FINANCIAL DISPUTES PARTNER AT TAYLOR WESSING
LAST Thursday, the FSA fined RSM Tenon Financial Services £700,000 for failings in its advice and sales processes relating to Lehman-backed structured products between 1 November 2007 and 31 August 2008. Tenon was also directed to conduct a past-business review and compensate those customers that it determines were mis-sold those products, estimated to total around £1.8m. This is the first enforcement action taken by the FSA for the mis-selling of Lehman-backed structured products since its 27 October 2009 review on the marketing and distribution of those products. Given that 6,000 investors purchased almost £200m of these products, the fallout is likely to just be beginning.
Complaints have arisen over Lehman-backed structured products as they were often described and sold, as “guaranteed”. Typically they offered a “floor” to any investment risk, limiting potential losses, along with “capped” participation in stock market returns. Investors purchased them because they sought access to the upside performance of the underlying equities but also a guarantee they not lose capital. The appeal was heightened – wrongly, with hindsight – because Lehman had offered either a full or partial “guarantee”. To many investors, such a guarantee would have appeared valuable as the probability (and therefore credit risk) of Lehman becoming insolvent, something that was considered remote at the time of purchase. After Lehman’s collapse in September 2008, investors quickly realised that capital guarantees in structured products are only as strong as the financial strength of the guarantee provider.
In the final notice issued by the FSA’s Enforcement Division against Tenon, the regulator identified a number of risks which the Tenon sales process failed to adequately address – investment risk (the investment returns and returns of capital were dependent on the performance of market indices), credit risk (the return of capital was subject to counterparty risk) and liquidity risk (a restricted ability to realise the investment during the term).
These all led to a diversity risk if such products made up too high a proportion of the total portfolio, particularly where the products were backed by only one counterparty (even if that counterparty was Lehman Brothers). Tenon was found to have failed to properly assess and disclose the risks and demonstrate the products were suitable for their customers’ profiles.
Firms involved in the sale of Lehman-backed structured products should now be alive to regulatory intervention and should, if they have not already, be conducting a past-business sales review, and protecting themselves, where possible, through the use of legal professional privilege. Disciplinary or employee-removal procedures may need to be put in place if individuals are found to have mis-sold products. However, given the potential for litigation, future cooperation of the relevant employees should be secured if possible. If problems are discovered as a result of internal investigations, advice should be taken so that the fine line between self-interest and regulatory co-operation is treaded carefully.
In addition to further enforcement action (two further firms are said to have been referred to the FSA’s enforcement division) these findings may well result in private litigation where investors sue their advisors for negligent advice. As well as pursuing breach of contract and common law negligence claims, investors may point to similar rule breaches by their own advisers as those breaches committed by Tenon and try and rely on the private action for damages under section 150 of the Financial Services and Markets Act 2000. If the draft provisions for collective redress in the Financial Services Bill are implemented, this may well be an area ripe for a test case under that legislation.