable, but that does not affect the question whether the advice given was in fact suitable. The judge properly recognised that that was a discrete question. Nor does it make a difference to show that failures of recording and monitoring which applied to the claimants and Mr Zaki were not confined to him but were replicated among a cross-section of Credit Suisse's customers and relationship managers. The FSA itself recognised the distinction between adequacy of systems and suitability of advice in paragraph 2.4 of its final notice, which I have already quoted. I refer to its statement that the FSA had not proceeded to examine whether any individual advised sales were in fact unsuitable. That was a separate issue from the issue which the FSA was investigating.
20. Accordingly, it is hard to see what difference the findings of the FSA, and the underlying material which may support it, might have made to the judge's findings on the crucial issues (a) whether the advice given was in fact suitable to Mr Zeid's investment objectives and ability to bear the loss, and (b) whether as a matter of causation he in fact relied on the advice given in relation to notes 8 to 10.
21. In his oral submissions Mr Anderson sought to establish a connection in three ways. First, he submitted that knowledge of the skilled person's findings may have affected Teare J's judgment on the question of what Mr Zaki himself knew about the nature of SCARPs and therefore whether he was capable of giving appropriate advice to Mr Zeid. At paragraphs 55 to 56 of his judgment the judge accepted that Mr Zaki probably lacked the degree of understanding of the products which a technician would have had, but he found that he did understand the basic structure of the notes, and so did Mr Zeid.
22. Mr Zaki was in the witness box for three days. He was cross-examined in detail about his understanding of the products. The court had all the PCRM (private client relationship management) entries which he had made in relation to the 40 products sold to Mr Zeid. I am unimpressed by the suggestion that additional documentation relating to the two other clients of Mr Zaki who were part of the FSA review, or that information about the monitoring and recording deficiencies of Credit Suisse in relation to other clients or relationship managers, would have had any bearing on the judge's assessment of what Mr Zaki understood about the nature of the products.
23. Secondly, Mr Anderson submitted that the judge might have concluded that the materials that must have been in the skilled person's report went to undermine any value in the entries made by Mr Zaki in the PCRMs. The judge gave his assessment of Mr Zaki at paragraph 12 of his judgment.

"12. Mr. Zaki gave evidence over three days. He left Credit Suisse at the end of 2008 and so did not appear to have a direct interest in the result of this litigation. At first he was keen to know where the questions were going and therefore appeared to be guarded in his answers. Some of his answers were also long and at times difficult to follow. From time to time he disagreed with what had been said in the contemporaneous documents. However, as time went on he engaged with the cross-examiner in a manner which appeared to be that of an honest witness, keen to give his evidence of what actually happened between himself and Mr. Zeid. Obviously, where the events in question took place between 2003 and 2008, his evidence must be tested against the contemporaneous (or almost contemporaneous) documents which are likely to be a better guide to what happened than his recollection in 2011. But where there are no documents to test his recollection I considered that his evidence, where it was clear, was worthy of belief unless there were some particular reason for regarding it as improbable. His assistant Rabih Khodari, who also gave evidence, appeared to me to be a witness who was seeking to tell the truth. He also had the merit of speaking with great clarity."

24. The claimants through counsel conducted a vigorous attack on the adequacy of the records maintained by Mr Zaki, but they did not suggest that he had acted dishonestly in relation to them. I cannot see any realistic basis for supposing that knowledge of the systemic deficiencies in monitoring and recording, which were revealed in the FSA notice, would rationally have caused the judge to form a different view of Mr Zaki's honesty and credibility as a witness.
25. Thirdly, an important aspect of the criticism made of the products was that they were too highly leveraged. The adequacy or inadequacy of the monitoring and recording of the suitability of degrees of leveraging was a matter which concerned the FSA, and I have already referred to the criticism in paragraph 2.3(3). Summarising the criticisms made in the report, I gave an abbreviated version of that paragraph. In this context it is fair to read out the entire subparagraph. It reads as follows:

"(3) Credit Suisse failed to have in place adequate systems and controls surrounding the recommendation of leverage to Customers. Where leverage was used to fund transactions there was often no documentation available to evidence the rationale for recommending leverage, the appropriateness and the amount of the leverage in the context of the Customer's overall wealth, or whether the risks associated with the use of leverage had been considered by the relevant Relationship Managers. In addition, there was no formal mechanism to monitor the amount of leverage within the Customers' portfolios;"

26. Those criticisms were developed further in the final notice at paragraphs 4.22 and following. At paragraph 4.22 the FSA explained the significance of leverage:

"4.22 ... If a customer uses leverage to make an investment and the investment rises in value, then the customer's gains are increased reflecting the amount of leverage used. Conversely, if the investment falls in value, the customer's losses are much greater than they would have been if the investment had not been leveraged. Consequently, leverage magnifies both the customer's gains and losses."

The judge found that in the instant case the degree of leverage was very high, and acknowledged by Mr Zaki to be so. The judge said at paragraph 124:

"124. ... Mr. Zaki accepted that it was 'excessive'. Its particular relevance lay in the fact that it increased the quantum of any loss of capital and that it would lead to a demand for additional collateral when the loan to value ratio fell below the ratio regarded by CSUK as acceptable, usually 70%. It seems clear that the amount of leverage extended to Mr. Zeid was usually the maximum or nearly the maximum available to him at any particular time."

The judge then had to consider the significance of this in relation to Mr Zeid. At paragraph 125 he found as follows:

"125 ... But whether or not the leveraging made available to Mr. Zeid, which was undoubtedly on a grand scale, was unsuitable for Mr. Zeid depends on his understanding of the risks involved and his ability to bear the consequences of those risks if they materialise. There can be no doubt, having regard in particular to the experience of June 2006 and the market and financial information provided to him by and discussed with Mr. Zaki, that Mr. Zeid understood the risks associated with leverage. No evidence was led which suggested that Mr. Zeid was unable to bear the risks involved. These matters, coupled with the fact that Mr. Zeid had accepted substantial leveraging since 2003, suggest that notes 1-7, notwithstanding the leveraging levels, were suitable for Mr. Zeid and I so find."

27. I cannot see the logical basis on which it might be said that the additional material about Credit Suisse's systemic failures in recording and monitoring would have caused the judge to reach a different factual conclusion in relation to what Mr Zeid understood and the risk which he was prepared to run. As to notes 8 to 10, the judge accepted that they were unsuitable, but once again there is no logical connection that I can perceive between the additional material which the claimants seek and the judge's finding of fact that Mr Zeid did not rely on the advice that he was given in deciding to buy those products.
28. Finally, I would note that a disclosure exercise of the kind now applied for by the claimants would be likely to involve a substantial review exercise on the part of the respondents. It is not a case where a single document or a small number of documents has been identified. Credit Suisse and its advisers would potentially have to trawl through a very large number of documents to see whether any of them might have some potential bearing, the basis of which, for reasons I have already given, seems to me to be at the upper end of speculation.
29. Taking all these matters into account, I am not persuaded that it would be appropriate to grant this application.

Lord Justice Davis:

30. The very wide-ranging disclosure sought by this application, in my view, does not and did not truly bear on the pleaded case as advanced at trial. As the witness statement of Mr Bisseker explains, the FSA investigation did not specifically relate to Mr Zaki's dealings with Mr Zeid or to the ten notes which were the subject of the proceedings, nor was the focus of the investigation of the FSA on the specific regulatory duties alleged in the proceedings to have been breached by the respondent. The respondent, in my view, therefore was under no obligation to disclose any of the documents "relating to" the FSA investigation in the course of the proceedings alone. Nor does the disclosure as now sought bear on the grounds of appeal as currently formulated. Those grounds allege errors of law, not of fact, on the part of the judge as to rule 7.9 of the Conduct of Business Rules and as to financing. Further, the disclosure sought does not bear on the Respondent's Notice either.
31. To the extent that such disclosure as sought might assist some amended case on appeal, that seems to me to be entirely speculative. As Mr Anderson QC himself frankly and fairly said in the course of argument, it is difficult without seeing the documents to formulate additional grounds of appeal. That concession really says it all. In my view, such documentation would be directed to matters entirely collateral to what was and currently is truly in issue. The disclosure sought would in effect amount to a fishing expedition to see if some new case or some ground of appeal might emerge. Mr Anderson accepted that he must meet the terms of CPR Rule 31.6 to obtain such disclosure and, in my judgment, he does not do so.
32. I therefore agree that this application should be refused.

Lady Justice Arden:

33. I agree with both judgments.

Order: Application refused