Another failed FOS judicial review on the issue of whether a customer was an "eligible complainant"

The High Court has rejected a judicial review claim arguing that (1) a complainant was not an eligible complainant having identified themselves as an "elective professional client" and (2) the FOS' approach to redress (adopting the FTSE UK Private Investors Income Total Return Index) and contributory negligence was irrational. The High Court judgment is a further example of the courts endorsing FOS' approach to complaints and its wide jurisdiction. The judgment is hot on the heels of the Court of Appeal judgment in Options last month. It is also a further example of permission having been granted to proceed with a judicial review and the increased appetite for respondent firms to challenge FOS, likely to be fuelled by the ever increasing FOS redress caps.

The facts

Professor Willcocks (the complainant) entered into a Managed Discretionary Advisory Agreement with Linear Investments Ltd (Linear) (the respondent) under which Linear provided discretionary investment management services.  Professor Willcocks completed an account opening form (AOF) and client application, depositing £100,000 in which trades were made in Contracts for Difference (CFDs).  Linear only worked with 'professional clients' and Professor Willcocks had been categorised by Linear as an "elective professional client" (having identified himself as falling within hat definition). 

At the time of his application to Linear, Professor Willcocks had been employed at the London School of Economics for 12 years specialising in robotic automation (and so his expertise was not in finance).  He had an investment portfolio of c. £800,000 with approximate annual income of £220,000 derived from savings and investments and an approximate net worth of £2.2m with no debts.  

The AOF recorded that Professor Willcocks worked in education and had the same employer for 12 years, it also recorded his investment portfolio at £800,000.  The AOF had various boxes to indicate investment experience, Professor Willcocks selected equities, CFDs and alternative investments/funds.  He selected "no" to options, futures and FX.  Having selected equities and CFDs, Professor Willcocks then had to identify the length of activity (indicating 2 years plus) and number of transactions (said to be 40-80) and for investment funds he had to confirm if he had experience in fixed income, bonds and funds (to which he selected all three).  He also selected that his experience included both execution only and advisory.  

Following his investment, Professor Willcocks complained to Linear albeit he did not directly challenge his categorisation as an "elective professional client", instead the focus was on what he described as a "misleading" contractual term that sought to exclude a right to complain to the Ombudsman.  He also complaint that Linear had used misleading terms and conditions relating to account fees, used misleading performance information relating to investment strategies and mismanaged his account including a failure to manage risk appropriately.  Professor Willcocks also explained that he had no experience in trading CFDs (despite the AOF he completed suggesting the opposite).

Relevant FOS rules – 'professional client'

In order to complain to FOS a complainant must be an "eligible complainant".  An "eligible complainant" does not include a "professional client" (amongst other carve outs).  For an FCA regulated firm to treat a client as a "professional client" at the time (2018) it was necessary to comply with COBS 3.5.3R which required:

1. The firm to undertake an adequate assessment of the expertise, experience and knowledge of the client that gives reasonable assurance in the light of the nature of the transactions or services envisaged that the client is capable of making their own investment decisions and understanding the risks involved (the 'qualitative test');
2. In the course of the assessment, at least two of the following must be satisfied: (a) the client has carried out transactions in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters, (b) the size of the client's financial instruments portfolio, defined as including cash deposits and financial instruments, exceeds EUR 500,000, and/or (c) the client works or has worked in the financial sector for at least one year in a professional position which requires knowledge of the transactions or services envisaged (the 'quantitative test')
3. The following procedure is followed (a) the client must state in writing to the firm that it wishes to be treated as a professional client either generally or in respect of a particular service or transaction or type of transaction or product, (b) the firm must give the client a clear written warning of the protections and investor compensation rights the client may lose in providing such a confirmation and (c) the client must state in writing, in a separate document from the contract, that they are aware of the consequences of losing such protections.

However, even if a customer is a "professional client" that can only relate to an activity where they are a professional client – i.e. just because a professional client meets the criteria in one instance does not mean they meet the definition in all instances (DISP 2.7.9AR).

FOS decision

The FOS investigator upheld the complaint which was then referred to the Ombudsman who produced two provisional decisions (the first applying contributory negligence at 25% and the second rejecting any contributory negligence argument).

In relation to whether Professor Willcocks was a "professional client" the Ombudsman found he was not and in doing so referred to the following:

• The AOF amounted to not much more than self-certification and the tick box answers alone did not amount to an adequate assessment of a client's experience, knowledge and expertise or provide enough evidence to give Linear reasonable assurance that Professor Willcocks was capable of making his own investment decisions and understanding the risks involved.
• The AOF itself required the potential client to attach appropriate evidence to support categorisation but no evidence was provided.
• The AOF put Linear on notice of certain "red flags" – (1) the form asked for a brief explanation of knowledge and experience and none was provided, (2) the planned transactions were in CFD but the information provided by Professor Willcocks was that he had invested for more than 15 years in blue chip stocks (indicating that he did not have evidence or knowledge of investing in CFDs) and (3) conflicting information had been provided in the broker application form where Professor Willcocks had ticked to confirm he had worked in the financial sector for at least a year but this was contradicted by his employment history.
• Linear could provide no evidence that it had verified details of Professor Willcocks' experience (including previous investments in CFDs).

The Ombudsman concluded that had Linear sought further evidence from Professor Willcocks to support the tick box answers (which the Ombudsman said it should have done), Professor Willcocks would not have been able to provide that information and so would not have satisfied the qualitative test.

Having found that Professor Willcocks was not a professional client (and so able to complain to FOS as an eligible complainant), the Ombudsman found that Professor Willcocks was misled into investing in the investment strategy as a result of it being described as medium risk when it was high risk and it was unlikely the investment would have been made had it been known it was high risk.  There was also a failure to provide the required information in relation to costs and charges as well as likely returns and other misleading information. 

Having applied a discount of 25% for contributory negligence in the first decision, the Ombudsman changed his mind in the second provisional decision instead finding that he had given too much weight to Professor Willocks' incorrect information in the AOF.  In reaching a decision not to apply any contributory negligence discount, the Ombudsman found that the onus was on Linear to properly assess Professor Willcocks' knowledge and experience and Linear had failed to do so, including the size of previous trades to satisfy the quantitative test and so Professor Willcocks should not have been classified as an elective professional client in the first place. 

The Ombudsman awarded redress based on a comparison of the return on Professor Willcocks' investment against what the return would have been adopting the FTSE UK Private Investors Income Total Return Index.

The judicial review

Linear challenged the Ombudsman decision by way of judicial review arguing that:

• The Ombudsman had failed to acknowledge the central importance of the contract Professor Willcocks had signed and that Linear was entitled to rely on Professor Willcocks' assertion that he was an elective professional client. Professor Willcocks was a wealthy, sophisticated and highly intelligent investor.  He could not go back on the contents of his AOF and associated documentation on which Linear was entitled to rely.
• The Ombudsman was irrational in deciding that Professor Willcocks could be both a professional client for the purposes of investment business and simultaneously a consumer in respect of his portfolio.
• The Ombudsman could not lawfully interfere with Linear's client classification based on the information provided by its client and having reached a properly conducted assessment it was entitled to reach. Further, Professor Willcocks did not challenge his elective professional client status in his detailed complaint.
• It was irrational for the Ombudsman to adopt the FTSE UK Private Investors Income Total Return Index – it was too mainstream and conservative.  Professor Willcocks had identified a hedge fund comparison himself in his complaint being a high risk alternative investment and a more apt comparison.  Further the Ombudsman's refusal to request disclosure as to where Professor Willcocks subsequently invested £100,000 when he left Linear meant that the Ombudsman deprived themselves of crucial information to adequately identify a rational benchmark.
• The decision not to adopt a discount for contributory negligence was irrational. 

The High Court rejected the arguments made by Linear on the basis that:

• The Ombudsman's finding that Professor Willcocks was not a 'professional client' was reached for "perfectly cogent reasons" as set out in the decision and in particular when relying on the finding that Linear had not undertaken an adequate assessment of the expertise, knowledge and experience of the client to meet the qualitative test.  Further, it is possible for a person to be a consumer for some purposes and not others.
• Linear's submissions on the primacy of the contract "bore little relation to the wording of COBS" when it came to the test Linear had to satisfy to treat a client as a "professional client", that is because the test required Linear to undertake an assessment of the expertise, experience and knowledge of the client and the test was not whether Linear's assessment was irrational faced with the documentation it was provided with.
• The Ombudsman explained the reasons for adopting the FTSE UK Private Investors Income Total Return Index and it was "self evidently not irrational and expressly took account of the circumstances of the case.  Similarly the Ombudsman's decision not to seek further disclosure from Professor Willcocks was not irrational".  Notably the High Court went as far as to say "… What relevance to the calculation of fair compensation would it have had if he [Professor Willcocks] had placed his money from Linear under the mattress in March 2019?", effectively concluding that what Professor Willcocks would have done with the monies had he not invested it via Linear was not relevant to the assessment of loss.
• The High Court rejected the arguments on contributory negligence finding that (1) the Ombudsman carefully explained their reasons, (2) the reasoning was sound – mistakes in the AOF were not causative of the losses and (3) the Ombudsman is not required to cite or apply common law principles in any event.

What next?

A broad takeaway from the decision is the failed challenge to FOS' adoption of the FTSE UK Private Investors Income Total Return Index which is often a cited by respondent firms as particularly unfair given the "high" returns it produces against the returns often sought by the complainants in the underlying investment which forms the basis of the complaint or otherwise might be considered as an appropriate investment for a complainant (if they had placed the monies elsewhere).  A further broad takeaway are the findings in relation to contributory negligence.  Both grounds for challenge required Linear to establish that the Ombudsman had acted irrationally in reaching the decision that it did (a high bar).

As to the judgment on the approach to classifying customers as 'professional clients', given the onus under COBS that the regulated firm effectively checks that a client meets the criteria, the take-away would appear to be that it's not enough to rely on what a customer merely says by reference to a tick-box exercise, more is needed.  In particular (1) evidence to back up what the client says and (2) checks to ensure that what they say "fits together" against other documents providing an insight into their investment experience.  Checks for inconsistencies is a trend at FOS where, with the benefit of hindsight and time, FOS often centre on inconsistencies to justify an assertion that red flags at the time were missed.  This means that more time (and cost) is likely to have to go into processes for firms (whether onboarding or otherwise) to try and provide some level of protection that statements made by customers are reliable.

Although this is another example of a judicial review of a FOS decision failing, it is also an indication that the courts appear more willing to grant permission for judicial review with cases going to a full hearing.  We expect more challenges to FOS with the increase in FOS limits given there is simply more money at stake for regulated firms and so we are likely to see further decisions testing FOS' jurisdiction going forward.