Although apparently devoid of any press coverage, the Chancery Division of the High Court in February delivered a judgment which will be of considerable interest to many regulated investment firms. The case in question was Singularis Holdings Limited (in official liquidation) v Daiwa Capital Markets Europe Limited.
The case amounted to a suit against Daiwa by the liquidators of Singularis for $200 million. Oliver Lodge was appointed by Daiwa as an expert witness. The judgment awarded some $150 million to Singularis’ liquidators. Before its insolvency, Singularis had been a client of Daiwa. When that client relationship came to an end, the sole shareholder of the company instructed Daiwa to make payments of some $200 million to two other companies under his control. These instructions were held by the court to be an attempt to defraud the creditors of Singularis. There are a number of aspects of the judgment which have considerable general significance.
Among the completely unsurprising findings was the key conclusion that the firm’s record keeping was inadequate. Such a finding must be the most common of any in the context of financial services judgments, whether from the courts or the regulator. In this case, it could be that the firm would have been fully indemnified through the disclaimers in its terms of business had it retained any record of presenting them to its client. The absence of such records led the judge (Mrs Justice Rose) to disregard completely all disclaimers. The message is obvious.
Equally obvious was the point about the need for experience and expertise. The firm was held to have invited a member of its staff who was not accustomed to managing major transactions to manage a series of major transactions. The consequence of his inexperience in this area was that the firm proceeded to make large payments on the instructions of the client’s director, who has been held to have acted fraudulently. The firm was unable to explain how it was that this member of its staff was put in that position. Mrs Justice Rose commented that “it was remarkable that when [the chief executive of the time] was asked at the close of his cross-examination who he thought should have been in charge of checking whether the payment was a proper one, his answer was confused and confusing.”
The judge also took the view that although senior management exchanged a wealth of emails between themselves, stressing how great care, extreme caution and so forth needed to be exercised in handling any requests for payment from the client, no one explained to those processing the transactions what they needed to do. In short, management was not managing.
Other aspects of the judgment were a great deal less obvious.
Although the fraud was held to have been committed by the dominant director and sole shareholder of the client, the firm was held liable for the loss because it had failed to prevent the fraud. The judge took the view that denial of the claim would have a material impact on the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. She pointed out that both expert witnesses had described how these matters and been the subject of substantial policy focus by the regulator for a number of years. She then concluded “if, however, a regulated entity can escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its mandated employee, that policy will be undermined.”
This is not a comfortable conclusion. The regulator requires that “A firm must establish, implement and maintain adequate policies and procedures sufficient … for countering the risk that the firm might be used to further financial crime” (SYSC 6.1.1R). Clearly, such an obligation falls short of a requirement to prevent financial crime, particularly where it is perpetrated by an authorised signatory against his own company.
It is also remarkable to note that the culpability of the client was held to amount to a mere 25% contributory negligence. In awarding to the client from the firm 75% of the value of the misappropriated money, the judge rejected the proposition that the client company had itself acted fraudulently. She ruled that the individual who she concluded had committed the fraud could not be considered to constitute the company, despite being the sole shareholder, the Chairman and the authorised signatory, because there were six other directors on the board, albeit that, as she commented, they “do not appear to have performed any kind of supervisory function even when the fortunes of the [group] started to decline” and had not troubled themselves to hold a Board meeting for two years. Still more to the point, the client company had not seen fit to put in place any discernible controls to reduce the risk of fraud.
So, how should firms react? I take as read the need for proper records, adequate expertise and effective management. Of much greater concern is the conclusion that a client can expect to recover losses from a firm which fails to prevent a fraud perpetrated by the client’s signatory, while the client itself neglects to put in place even rudimentary systems and controls to counter that very risk.
Two observations are worth making.
First, if firms are to bear so much responsibility, they will need to instruct their clients in basic business management. This might be achieved, for instance, by introducing a process by which clients produce a certificate from their auditors confirming the adequacy of their anti-fraud procedures. While that may be a pretty unpalatable proposition, the extent of the liability emerging indicates the need for a radical review of prevailing standards.
Secondly, it should be noted that this judgment could, at least in theory, be overturned by a higher court.