Banking StandardsWritten evidence from Iain G Mitchell QC

1. Introduction:

I am Iain Grant Mitchell QC, a member of the Murray Stable, Advocates Library, Parliament House, High Street, Edinburgh EH1 1RF and an Associate Member of Tanfield Chambers, 2–5 Warwick Court, London WC1R 5DJ. I am a Scottish QC and an English Barrister who is presently engaged in both advising and acting in a number of cases in which small businesses are seeking redress from various banks for alleged interest rate swap mis-selling. I acted for the Pursuers in the recent case of Grant Estates Ltd. v Royal Bank of Scotland plc [2012] CSOH 133. I am also a member of QA Legal, a grouping of lawyers and other professionals who are engaged in similar work.

It will be appreciated that the details of individual cases are not matters which it would be appropriate for me to comment upon. I have, however, noticed a number of common issues in these cases which give me concern as to whether the regulatory regime is working as it ought to. I am particularly concerned that (as highlighted in the published judgement in Grant Estates) there are two areas where claimants may be prevented from bringing actions in court to seek compensation: first, the exclusion of claims brought by persons other than “private individuals” (as defined in the legislation) and, second, the effect of various standard-form exclusion clauses routinely inserted by the Banks into their terms of business.

The more I see of the cases, the more I become concerned at regulatory lacunae in the system. I also have misgivings about the adequacy of the review scheme which has been adopted by the banks under pressure from the FSA.

It is the purpose of this written evidence to set out these concerns and to suggest possible regulatory reforms which might address them.

2. The Regulatory Context:

Registered financial institutions are under a legal obligation to follow the requirements of the FSA’s Conduct of Business Sourcebook Rules (“the COBS Rules”), which, in their present version, came into effect on 1st November, 2007 in order to give effect in UK law to the provisions of the Markets in Financial Instruments Directive (Directive 2004/39 EC as implemented by Directive 2006/73/EC) (here together referred to as “MiFID”).

The provisions of the Rules are obligations which are owed to clients who fall within the protection afforded by the Rules. In particular, it is a fundamental requirement of MiFID and of rule 3.31 of the Rules that the bank should categorise the client as either a retail client or a professional client and should inform the client of that categorisation and the limitations of the protection afforded by that categorisation prior to undertaking any business on behalf of the client.

The Rules place heavy obligations upon the bank in dealing with retail clients, including the general obligation under rule 2.1.1 of the Rules to act honestly, fairly and professionally and in accordance with the best interests of the client (the “client’s best interest rule”). Though the client’s best interest rule (as well also as the obligation to secure best execution) does not normally apply in the case of an execution-only contract, this is not true where the subject matter of the contract is a complex financial instrument as defined in the rules and MiFID.

Although spokesmen for various Banks have from time to time suggested that an Interest Rate Swap Agreement (“IRSA”) (or at any rate a “vanilla” IRSA) is not a complex financial instrument, this is inaccurate. All IRSAs are classified under MiFID and the rules as complex financial instruments.

In consequence, if, in selling an IRSA, a registered financial institution, such as a Bank, fails to follow the requirements of the rule it is in breach of the obligations owed to the client under the rules.

3. Actionability:

(a) The Problem:

Although a bank may have breached Rules, that breach is not necessarily actionable.

Section 150 of the Financial Services and Markets Act 2000 (“FSMA”) provides:

“(1)A contravention by an authorised person of a rule is actionable at the suit of a private 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. ...

(5)“Private person” has such meaning as may be prescribed.”

Such prescription is found in regulation 3 of the Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001 (SI 2001 No 2256) (“the 2001 Regulations”), which provides:

“3.(1) In these Regulations, “private person” means -

(a)any individual, unless he suffers the loss in question in the course of carrying on -

(i)any regulated activity; or

(ii)any activity which would be a regulated activity apart from any exclusion by article 72 (overseas persons) or 72A (information society services) of the Regulated Activities Order; and

(b)any person who is not an individual, unless he suffers the loss in question in the course of carrying on business of any kind”.

The apparent effect of these provisions is to confer upon persons a right to sue for breaches of COBS, but to exclude from that conferral those persons who are not “individuals” (presumably intended as a synonym for natural persons) if they incur the losses in the course of business. What, however, is noteworthy is that the provisions do not purport to negate the existence of the relevant duties, only to restrict the extent to which a breach of such duties is actionable at the instance of anyone who is not a “private person.”

In this regard, I note a remark made by Mr. Mark Garnier MP at an earlier session of the Commission’s hearings that “you can’t mis-sell to a corporate”, but, as is explained above, that is not accurate: a financial institution may breach a duty owed under the FSA Conduct of Business Rules—ie mis-sell—to a customer who is a non-natural person, but, although the institution will have breached a statutory duty owed to the customer, the effect of the regulations is that this breach may not be actionable.

(b) Legislative History of section 150 and regulation 3:

The legislative history of section 150 and regulation 3 is explained in the judgement of Mr Justice David Steel in Titan Steel Wheels Ltd v The Royal Bank of Scotland Plc [2010] EWHC 211 (Comm) (11 February 2010) at §§53 to 60. I reproduce the relevant section of this Judgement in Appendix A to this Evidence.

In short, the present regulatory regime was originally designed to protect financial services firms from strategic lawsuits by competitors, but the language in which the regulations were (and remain) couched are far wider than is necessary to attain that objective, effectively blocking any court actions which may be brought by any company (no matter how small) which makes losses in the course of its business.

Furthermore, attempts by the claimants in Titan Steel Wheels and Grant Estates Ltd. to narrow the effect of regulation 3 by urging that the test of “in the course of business” should be construed so as to mean integral to the business, were unsuccessful. As Lord Hodge stated in Grant Estates Ltd at §58:

“If Parliament had intended the phrase to cover only transactions which were an integral part of the person’s business, that would have confined the restriction principally to such regulated activities. Instead, it appears to have cast the net more widely to prevent a competitor from using an associated company, which was engaged in other business activities, as the claimant in a strategic action. In that context the “integral part” test makes little sense”.

There is a mismatch here with MiFID, which has client protection as one of its principal stated aims. However, MiFID does not in terms require breaches of its requirements to be actionable in the courts of the Member States, and there are certain member states which accord regulatory remedies instead.

In these circumstances, as the judgement in Grant Estates illustrates, it is difficult to argue that the UK regulations fall to be “read down” (though that is an argument which might be revisited in a future suitable case). In consequence the courts have not seen a conflict between the UK regulations and MiFID.

The result is that a regulatory regime which was promulgated two decades ago to protect the financial services industry from strategic claims is now employed in very different circumstances to protect the financial services industry from claims by retail clients, many of whom are small or micro-businesses with inexperienced directors who may have relied upon their bankers to do what was best for them: it is not that section 150 and regulation 3 are unfit for purpose; it is, rather that the purpose for which they are ideally suited is arguably no longer defensible or appropriate.

(c) Regulatory Remedies:

The effects of this might be have been mitigated if there had existed any satisfactory regulatory remedy, but in many cases there will be no such remedy.

First, all regulated persons are subject to appropriate sanctions by the FSA, but that may not translate into recovery by a client of his losses incurred as a result of any misselling. Although section 382 of the 2000 Act provides for an application to be made to the Court by the Secretary of State or the FSA for a restitution order, this would appear to be a power which has rarely been exercised, and, in particular, has not been exercised in the context of alleged IRSA misselling. It may be that the Commission would wish to seek clarification from the FSA as whether and if so how frequently and in what circumstances this power has ever been exercised.

Second, a claim may be made by a client to the Financial Services Ombudsman, such complaints may only be brought by “micro-buinesses” or individuals and, in any event the maximum compensation is limited to £150,000. In consequence, small business who, however, are not microbusinesses, will be unable to obtain compensation, and, further, even where compensation is ordered, it may well be substantially less than the losses made. Further, the criteria employed by the Ombudsman do not necessarily match the provisions of MiFID or the COBS rules.

There is, of course, the scheme which has been devised by the Banks at the behest of the FSA (

This scheme, however, contains a number of questionable features.

First, the undertaking to pay compensation relates only to the most complicated kind of IRSAs, structured collars. The only promise in relation to the sale of other IRSAs is to have them reviewed by an “independent reviewer” to be appointed by each of the banks who have agreed to be bound by the scheme. Others have commented upon whether or not this is satisfactory.

Second, the promise is made only to what are described as “non-sophisticated customers”. So-called “sophisticated customers” are not entitled to an independent review but instead have to take their chances with their Bank’s own internal complaints procedure.

This scheme does not accord with the provisions of MiFID and the COBS rules and falls short of the protections afforded in MiFID and the rules.

The rules give the widest protection to “retail clients” and narrower protection to “professional clients”. There is no class under the rules of “sophisticated customers”. The probability is that the banks will categorise a substantial number of retail clients as “sophisticated customers”, thereby cutting them out of the compensation scheme.

Under the rules, all IRSAs are “Complex Financial Products”. The undertaking narrows that down by guaranteeing compensation only for the most complicated of the various Complex Financial Products which Banks are accused of having mis-sold.

Third, there is no suggestion that any compensation will extend beyond the refunding of excess payments. In particular, there is no undertaking to provide compensation for consequential losses, such as, for example, where the excess charges might have restricted a businesses expansion, caused it to lose profits, or tipped it over the edge into insolvency. Furthermore, there is increasing anecdotal evidence that the compensation awarded under the scheme is being quantified in the difference between the cost of the mis-sold swap and a simpler form of swap, such as a vanilla swap, without any consideration as to whether a swap should have been sold at all.

4. Standard Terms:

Given the difficulties posed by section 150 and regulation 3, a person who does not fall under the definition of a “private person” might choose to bring an action founded not in breach of statutory duty, but, rather, based in common law. Indeed, a “private person” may also wish to bring a common law claim.

It is a common feature of many of the cases which I have seen that the clients believe themselves to have been given advice by their bank, and often the circumstances have disclosed that, to a greater or lesser degree, such advice indeed appears to have been given. The position of the Banks is consistently that their staff were not giving advice and were only salespeople. When such a statement is made it is often met with incredulity by the client, coupled with some such comment as “but I trusted the Bank to do what was right for me”.

In these circumstances, a client will often seek to set up either a contract between the Bank and himself for the giving of advice and claim that the bank was in breach of contract by reason of having fallen short of the appropriate professional standard for the giving of advice, and/or will seek to found a claimed in negligence, claiming that the Bank gave advice intending that it would be relied upon.

The Banks all tend to have standard form exclusion clauses contained within their terms of business. Such clauses would not give too much difficulty if they were restricted to limiting or excluding a Bank’s liability, since such clauses may not be able to pass the test of fairness and would be likely to be struck at in England by sections 2 and 3 and, in Scotland, by sections 16 and 17 of the Unfair Contract Terms Act 1977.

However, the terms are usually couched in such a way that they exclude the existence of either a contract to advise, the very relationship of advisor and client and/or any entitlement to rely upon any advice given. Those clauses are not struck at by the 1977 Act, and will usually be effective.

What makes this even more difficult for clients is that, although the standard form contracts would often have included warnings to the clients to take independent advice, at the time of the alleged mis-selling there were few if any independent advisors licensed by the FSA to give advice on complex financial instruments. there was nowhere for the client to turn for advice.

It is clear that a substantial number of claims may be excluded by the effects of section 150 and regulation 3 and/or the Banks’ exclusion clauses. Furthermore, the regulatory alternatives and the Banks’ scheme are likely to be inadequate in many cases.

These problems might be addressed, first, by amending section 150 and regulation 3, either by removing altogether the exclusion of actionability, or, if it were considered appropriate to protect Financial Services Providers from strategic lawsuits brought by their competitors, to seek to recast the regulation so as to target only that particular perceived mischief.

Additionally (or alternatively), if the route of reform of section 150 and regulation 3 were not to be followed, then a high priority should be afforded to providing a suitable alternative administrative remedy so as to allow claims to be brought to the Ombudsman by any retail client, and removing the cap on compensation.

So far as the exclusion clauses are concerned, the obvious approach would be merely to extend the scope of the Unfair Contract Terms Act to cover all clauses excluding the arising of a liability. However, this would affect all standard form contracts in any sector and would not be restricted to contracts in relation to financial advice.

The position under German law is that there is a presumption that a bank stands in an advisory relationship to its customers. A less far-reaching amendment would be to enact a similar provision in the United Kingdom, together with a prohibition on contracting out from that presumption.

6. Conclusion

I present this as my written evidence. Should the Commission wish me to expand upon it or respond to any queries which it may have, I should be pleased to attend to give oral evidence if required.



53. The first statutory provision furnishing a cause of action for breach of the regulatory regime was Sect. 62 of the Financial Services Act 1986 (“FSA”):

“(1)Without prejudice to section 61 above, a contravention of—(a) any rules or regulations made under this Chapter;

(b)any conditions imposed under section 50 above;

(c)any requirements imposed by an order under section 58(3) above; (d) the duty imposed by section 59(6) above,

shall be 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….

54. The 1986 Act represented a wide ranging overhaul of financial services’ regulation in the UK including the establishment of the Securities Investment Board. In order to give investment firms the opportunity of becoming familiar with the provisions of the Act, Sect. 62 was not brought

into force for six months.

55. During this period the industry expressed concern that the open ended provision for claims by any investor might encourage strategic lawsuits brought for competitive advantage: see DTI Consultation Paper “Defining the Private Investor” September 1990. This concern led to the inclusion by virtue of Sect 193 of the Companies Act 1989 of a new Section 62A to the FSA:

62A.—(1) No action in respect of a contravention to which section 62 above applies shall lie at the suit of a person other than a private investor, except in such circumstances as may be specified by regulations made by the Secretary of State.

(2)The meaning of the expression “private investor” for the purposes of subsection (1) shall be defined by regulations made by the Secretary of State.

(3)Regulations under subsection (1) may make different provision with respect to different cases.

(4)The Secretary of State shall, before making any regulations affecting the right to bring an action in respect of a contravention of any rules r regulations made by a person other than himself, consult that person.”

56. The Consultation Paper went on to annex a draft form of regulation defining “private investor” which in all material respects is the same as later adopted in the FSMA Regulation. In proposing the definition the DTI expressed a desire to avoid complexity and to introduce the definition as “brief and as clear as possible”. Having drawn attention to the fact that any contractual rights of action would remain unaffected, the paper went on (para 52):

“This proposed definition is intended to have the following effects:

All individuals would retain their s62 rights for all purposes. Individuals who carry on investment business would lose their s62 rights only in relation to any action taken by them, or anything done to them, in the course of that investment business;

All non-individuals would lose their s62 rights in relation to any form of business. Most charities and similar bodies do not carry on any form of business, and would therefore retain their s62 rights only in relation to any action taken by them, or anything done to them, in the course of that business.”

57. The draft regulations were in due course promulgated as the Financial Services Act 1986 (Restriction of Right of Action) Regulations 1991. The wording was in due course adopted in the 2001 Regulations in accord with the recommendation in a consultation paper issued by the

Treasury dated December 2000.

58. Whether such consultation papers were strictly admissible or not, there is nothing in this material which gives substantive support for the proposition that the phrase “in the course of carrying on business of any kind” has the restricted meaning urged by Titan. But Titan relies in addition on observations made by ministers during the course of the passage of the Companies Act 1989 in Parliament which emphasised the exclusion of “professional investors”.

59. In the House of Commons, the Minister for the DTI said:

“Part VIII makes a number of individual changes to the Financial Services Act 1986, the Insolvency Act 1985, the Policyholders Protection Act 1975 and the Building Societies Act 1986. Most of these changes are for clarification or tidying up purposes rather than being major policy departures. But I should refer briefly to clause 158 which removes the right of a professional investor to sue under section 62 of the Financial Services Act if he suffers loss as a result of a breach of the rules made under that Act. In considering experience of the working of the Act we have concluded that in respect of professionals--I emphasise professionals--the provision is inappropriate. I stress, however, that there is no change in the position for private investors, who will retain the additional safeguard provided by section 62.”

60. To similar effect, the Secretary of State for the DTI said in the House of Lords: “Finally, I come to Clause 132, which amends the Financial Services Act 1986 by removing the right of a professional investor to sue under Section 62 if he suffers loss as a result of a breach of the rules made under that Act. Section 62 provides valuable safeguards for private investors but it has been suggested that this provision risked contributing to an excessively litigious atmosphere between professional investment businesses. Such an atmosphere would hinder healthy competition and growth. The definition of “professional investor” is to be included in secondary legislation so that it can be adjusted if necessary in the light of experience and of any changes in the relevant rules.”

16 October 2012

Prepared 24th June 2013