"I like risky": spread betting firm did not exceed permissions by providing advice

15 November 2011

In for a penny, in for a pound, or in for £313,067.02.

In an important case for financial firms offering execution-only services, the high court in City Index Limited v Romeo Balducci has held that Courts must have regard to the 'reality of the trading relationship' when considering whether the provision of market information to customers constitutes regulated advice.

In addition to Mr Balducci's spread betting losses which City Index was seeking to recover, this was a high-stakes dispute for both parties. Not only did Mr Balducci file a remarkable counterclaim of $1.625 million for damages for breach of confidence and psychiatric injury against the claimant, it was also made clear at the outset that, as spread betting companies hedge their exposure to their client's trades with derivatives contracts, failure to collect from a defaulting client can leave a company with a substantial overall loss.

There were three key issues on which the case turned. The first, which was necessary to establish the claimant's claim for breach of contractual payment terms, was whether Mr Balducci had been the claimant's client at all given that the claimant did not originally own the company, Finspreads, through which he had placed his trades. Proudman J held that when Finspreads, and therefore Mr Balducci's account, was transferred from its original owner to the claimant, Mr Balducci was properly notified by letter. His action in clicking an acceptance box on-line was sufficient to signify his consent to becoming a client of the claimant.

Secondly, arising out of Mr Balducci's counterclaim, was the question as to whether the claimant had caused Mr Balducci's loss by failing to assess his understanding of the risks he was taking. s.150 FSMA provides that a person may claim damages for losses caused by the contravention of an FSA Handbook rule. Mr Balducci claimed that the trades were governed by the old COB rules and that the claimant had failed to comply with COB 5.4.3 which prohibited it from implementing transactions of the type the case centred on, '…unless it has taken reasonable steps to ensure that the private customer understands the nature of the risks involved.' Despite Mr Balducci's claims that he had never signed a written contract, the court found that the nature of the risks had been clearly set out in a risk warning notice which featured on both the original Finspread's application form and customer agreement.

In any case the trades in question had occurred under the claimant's ownership and were governed by the current COBS 10. These place an obligation on firms to 'assess appropriateness' of a product or service for a particular client. However, Proudman J held that COBS 10.2.6 (G) explained that firms may be satisfied that a client's own knowledge was sufficient and that it did not need to communicate this fact to the client (COBS 10.2.8 (G)). The Court held that Mr Balducci had sufficient knowledge of the risks of spread betting by the time the claimant executed trades for him given that he had already suffered large losses by this stage and yet continued to place trades. In fact, Mr Balducci was well aware of the risks, as he reportedly said to his contact at Finspreads in 2008: '…it is too risky but anyway, I like risky.' As there was no breach of the COBS rules, there was no action under s.150 FSMA.

The third issue, again arising from the counterclaim, was whether the claimant had been advising Mr Balducci on the investments he was making contrary to its permissions. Had it done so, and had he suffered loss as a result, s.20(3) FSMA would have provided an action against the claimant. In addition providing advice when authorised simply as an execution-only provider would be a contravention of COBS 9.2.1, which would also found an action under s.150 FSMA.

Proudman J accepted that 'there is a fine line' between passing on the interpretation of market data and market commentary and giving advice: there 'must always be a 'spin' when views of others are summarised and passed on.' However, she held that one could not simply pluck individual passages that appeared to be advice out of the course of numerous conversations that spanned several years. Explicitly endorsing the approach of Eady J in Wilson v MF Global, Proudman J said that the Court had to 'have regard to the reality of the trading relationship'. One had to consider the factual background against which occasional 'spin' was given.

It was clear on the facts that Mr Balducci would call the trading desk several times a day to check prices and that he was given prices with general comments about the market, rather than specific advice. Single sentences could not in themselves change the express terms of the parties' contractual relationship, which formed the background to the conversations. As Eady J had warned in Wilson, the consequences of such an approach would be that 'brokers would not be able to operate and communications would soon be drastically curtailed.' As no advice had been given there was no action available under either s.20(3) or s.150 FSMA.

The message from the case is that the High Court has again taken a practical approach to evaluating communications between traders and clients. These conversations, if sustained over a period of years, will inevitably contain some grey areas: what matters is the overall factual context.

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