4.01  During the investment cycle, the investor relies on the skills and knowledge of investment firms in the context of the acquisition or disposal of financial assets. Consequently, at each stage in the investment cycle, information will be exchanged between the investor and the investment firm. In this context, ‘information’ may range from the objective, facts and figures, to the subjective, opinions and recommendations. If the transaction or series of transactions result in a loss for the investor, questions may arise about the scope of the responsibility of the investment firm for the quantity and quality of information provided, or the omission to provide information, or omissions in the research or consideration of the investor’s purpose and situation so that the information would be provided based on an accurate and complete set of data.

(p. 148) 4.02  In the absence of an express undertaking, the question turns on the facts, including to what extent the circumstances justify investor reliance. The scope of that responsibility can be plotted on a spectrum: at one end, the responsibility is not to make misrepresentations; at the other end, the responsibility is to consider all circumstances and consequences that are material to the investor and the course of action contemplated by the investor. At law, outside breach of express contractual agreement, actions may be based on misrepresentation or the principle of assumption of responsibility. As will be discussed in section 4 below, the duties at law appear to correspond closely to the investment firms’ regulatory obligations under MiFID II.¹

4.03  As a matter of general law, the investment firm must not provide information unless there are reasonable grounds to believe that the information is not false, that is, is correct and not misleading. It will not be difficult for the investor to establish that statements of fact made by the investment firm in reply to the requests, provided they were material to the appointment,² were relied on reasonably in connection with the appointment.³ Should they be false, and should that be due to the investment firm’s carelessness, that is, should the investment firm not have had reasonable grounds to believe that the representation was true, then that would be an actionable misrepresentation.⁴

4.04  The information that an investment firm provides to an investor may include general statements of opinion about the risk and return properties of the financial asset, or more generally, about future economic trends. These opinions may be based on specialist research relating to the financial asset class and the relevant markets. Although as a rule, honestly held opinions or intentions that turn out to (p. 149) be unfounded will not invalidate a contract,⁵ the general rule knows many exceptions. In particular, following Esso Petroleum Co v Mardon,⁶ it would appear that a statement of opinion made by a person with a special skill, who has relied on that skill and his/her judgement to arrive at that opinion in the course of a business proposition, may give rise to an action for damages for misrepresentation if the opinion was not prepared with due skill and care.⁷

4.05  Chitty on Contracts, summarizes the position as follows:⁸

“[A] statement of opinion or of intention may itself be a misrepresentation if the maker does not in fact hold the opinion or have the intention stated. Also a statement of opinion may amount to an implied representation that the maker has reasonable grounds for the opinion, and a statement of intention that he reasonably believes that he can carry out his intentions. … The question is whether the statement is one upon which the representee was intended, and was entitled, to rely.”

In that context it is worth noting that the regulatory rule requires the investment firm to ensure that ‘marketing communications shall be clearly identifiable as such.’⁹ In other words, reasonable reliance in the circumstances determines liability for a statement, whether of fact or of opinion.¹⁰ According to Esso Petroleum Co,¹¹ it is clear that special skill or knowledge of the person that gives the opinion is a relevant factor in determining whether reliance was reasonable. In the context of financial services, it will therefore be important to distinguish between different investment services and the associated skillsets. It matters whether an opinion about investment risks associated with any financial asset is offered by a broker or by a portfolio manager. The former’s role is to trade the asset in the market pursuant to a client’s instruction; the latter’s role is to research the financial asset and make long-term investment decisions on that basis. The skill and care that may reasonably be associated with the preparation of the opinion is commensurate to the scope of each role.

(p. 150) 4.06  Notwithstanding the responsibility of the maker of a statement for the content of that statement, the sophistication of the recipient of the statement of opinion or intent acts as a counterbalance by limiting the scope of what, in the circumstances, is justifiable reliance. Esso Petroleum Co involved a plaintiff who was less sophisticated and informed than the defendant. Where plaintiff and defendant are, or are presumed to be, on a level playing field, reliance on statements of opinion is not easily judged reasonable. In Bankers Trust v Dharmala Sakti Sejahtera Mance J observed, what may perhaps be classified as ‘the conspicuously obvious truth’:¹²

The meaning and effect of words never falls to be viewed in a vacuum. It is shaped by the context of their communication, including the parties’ respective positions, knowledge and experience. A description or commendation which may obviously be irrelevant or may even serve as a warning to one recipient, because of its generality, superficiality or laudatory nature, or because of the recipient’s own knowledge and experience, may constitute a material representation if made to another less informed or sophisticated receiver. Even in the case of a written description, there may be cases where a proposal or presentation misrepresents the nature or working of a transaction to a particular reader, although another sophisticated, more analytical or legally qualified reader would have been expected to appreciate the real nature or working of the transaction. What is fair and adequate presentation in one context between one set of negotiating parties may be unfair or inadequate in another context. Whether there was any and if so, what particular representation must thus depend upon an objective assessment of the likely effect of the proposal or presentation on the recipient. In making such an assessment, it is necessary to consider the recipient’s characteristics and knowledge as they appeared, or ought to have appeared, to the maker of the proposal or presentation. A recipient holding himself out as able to understand and evaluate complicated proposals would be expected to be able to do so, whatever his actual abilities. These are problems on which it is commonly not necessary to focus in a commercial context. The assumption on which most business is conducted is that both parties understand, or avail themselves of advice about, the area in which they are operating and the documentation which they use. Business could not otherwise be carried on.¹³

4.07  The case concerned a dispute in relation to two interest rate-swap transactions. Dharmala argued, among other things, that Bankers Trust’s pre-contractual statements in relation to the swaps amounted to misrepresentations, particularly negligent statements of opinion. Mance J held in relation to the first swap, which preceded the second swap in time, that there was no basis on which the defendants could be said to have represented that the swap was ‘suitable’ or ‘safe’. In relation to the second swap it was held that, although the representations were formulated in a manner which created a risk that the statements would be accepted without an appreciation of all the implications, the plaintiff had failed to establish that this fact actually made any difference to its decision to enter into the second swap, but the judicial considerations confirmed that in some (p. 151) circumstances lack of clarity, rather than a misleading or suggestive presentation, may constitute a misrepresentation.

4.08  The underlying rationale for the findings in Dharmala appears to be that the plaintiff ‘was by and large capable of evaluating and looking after its own position and, in [Mance J’s] judgment and contrary to its own case, did so’.¹⁴ The fact that, at the time Dharmala entered into them, the swap transactions were considered novel and complex did not change that conclusion. The sophistication of the investor, therefore, will be relevant both in relation to the question whether, in the circumstances, the representation should be considered false or misleading, and in relation to the question whether, in the circumstances, the recipient should be considered to have relied on that statement. On the facts and the decisions of Dharmala it may well be argued that, in a commercial context, there is a presumption of sophistication so that the professional client claiming to be ‘able to understand and evaluate complicated proposals would be expected to be able to do so, whatever his actual abilities’.¹⁵

4.09  Clearly, liability based on misrepresentation will arise if the investor relied on a statement of fact that is subsequently proved to be false and the investment firm did not have reasonable grounds to believe that the representation was true. The threshold will be higher if a professional or commercial investor seeks to rely on Esso Petroleum Co and treat a statement of opinion or intent as a misrepresentation on the grounds of an investment firm’s special skill. Prima facie, a professional or commercial investor ought to be able to understand and evaluate complicated investment products and, therefore, may not rely on the investment firm’s opinion or statement of intent as constituting representations, regardless of the investment firm’s special skill and knowledge. However, that does not mean that the facts and circumstances could not provide grounds for a different conclusion.

4.10  A clause or provision which states that neither party has relied on any statements or representations during the negotiations other than those expressly incorporated into the agreement will generally be construed as precluding either (p. 152) party from bringing claims in respect of misrepresentation made during the negotiations.¹⁶

4.11  The general liability at law for misrepresentation, that is, the duty not carelessly to provide false information, aligns only partly with the principle-based regulatory duty set out in Article 14(3) of MiFID II: ‘all information, including marketing information, addressed by the investment firm to clients or potential clients shall be fair, clear, and not misleading.’¹⁷ Although a representation may be considered false at law if it lacks clarity as a result of its complexity, or if it is misleading or suggestive, it would appear that a responsibility to ensure that the communication is fair, clear, and not misleading exceeds that duty at law. The reason is that unless the relationship concerns a contract uberrimae fidei in which knowledge of the facts lies with one party alone,¹⁸ mere non-disclosure does not normally constitute misrepresentation for there is no general duty at law on parties to a contractual relationship to disclose material facts to each other,¹⁹ unless the omission results in a misleading statement but that will usually require some element of concealment.²⁰ The MiFID II obligation would appear to reach further than that, in particular as it requires the communication to be ‘fair’.²¹ Notwithstanding, in circumstances where one party uses a special skill or knowledge to provide a service to another party, a duty may be implied beyond the responsibility not to make misrepresentations. This is discussed next, in section 3.

4.12  Given the professional nature of the services offered by an investment firm, liability may arise in tort, in concurrence with contractual duties, for negligent omission of material information if that omission would fall within the scope of an assumed responsibility within the meaning of Hedley Byrne & Co Ltd v Heller & Partners Ltd,²² as confirmed and clarified in Henderson v Merritt Syndicates Ltd.²³ These cases established a broad principle of liability for negligently providing information or negligently omitting to provide information that is material to the recipient. Liability centred on the notion of assumption of responsibility—a test that appears to be satisfied whenever a person, who possesses or holds out as possessing a special skill or knowledge—undertakes in some form, whether in contract or otherwise, to perform a service for another party, using that special skill or knowledge, and this other party justifiably relies on the provider of that service to use the skill and know-how for a specific purpose. The cases may be divided into those that deal with the responsibility for information, or lack thereof, provided by a professional who agreed to arrange a transaction, and those that deal with responsibility for information, or lack thereof, provided by a professional who agreed to provide advice-oriented information in the form of technical data, an opinion or a recommendation in view of a transaction that the client intends to enter.

4.13  In Hedley Byrne, the professional or quasi-professional defendants provided an advice-oriented service. The question arose whether bankers could be held liable in tort for the gratuitous provision of an unduly favourable reference in respect of one of their customers. Prior to Hedley Byrne it was accepted in England and Wales that, in the absence of contract or a fiduciary relationship, the maker of a statement of fact or opinion owed to a person whom he could reasonably foresee would rely on it in a matter affecting his/her economic interest a duty to be honest in making that statement, but not a duty to be careful.²⁴ Hedley Byrne changed that understanding. Lord Morris summarized the governing principle as follows:²⁵

My Lords, I consider that it follows and that it should now be regarded as settled that if someone possessed of a special skill undertakes, quite irrespective of contract, to apply that skill for the assistance of another person who relies upon such skill, a duty of care will arise. The fact that the service is to be given by means of or by the instrumentality of words can make no difference. Furthermore, if in a sphere in which a person is so placed that others could reasonably rely upon his judgement or his skill or upon his ability to make careful inquiry, a person takes it upon himself to give information or advice to, or allows his information or advice to be passed on to, (p. 154) another person who, as he knows or should know, will place reliance upon it, then a duty of care will arise.

Although it was held that an action could be upheld in such circumstances, in casu a duty of care did not arise because the bankers supplied the reference under cover of a disclaimer of responsibility.

4.14  In Henderson, the defendants provided an execution-oriented service. Lord Goff had to consider the principle upon which a duty of care in tort based on the principles set out in Hedley Byrne could be imposed in concurrence with contractual duties. The defendants were Lloyd’s managing agents who were sued by members of the underwriting syndicate, the ‘names’, for failure to take sufficient care in the performance of their underwriting services. Lord Goff reviewed the speeches given in Hedley Byrne and concluded that defendants may be held to have ‘assumed a responsibility’, so that a duty of care may be incurred, if they acted in a professional or quasi-professional context.²⁶ The duty may include a responsibility not to omit to do or say things negligently.²⁷ If plaintiff and defendant are in a contractual relationship, the remedies in contract and tort may exist concurrently, provided that the contract does not preclude this.²⁸ Accordingly, where the Hedley Byrne principles operate in a contractual relationship, it could be described as a gap filler, that is, as a vehicle to imply terms where consideration may otherwise have failed.²⁹

(p. 155) 4.15  Lord Goff also clarified in Henderson that the Hedley Byrne principle cannot operate unless the beneficiary of the service actually and justifiably relies on the assumption of responsibility to use the skill and know-how in the performance of a particular task:³⁰

It follows, of course, that although, in the case of the provision of information and advice, reliance upon it by the other party will be necessary to establish a cause of action (because otherwise the negligence will have no causative effect), nevertheless there may be other circumstances in which there will be the necessary reliance to give rise to the application of the principle. In particular, as cases concerned with solicitor and client demonstrate, where the plaintiff entrusts the defendant with the conduct of his affairs, in general or in particular, he may be held to have relied on the defendant to exercise due skill and care in such conduct.

It follows that not all special skills qualify. It must be a special skill of a particular kind,³¹ a relationship ‘where the plaintiff entrusts the defendant with the conduct of his affairs’; that is, it must concern a professional or quasi-professional service. The special skills possessed or held out to be possessed by investment firms, since the investment firm is entrusted with the financial affairs of the investor,³² qualify prima facie.

4.16  It also follows that in the absence of a specific undertaking, the mere existence of a special skill or ability in a qualifying relationship does not equate to an assumption of responsibility to use it in any manner. For instance, in Customs and Excise Commissioners v Barclays Bank plc,³³ it was not so obvious whether the defendant bank, served with an order freezing a customer’s account, had assumed responsibility to the claimant-beneficiary of the freezing order to take reasonable care to ensure that no payments would be made from the account after the order took effect. The Court of Appeal held that the bank did, but the House of Lords held that it did not. Lord Hoffman, in search of a guiding principle, considered the authorities that applied the Hedley Byrne principle³⁴ and concluded that the (p. 156) determination that a person has assumed responsibility within the meaning of the principle in Hedley Byrne ‘does not depend upon what the defendant intended but, as in the case of contractual liability, upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case’.³⁵ It must be observed that Customs and Excise Commissioners v Barclays Bank plc, unlike Hedley Byrne, Henderson, and Clark Boyce v Mouat, discussed next, did not involve complaints about the negligent provision of information or negligent omission to provide information.

4.17  A relevant circumstance is the appearance and position of the client who seeks to rely on the assumed responsibility. In Clark Boyce v Mouat,³⁶ which concerned an execution-oriented service, Lord Jauncey held:

[W]here a client is in full command of faculties and apparently aware of what he is doing seeks the assistance of a solicitor in the carrying out of a particular transaction, that solicitor is under no duty whether before or after accepting instructions to go beyond those instructions by proffering unsought advice on the wisdom of the transaction.

Similar reasoning prevails in Springwell,³⁷ a mixed case of execution and advice-oriented services:

My conclusion, as a matter of fact, and on the evidence restricted to the role discharged by [the employee of the bank] in practice, without regard to the terms of the contractual documentation, is that, [the employee of the bank], in his capacity as salesman, did give investment advice, in the sense of personal recommendations to [the employee of the client] about what emerging market investments [the client] should buy and sell, and, in a very generalised way, about the state of, and strategy for, its emerging markets portfolio. However, I find that, at all times (save in relation to relatively few and unimportant instances, where, largely for practical reasons, a decision was taken by [the employee of the bank], eg to roll over a particular investment), [the employee of the client] retained control over the decision-making and all decisions as to whether to initiate trades were taken by him on [the client’s] behalf.

It may be concluded that in the context of an execution-oriented professional service, if the client reasonably appears able to evaluate the proposed transaction (p. 157) or transactions and does so without requesting advice, the courts are reluctant to imply a duty beyond a responsibility not to make misrepresentations.

4.18  The scope of the assumed responsibility in the context of an advice-oriented service was at the core of the decision in South Australia Asset Management Corporation (SAAMCO) v York Montague Ltd.³⁸ It concerned three appeals before the House of Lords which raised a common question: what the extent of the liability of a valuer is who provided a lender with a negligent overvaluation of the property offered as security for a loan?³⁹ Lord Hoffman observed:⁴⁰

The principle thus stated distinguishes between a duty to provide information for the purpose of enabling someone else to decide upon a course of action and a duty to advise someone as to what course of action he should take. If the duty is to advise whether or not a course of action should be taken, the adviser must take reasonable care to consider all the potential consequences of that course of action. If he is negligent, he will therefore be responsible for all the foreseeable loss which is a consequence of that course of action having been taken. If his duty is only to supply information, he must take reasonable care to ensure that the information is correct and, if he is negligent, will be responsible for all the foreseeable consequences of the information being wrong.

4.19  Lord Millett examined Lord Hoffman’s considerations in Aneco Reinsurance Underwriting Ltd v Johnson & Higgins Ltd,⁴¹ which concerned execution-oriented services. The plaintiffs, reinsurers, claimed damages from the insurance brokers for breach of contractual duty and negligence, arguing that the brokers did not make fair representations of the risk and all material circumstances to the reinsurers as underwriters. Lord Millett concluded that Lord Hoffman’s observations in SAAMCO on the distinction between information and advice were misunderstood. He noted:⁴²

Lord Hoffmann drew a distinction between ‘a duty to provide information for the purpose of enabling someone else to decide upon a course of action and a duty to advise someone as to what course of action he should take’… This has been widely misunderstood. Lord Hoffmann was not distinguishing between a duty to provide information and a duty to give advice. That is a distinction without a difference, for the terms are interchangeable. He was distinguishing between a duty to provide particular information or advice on request and a duty to advise generally when (p. 158) it is left to the adviser to decide what matters he should consider. Even where the defendant assumes responsibility for advising generally ‘whether or not a course of action should be taken’ it is still necessary to identify the particular course of action in question. Where the question is whether to enter into a particular transaction, it is necessary to identify the relevant transaction, for the defendant is not responsible for loss arising from any other transaction. … It is never enough to say: the defendant was responsible for advising the plaintiff what action he should take. It is necessary to ask: in relation to what? … As always, in Lord Roskill’s words in Caparo at p. 628 it is necessary to determine ‘for what purposes and in what circumstances the information in question is to be given’.

4.20  Lord Millett, following Lord Roskill’s approach in Caparo,⁴³ confirms that the scope of the responsibility the professional or quasi-professional service provider may have assumed in Hedley Byrne and Henderson terms is defined by an interpretation of the purpose of the service against the background of all the relevant circumstances, including the conduct of the parties, in particular whether the recipient relied, and could have reasonably relied, on the provider applying a special skill in view of that particular purpose.⁴⁴ The prevalence of the factual matrix was reaffirmed by Lord Sumption in BPE Solicitors v Hughes-Holland.⁴⁵ Lord Sumption, surveying Lord Hoffman’s observations in SAAMCO and extrapolating the line set out by Lord Roskill in Caparo and Lord Millett in Aneco, concluded that ‘every case is likely to depend on the range of matters for which the defendant assumed responsibility and no more exact rule can be stated’.

4.21  It may be concluded that the assumption of responsibility for the provision of information in the form of facts or professional judgement that considers the interest of the investor in the context of the situation and purpose of the investor is entirely fact-bound. According to Lord Sumption, the scope of responsibility will very much depend on the circumstances of the case and ‘no more exact rule can be stated’. It cannot be said, therefore, that the question turns on whether a defendant can be categorized as an adviser or not. Nevertheless, the purpose and character of the professional service in context of which information was provided by the investment firm are important factors: if the service is execution-oriented, that is, the investment firm is engaged to arrange a transaction and gives information in that context, the courts are reluctant to imply a duty beyond a responsibility not to make misrepresentations. This is true even in situations where the investment firm gave certain opinions on the desirability of a course of action.⁴⁶ If the service is advice-oriented, that is, the investment firm is engaged to provide (p. 159) information about an investment or transaction based on a consideration of the investor’s investment objective and situation, the courts are more inclined to find an expanded scope of the responsibility as ‘the adviser must take reasonable care to consider all the potential consequences of [the] course of action’ that is the subject matter of the advice, vide SAAMCO. This bifurcation makes eminent sense. The skills, know-how, and resources needed to arrange a transaction are of a different nature than the skills, know-how, and resources needed to provide an advice-oriented service. In determining whether reliance was reasonable, that purpose should be considered. The bifurcation, naturally, does not prevent a conclusion that, in certain circumstances, an investment firm has been engaged to provide both an advisory service and an execution service

4.22  As is true for claims based on misrepresentation,⁴⁷ a claim based on assumption of responsibility may be negated by contract.⁴⁸ Depending on its scope and constitution, it will have to pass the fairness test of the Unfair Contracts Terms Act 1977 (UCTA).⁴⁹ The operation of that principle is on display in the mis-selling of swaps decisions, as demonstrated in Crestsign v NatWest and RBS.⁵⁰ The judge found that the bank had assumed a responsibility, according to Hedley Byrne, to advise on the suitability of the proposed swap transaction and that the advice was given negligently. Nonetheless, he held that the banks were not liable because: ‘they successfully excluded any duty not to do so’.⁵¹ The banks, he said, ‘did not show themselves worthy of the trust Mr Parker had placed in them, but unfortunately for Crestsign, the common law provides it with no remedy because the banks successfully disclaimed responsibility for the advice they gave on the suitability of the swap, which was negligent but not actionable’. The judge concluded his judgment with the comment that ‘[w]hile the result may seem harsh to some, it is not the role of the common law and the court to act as a regulator’.⁵²

4.23  Based on the notion of assumption of responsibility discussed in the previous section, an investment firm may find that its responsibility to the investor in relation to the provision of information is not limited to a duty not to (p. 160) misrepresent. Notwithstanding, in the context of services and activities other than investment advice and portfolio management,⁵³ if a reasonably sophisticated professional or corporate investor engages an investment firm for one or more broker-dealer or other execution-oriented services, the cases do not seem to support an investor argument ex post that the investor had placed justifiable reliance on an implied assumption of a responsibility that goes beyond the reasonable care to provide accurate and not misleading information. In other words, the professional investor and not the investment firm is prima facie responsible for ensuring the investor’s broader investment interests are served with the proposed transaction.

4.24  The position at law re the combined operation of the notions of misrepresentation and assumption of responsibility on execution-oriented investment services appears mostly in line with the fair, clear, and not misleading rule under MiFID II, except that MiFID II insists explicitly that the investment firm investigates what level of understanding persists. Article 25(3) of MiFID II requires an investment firm that provides services other than portfolio management or investment advice to ask the client to provide information that enables the firm to assess whether the investment service or the investment product is ‘appropriate for the client’. The appropriateness test requires that the investment firm satisfies itself, based on information requested from and provided by the investor, that the investor has the knowledge and experience to understand the investment service and the investment product.⁵⁴ Article 25(4) excludes from the art 25(3) obligation certain specified non-complex investment products provided the investment service concerns ‘execution only’ services, that is, execution without any ‘ancillary service’ that consist of financing of the trade. The investment firm may assume that the information provided by the client is correct, unless it is manifestly out of date, inaccurate, or incomplete.⁵⁵ Further, an investment firm may assume, in line with the position at law, that a professional client has the necessary level of experience and knowledge to understand the risks involved with the investment services or products for which that client is classified as professional.⁵⁶

(p. 161) 4.25  Although the cases on assumption of responsibility do not appear to address the existence of an explicit duty to investigate what level of sophistication the investor possesses, in view of the confirmation in BPE Solicitors v Hughes-Holland⁵⁷ that every case is likely to depend on the range of matters for which the investment firm assumed responsibility, it is conceivable that the courts may in the context of an execution-oriented investment service find that the MiFID II distinction between complex and non-complex investment products is very persuasive. That would support a determination that the investment firm has assumed responsibility not only for ensuring that the information provided to the investor in connection with the execution-oriented investment service is fair, accurate, and not misleading, but also for satisfying itself that there is a reasonable basis to conclude that the investor has the knowledge and experience to understand the investment service and the investment product, which would include a duty to ask the investor to provide relevant information about the investors’ circumstances.

4.26  The position at law ought equally to be informed by the regulatory position in the context of advisory rather than execution-oriented investment services relationships. A person who provides information to another person would be considered to be giving investment advice within the meaning of MiFID II if the information is provided by way of a personal recommendation to an investor or potential investor, or an agent for that investor, in relation to a specific transaction or transactions in, or the exercise of rights attaching to, a financial asset.⁵⁸ A recommendation is considered to be personal if it represents either that the recommended transaction is suitable for the recipient, or that it is based on a consideration of the recipient’s circumstances.⁵⁹ The maker of the personal recommendation is providing investment advice and will be under a duty pursuant to art 25(2) of MiFID II to ensure that the firm obtains information from the client necessary to determine whether an investment is suitable.⁶⁰ The adviser ‘must take reasonable steps’ to ensure that the situation of the investor is sufficiently understood, so that the consideration of the investor’s purpose and situation can be carried out properly.⁶¹ The investment firm may assume that the information (p. 162) provided by the client is correct, unless it is manifestly out of date, inaccurate, or incomplete.⁶² An investment firm may assume, in line with the position at law, that a professional client has the necessary level of experience and knowledge to understand the risks involved with the investment services or products for which that client is classified as professional.⁶³

4.27  A personal recommendation must be distinguished from a general recommendation about the desirability of an investment product, a marketing communication, or simply information given on request. A communication may involve an overlap between two or more categories. For example, where the maker of the communication prepares a brochure, a leaflet, or a prospectus that constitutes a general recommendation, a marketing communication, and/or involves the provision of information, this document may also be used as a basis for a personal recommendation. Equally, a general research report may be sent by way of a personal recommendation to a specific client.⁶⁴

4.28  The link between the regulatory concept of investment advice and the concept of ‘personal recommendation’ ensures a relatively circumscribed scope. It was deemed not to be in the public interest to cast the net too wide and catch the provision of technical investment data in the form of marketing materials, including investment research, or other sales and marketing communications that include general recommendations about the desirability of an investment product, as ‘investment advice’ within the meaning of the regulatory framework. A ‘personal recommendation’ implies some form of consideration of the personal circumstances and purpose of the recipient in relation to a certain investment. There must be a relationship between the investor and the investment firm that justifies reliance by the investor on the fact that the investment firm would consider all material facts in the context of the investment service and inform the investor accordingly. That means there must be a relationship that comprises more than generic communications about investment services and products, and is relatively specific about its purpose, that is, to include a determination whether an investment is suitable.

(p. 163) 4.29  The regulatory approach to the facts and circumstances that impose the duties of a firm that provides ‘investment advice’ appears to reconcile to Lord Millett’s stipulation in Aneco that ‘[i]t is never enough to say: the defendant was responsible for advising the plaintiff what action he should take. It is necessary to ask: in relation to what? … As always, in Lord Roskill’s words in Caparo at p. 628 it is necessary to determine “for what purposes and in what circumstances the information in question is to be given” ’.⁶⁵ Equally, it levels with the observations of Gloster J in Springwell that the employee of the bank ‘did give investment advice, in the sense of personal recommendations … about what emerging market investments Springwell should buy and sell’, but found that there was no reliance on those recommendations, as the employee of Springwell ‘retained control over the decision-making and all decisions as to whether to initiate trades were taken by him on Springwell’s behalf’.⁶⁶ Reliance is likely not to be justifiable if the investment firm is reasonably entitled to expect either that the investor, taking into account the level of sophistication of the investor in the relevant matter, will make an independent evaluation, including the information, opinion, or recommendation received from the investment firm, or that the investor otherwise has assumed responsibility for how his/her interests are best served.

4.30  If the relationship in which an investment recommendation is made meets the threshold requirements that lead to duties that exceed the responsibility not to negligently or carelessly provide information, the possibly more vexing question of scope arises. The judicial reasoning in Martin v Britannia Life Ltd (Martin),⁶⁷ unsurprisingly, illustrates that the courts are inclined to analyse that scope as a function of the purpose of the relationship against the background of all the relevant facts. Therefore, the scope of the responsibility at law may potentially be wider than the regulatory scope. In Martin, the defendant, a financial adviser within the meaning of the (then) applicable regulatory rules, had recommended that the plaintiff enter into a package of transactions consisting, among other things, of a remortgage of his home. The defendant sought to escape liability for breach of statutory duty; the claim was for negligent financial advice, based on the argument that the advice on the remortgage transaction was not ‘investment advice’ for the purposes of the Financial Services Act 1986, the predecessor of the FSMA,⁶⁸ since a remortgage did not constitute ‘investment business’ within the meaning of that Act. In rejecting this submission, Parker J held that ‘investment advice’ comprehends all financial advice (p. 164) given to a prospective client, not only in relation to the purchase, sale, or surrender of an ‘investment’ as defined, but also in relation to any ancillary or associated transaction, notwithstanding that such transaction was itself outside the definition of ‘investment business’ as provided in the Financial Services Act 1986. Therefore, the adviser had to consider all circumstances relevant in view of the ‘wider financial context’:

In my judgment, advice as to the ‘merits’ of buying or surrendering an ‘investment’ cannot be sensibly treated as confined to a consideration of the advantages or disadvantages of a particular ‘investment’ as a product, without reference to the wider financial context in which the advice is tendered. … In my judgment it is neither appropriate in the context of the 1986 Act, nor for that matter would it be realistic, to seek to limit the concept of ‘investment advice’ by reference to the extent to which the advice relates to the ‘merits’ (ie to the advantages or disadvantages) of a particular ‘investment’ as defined; and if that be accepted, it seems to me that it must follow that the concept of ‘investment advice’ will comprehend all financial advice given to a prospective client with a view to or in connection with the purchase, sale or surrender of an ‘investment’, including advice as to any associated or ancillary transaction notwithstanding that such transaction may not fall within the definition of ‘investment business’ for the purposes of the 1986 Act.⁶⁹

Accordingly, the courts look for conduct and reliance in the relationship between adviser and recipient. If justifiable reliance on a personal recommendation is found, a commensurate level of responsibility will be assigned to that adviser, which will mean that the investment firm will have to research the situation and purpose of the investor in a wider context.

4.31  In conclusion, it is likely:

1. (a)  that the courts will find that the circumstances that bring the activities of an investment firm within scope of the regulatory concept of investment advice—that is, making a recommendation that represents either that the recommended transaction is suitable for the client or that it is based on a consideration of the client’s circumstances—and that trigger a regulatory duty to investigate the client’s situation and purpose to inform the firm’s suitability analysis, will give rise to a similar responsibility at law based on the notion of assumption of responsibility;

2. (b)  that the scope of the responsibility will depend on the scope of the permitted reliance, which in turn depends on the facts and circumstances, that is, without limitation, the nature and complexity of the investment product, the nature of the advisory relationship, the conduct of parties, the sophistication of the investor, and the documentation and information exchanged between them.

4.32  In addition to ‘investment advice’, art 25(2) of MiFID II identifies ‘portfolio management’ as an investment service that subjects the investment firm to the suitability duty. Asset management concerns discretionary investment and reinvestment of the investor’s capital.⁷⁰ Discretionary means that investment decisions are made independently from the investor, although within the investment parameters of the mandate. The investment parameters will be informed, predominantly, by the specialist investment strategy that is chosen by the investor from the suite of investment strategies that the investment manager has on offer. In practice, therefore, the relationship between the investment manager and the investor is akin to a, albeit complex and long-term, execution-oriented investment service. The discussion at the time of engagement bears that dynamic out. Typically, the investor seeks the investment manager out for some special skill, such as emerging markets. The investment manager will explain the available investment strategies and the associated risks, not by way of a personal recommendation, but by way of a description of the risk and return properties of the investment strategy and its resulting portfolio, independent from the situation of the investor. On those facts, it is not immediately obvious why the regulatory regime equates portfolio management to investment advice. The development, offering, and maintenance of a specialist investment strategy concerns the creation of an investment product, which is then offered to the investor. In fact, the purchase by an investor of an investment management product, be it in the form of an investment fund or discretionary mandate, is more likely to be the result of investment advice. An investment manager may, of course, offer bespoke mandates based on a review of the investor’s situation. However, it is suggested that the design of the bespoke mandate ought to be characterized as a pre-contractual investment advisory service that is separate from the execution-oriented investment mandate itself.

4.33  The practical implication of Article 25(2) of MiFID II for investment firms that offer individual, rather than collective, portfolio management services is that such firms are per se investment advisers in respect of their proprietary investment product. Consequently, the manufacturing investment firm must consider the risk and return properties of the selected asset management product in the context of an individual investor’s situation before executing the mandate. It is not sufficient to be satisfied that the investor can understand the risk and return properties of the asset management product. That requirement to some extent duplicates the product governance obligations, which already require a manufacturing firm to consider the suitability of the product for a target market. It also leads to different (p. 166) regulatory treatment of investment products which have the same risk and return properties: a manufacturing investment firm that offers an otherwise identical investment strategy in the form of a collective investment scheme or a structured note rather than an individual mandate would be subject to Article 25(3), and an appropriateness test would suffice.

4.34  There appears to be no good reason for this differentiation.⁷¹ Discretionary portfolio management, collective portfolio management, and certain structured products may all offer the same embedded discretion and risk-return properties. The better position would be to approach suitability-based investor protection in the context of the offering of an investment management product (whether by way of separate mandate, collective investment scheme, or structured product) from a product regulation perspective and prescribe such as that certain asset management products may not be offered without there having been investment advice. Where investment management products are comparable to other investment products, those other products should be treated the same.

4.35  The position at law would not appear to support the implication of a status-based, or per se, advisory duty in case of individual portfolio management. It is conceivable, of course, that the investment manager has considered facts and circumstances personal to the investor and has made a recommendation to the investor to invest in the manager’s proprietary strategy on the basis of those facts. If it was clear, or ought to have been clear, to the investment manager that the investor placed reliance on that personal recommendation in deciding to appoint the manager, the investment manager may be held to have assumed responsibility to the investor to advise the investor on whether the investment strategy is right and appropriate for the investor’s purpose and situation. That responsibility could include a duty to ensure that all facts and circumstances relevant to that purpose and situation have been discovered and considered. But that will certainly not be true in all cases, least so in the event of a professional or corporate investor who will often select the investment manager with the assistance of a third-party consultant.

4.36  The investor’s rationale for, and understanding of, the investment risk associated with a certain acquisition may affect the scope of the duty of care of an investment firm engaged by the investor with a view to the acquisition of a financial asset. MiFID I implemented, and MiFID II continued, a division of client relationships into client ‘categories’ to recognize that investors have different levels of experience, knowledge, and expertise, and divided investment firms’ client relationships into three regulatory categories: ‘retail clients’, ‘professional clients’, and ‘eligible counterparties’.⁷² Investment firms must provide their clients with one of these categorizations at the start of the relationship and keep the classification under review.⁷³ Investors will automatically be categorized upon meeting certain criteria, ‘per se categorization’, or may ask to be treated as a more sophisticated client, resulting in a lower level of regulatory restrictions on the investment firm and permitting the investor access to a wider range of products or services, subject to meeting applicable opt-out criteria .⁷⁴

4.37  Certain developments since the implementation of MiFID I gave the European legislator cause for recalibration of the client categorization in relation to those investors who would previously be categorized as per se professional clients, or even eligible counterparties, and to broaden the regulatory information responsibilities of investment firms to eligible counterparties. Recital (104) of MiFID II is most instructive:

The financial crisis has shown limits in the ability of non-retail clients to appreciate the risk of their investments. While it should be confirmed that conduct of business rules should be enforced in respect of those investors most in need of protection, it is appropriate to better calibrate the requirements applicable to different categories of clients. To that extent, it is appropriate to extend some information and reporting requirements to the relationship with eligible counterparties. In particular, the relevant requirements should relate to the safeguarding of client financial instruments and funds as well as information and reporting requirements concerning more complex financial instruments and transactions. In order to better define the classification of municipalities and local public authorities, it is appropriate to clearly exclude them from the list of eligible counterparties and of clients who are considered to be professionals while still allowing those clients to ask for treatment as professional clients on request.

(p. 168) 4.38  Accordingly, MiFID II has brought some conduct of business requirements back in scope for clients that are eligible counterparties. If an investment firm supplied brokerage, order routing, or dealing services to an eligible counterparty, then MiFID I permitted the investment firm to derogate from certain communication, informational, and know-your-customer requirements, as well as order execution and order-handling requirements. MiFID II chiefly continues those exemptions,⁷⁵ but introduces a few carve-outs regarding information and reporting requirements. In addition, MiFID II introduces a ‘client’s best interest’ obligation that applies notwithstanding the exemptions for investment services to eligible counterparties.⁷⁶ Investment firms must ensure that, in dealing with eligible counterparties, they ‘act honestly, fairly and professionally and communicate in a way which is fair, clear and not misleading, taking into account the nature of the eligible counterparty and of its business’.⁷⁷

4.39  In summary, classification as an eligible counterparty under MiFID II means that brokers, dealers, and firms that receive and transmit client orders, may execute transactions with or for such clients without being obliged to comply with the obligations under Article 24 (general principles and information to clients), with the exception of paras 4 and 5 (disclosure requirements in respect of products, services, and costs and charges);⁷⁸ Article 25 (assessment of suitability and appropriateness and reporting to clients), with the exception of para 6 (client reporting);⁷⁹ Article 27 (best execution); and Article 28(1) (fair and expeditious execution of client orders) of MiFID II. Classification as ‘professional client’ will (p. 169) result in tailored levels of regulatory requirements under Articles 24,⁸⁰ 25,⁸¹ and 27⁸² of MiFID II. Classification as retail client will impact on the ability of investors to access more complex, risky investments.

4.40  Curiously, the regulatory rules typically prescribe that the classification communication refers to a ‘higher degree of protection’ that may be obtained if a different client classification is applied. Regulatory classification per se, however, does not offer protection to a client, except, perhaps, to the extent that the client would be eligible for different collective insurance protection. If the intention is to inform the client that the firm is subject to different conduct of business requirements depending on the regulatory classification, and therefore, that the client should expect different levels of information or advice, it would be better if regulators required firms to use language that refers to those differences in regulatory responsibility, rather than insisting on institutionalizing a misrepresentation.

4.41  Firms that supply portfolio management services may not treat clients as eligible counterparties for purposes of the exemptions set out in Article 30(1) of MiFID II. (p. 170) Often a broker will seek to treat an investment manager as an ‘eligible counterparty’ for purposes of an order or a trade that the manager places, or enters into, with that broker for the account of a client, but, if the client is a professional client, the manager will be subject to a regulatory duty of best execution as it is owed to professional clients and therefore, practically, may not be in a position to comply with the broker’s request.

4.42  It is common ground in commercial relationships that parties look after their own interest. There is ordinarily no expectation, subject to the boundaries of vitiating factors, that one party protects the interest of the other party; caveat emptor prevails.⁸³ The business of an investment firm, however, comprises more than an arms’ length commercial arrangement. The investor would expect that the investment firm acts in accordance with high standards of competence and integrity and puts the investor’s interest at the heart of the service.⁸⁴

4.43  To undertake by way of business to act in someone’s interest rather than at arm’s length connotes professionality. Article 24(1) of MiFID II places the responsibility to act professionally and in the interest of the investor at the core of the investment firms’ regulatory responsibilities. Investment firms must ‘act honestly, fairly, and professionally in accordance with the best interest of the client’ when providing an investment service. The United Kingdom’s FCA refers to this duty as ‘the client’s best interest rule’.⁸⁵ Article 24(2) supports the best interest rule with a duty not to offer financial instruments unless that is in the investor’s interest, which can be described as an overarching obligation to consider clients’ interests when distributing products through any distribution channel.⁸⁶ In simple terms, therefore, Article 24(2) can be said to be a prohibition on ‘mis-selling’, that is, it aims to remove the arm’s length sales dynamic from the offering of investment products and, in doing so, to redress the significant imbalance between the parties’ skills, knowledge, and understanding. In summary, the consideration of the investor’s interest must permeate the way investment services are offered and performed. Caveat emptor suspended, so to speak.

(p. 171) 4.44  Although the rationale and justification of the client’s best interest rule is easily argued, the operative scope of the best interest rule remains elusive. A person has an ‘interest’ if circumstances or an arrangement bring or could bring a benefit or disadvantage, or, more broadly, could affect that person or something connected with the person. Which of these myriad potential interests are in scope of the best interest rule and to what extent cannot be answered by reference to a set of rules that approaches any measure of exactitude. There is no meaningful guidance on the scope or nature of the ‘client’s best interest’ within the meaning of Article 24(1) of MiFID II and the drafting structure of the best interest rule and its components does not provide much contextual or systemic support, either. Articles 24 and 25 provide detailed rules that focus on disclosure requirements,⁸⁷ management of conflicts (independency of investment advice,⁸⁸ inducements,⁸⁹ and remuneration⁹⁰), and duties to obtain information from the investor to assess suitability and appropriateness.⁹¹ But these are examples of expected behaviour that is considered fair and in the best interest of the client. They do not constitute a perimeter. The examples are a mixed bag that includes both enhanced duties of care (disclose and advise), service quality standards (requirement to include a ‘sufficient’ range of investment products in the advice⁹²), and restrictions on conflicts (no inducements and restrictions on remuneration). In the United Kingdom, importantly, the best interest rule includes a duty ‘not, in any communication relating to designated investment business [to] seek to (1) exclude or restrict; or (2) rely on any exclusion or restriction of; any duty or liability it may have to a client under the regulatory system.’⁹³

4.45  Accordingly, the best interest rule does not appear to have been designed with any conceptual precision in mind. Niamh Moloney points to its ‘inchoate nature’ and observes that the rule may perhaps be best described as a normative, ‘good outcome’ oriented regulatory tool that permits intervention if a practice develops or behaviour occurs that is considered not to be desirable or permitted:⁹⁴

Although its inchoate nature carries risks, including with respect to ex post enforcement action, a fair treatment obligation provides NCAs with a useful, catch-all mechanism for reviewing investment firm behaviour, for capturing emerging risks, and for proactively addressing the asymmetry in bargaining power which characterizes the firm/client relationship.

(p. 172) It means that the scope of the best interest rule will need to be determined on a case-by-case basis—by the competent regulator—by considering the client’s interest against the background of all relevant facts, particularly the nature and purpose of the investment service. The words of Lord Sumption in BPE Solicitors v Hughes-Holland⁹⁵ spring to mind that ‘every case is likely to depend on the range of matters for which the defendant assumed responsibility and no more exact rule can be stated.’ Therefore, the rule imports a measure of uncertainty for regulated firms; they cannot be—entirely—certain of the scope of the operation of the rule in the context of an investment service.

4.46  Regulatory intervention based on empirical grounds that addresses a perceived lack of competence should be distinguished from normative intervention that addresses a perceived lack of fairness. The duty to act fairly and regard to someone else’s interest should be distinguished from duties to act competently with requisite skill and diligence to serve that interest. The former balances the relationship away from caveat emptor. The latter safeguard quality of professional skill. The best execution duty of Article 27 of MiFID II, for instance, primarily relates to competence. When instructing a broker, one reasonably and justifiably expects that the broker seeks to get the best possible result. It is the discerning professional skill of a competent broker. The question of due performance of the characteristic undertaking of a commercial contract is separate and distinct from the question whether the service provider acted fairly by having regard to the interest of the other party. Article 24(1) of MiFID II, which refers to the need to ‘comply, in particular, with the principles set out in this Article [24] and in Article 25’, appears to confirm, also in view of Recital 71,⁹⁶ that the best interest rule is not intended as a duty of competence, but a duty to consider and protect the investor’s interest in a fair manner.

4.47  Acting fairly in the interest of another aims at the suspension of caveat emptor. It corrals the investment firm into protecting the interest of the investor beyond competent performance of the investment service. The protection manifests in disclosure duties (appropriateness), and duties to research, advise, and to refrain from offering (suitability).⁹⁷ ‘Fairness’—in the context of protection of the client who relies on the investment firm to exercise professional skill, knowledge, and judgment in the client’s interest—is the driving principle behind the operational scope of the best interest rule. The objective of Article 24(1) of MiFID II appears close to the objective of Regulation 5(1) of the Unfair (p. 173) Terms in Consumer Contracts Regulations 1999, which also seeks to redress imbalance:⁹⁸

A contractual term which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer.

4.48  Regulation 5(1) recognizes that notions of fairness in contractual relationships derive from the operation of the doctrine of good faith, which is distinctively Continental European in origin. Dalhuisen traces the normative interpretation technique that is embedded in the notion of good faith flawlessly:⁹⁹

In countries such as Germany, Austria, Switzerland, and The Netherlands, the normative interpretation technique is now indeed closely associated with the good faith notion in the interpretation and supplementation of contracts. Again, good faith may acquire here a specific meaning as an interpretation tool, not any longer merely the opposite of bad faith and interpretation is then governed by it. In appropriate cases, this may lead to contractual supplementation on the basis of duties of care and cooperation, duties of disclosure and of negotiation or renegotiation duties.

4.49  Fairness, or good faith, therefore, in the construction of contracts, may be characterized, based on its derivation, as a source of implied duties. It is a technique to supplement gaps and redress imbalances to conform a contractual relationship to ‘what may be required in a social sense or is morally demanded in an advanced society’.¹⁰⁰ That technique appears to lie at the heart of Article 24(1), which imposes regulatory duties of care, disclosure, and negotiation on the professional service provider in the context of the normative concept of investor protection.

4.50  The law’s—or, more properly, equity’s—classic tool to redress the potential imbalance in a relationship where one party’s interest is in the hands of another party is the imposition of fiduciary duties. The core requirement for the recognition of fiduciary responsibilities is the assumption of responsibility for the property or affairs of another.¹⁰¹ The central axiom is that a person who assumes responsibility to serve the interests of another, to the exclusion of his/her own interest, shall owe a duty of loyalty as fiduciary, as far as that other person is entitled to expect this.¹⁰²(p. 174) The rationale for the implication of fiduciary duties is that in these relationships, one party ought to be able to rely on the other party’s integrity in dealing with the dependent party’s affairs.¹⁰³ In an Australian case, Hospital Products Ltd v United States Surgical Corporation, Mason J identifies that rationale:¹⁰⁴

The accepted fiduciary relations are sometimes referred to as relationships of trust and confidence …; viz trustee and beneficiary, agent and principal, solicitor and client, employee and employer, director and company, and partners. The critical feature of these relationships is that the fiduciary undertakes or agrees to act for, on behalf of, or in the interests of another person in the exercise of a power or discretion which will affect the interests of that other person in a legal or practical sense. The relationship between the parties is therefore one which gives the fiduciary a special opportunity to exercise the power or discretion to the detriment of that other person who is accordingly vulnerable to abuse by the fiduciary of his position. The expressions ‘for’, ‘on behalf of’ and ‘in the interests of’ signify that the fiduciary acts in a ‘representative’ character in the exercise of his responsibility. …

4.51  The governing principle for duties arising in a fiduciary relationship is loyalty. A classic American judicial account of that principle was given by Cardozo J, in Meinhard v Salmon,¹⁰⁵ a much-cited case in which the New York Court of Appeal held that partners in a business have a fiduciary duty to inform one another of business opportunities that arise:

Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden for those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honour the most sensitive, is then the standard of behaviour. As to this there has developed a tradition that is unbending and inveterate. Uncompromising (p. 175) rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.

4.52  Loyalty—the ‘punctilio of an honour the most sensitive’—and conduct of a standard ‘higher than that trodden by the crowd’, therefore, may be identified as the guiding principles for the formulation of fiduciary duties.¹⁰⁶ It follows that to ‘say that a man is a fiduciary only begins the analysis; it gives direction to further enquiries. To whom is he a fiduciary? What obligations does he owe as a fiduciary?’¹⁰⁷ Finn has probably given the most authoritative summary of the consequences for those who owe a fiduciary duty of loyalty to another person:¹⁰⁸

A fiduciary (a) cannot misuse his position, or knowledge or opportunity resulting from it to his own or to a third party’s possible advantage; or (b) cannot in any matter falling within the scope of his service, have a personal interest or an inconsistent engagement with a third party—unless this is freely and informedly consented to by the beneficiary or is authorised by law.

4.53  These two themes have given rise to the formulation of a body of fiduciary duties that restricts a fiduciary’s freedom to act in the absence of informed consent, particularly if that fiduciary has powers as agent or trustee to deal with another person’s assets. In the English legal realm, that body of fiduciary duties is commonly divided into four categories. In the absence of informed consent, a fiduciary must:

1. (a)  not put his/herself in a position where his interests and his duty to the beneficiary conflict (‘no conflicts’);

2. (p. 176) (b)  not make a profit from his position other than his agreed remuneration (‘no secret profits’);

3. (c)  not place his/herself in a position where a duty to one beneficiary conflicts with a duty to another (‘undivided loyalty’ or ‘no double employment’);

4. (d)  not use information obtained in confidence from one beneficiary for any purpose other than the benefit of that beneficiary (‘strict confidentiality’).¹⁰⁹

Each of these restrictions can be said to be derived from the general duty of loyalty, that is, the duty that results from the undertaking to act exclusively in another person’s interest.

4.54  Breach of fiduciary duties attracts special legal consequences. It is therefore important to determine carefully which duties owed by a fiduciary are fiduciary in nature. The beneficiary does not have to prove loss. Instead, a breach gives rise to the equitable remedies of rescission, or if rescission is no longer possible, the fiduciary will be liable to account for benefits received as a result of the breach. Therefore, profits from secret commissions, front running, self-dealing, dealing for two principals, and all other benefits which an investment firm may obtain in breach of the duty of loyalty are subject to a claim for disgorgement by the client.¹¹⁰ Fiduciary duties should be distinguished from the equitable duty of skill or care that does not attract special legal consequences.¹¹¹ Breach of an equitable duty of skill and (p. 177) care does not equate to breach of a fiduciary duty.¹¹² Equity does not impose a general duty of skill and care on a fiduciary that is separate or different in scope from the duty that is to be found at common law.¹¹³ As is the case for duties sourced in contract or in tort, the scope of the duty of skill and care sourced in equity is to be determined against the background of all relevant circumstances, including the conduct and reasonable expectations of the parties.¹¹⁴ This means that, in the context of an investment services relationship, one cannot in practice distinguish between a general duty of care that is implied as a matter of equity, contract, or tort.¹¹⁵

4.55  To avoid unintended consequences, the fiduciary may, subject to applicable restrictions,¹¹⁶ seek to vary the duties implied by operation of equity. In one line of authority, emphasis is placed on the primacy of contract suggesting that parties may modify fiduciary duties to the fullest extent possible.¹¹⁷ Other authority suggests that the ‘essence of a fiduciary obligation is that it creates obligations of (p. 178) a different character from those deriving from the contract itself’.¹¹⁸ Bowstead & Reynolds on Agency accepts that there is room for the parties to vary the scope of the fiduciary duties that would otherwise apply by operation of law in an agency relationship,¹¹⁹ but reminds us of the rationale that prompted the development of the fiduciary principle in equity:¹²⁰

The agreement of the parties or the background of the case may certainly establish that the relationship is to one of agency or otherwise justify modification of the normal standards; but equally a fiduciary relationship may, while consistent with them, increase the contractual duties. A too casual failure to recognise the requirement of a fiduciary position, and sometimes a short-sighted position that all relevant duties are prescribed in a contract, can be and has been responsible for serious misbehaviour in the financial markets and elsewhere, as is shown by many litigated cases in the last quarter-century.

The prudent course would be to draft terms that identify the key components of the investment firm’s operating model with sufficient precision so that the clause operates both as informed consent as well as exclusion of liability.

4.56  Fiduciary duties arise in equity and derive, historically, from the law of trust. The duties have been developed in equity in response to reliance and vulnerability of a dependent party by formulating a prescriptive framework aimed at controlling the context in which a fiduciary may use powers and discretions: ‘the fiduciary obligation is the law’s blunt tool for the control of the discretion’.¹²¹ DeMott describes it, in the context of agency relationships, as follows:¹²²

The fiduciary character of the relationship means that the principal does not have to bear the risk that its stated instructions contain gaps that the agent is free to exploit in a fashion that is either self-interested or oriented to serving interests other than those of the principal.

4.57  The implication of fiduciary duties, therefore, does not start with the question whether a party is a fiduciary.¹²³ It starts with the question whether one party’s exercise of powers or discretions ought to be ring-fenced from self-interest or the interest of third parties to protect the interest of the dependent party. Discretion (p. 179) is the condicio sine qua non for the imposition of fiduciary duties.¹²⁴ Ergo, the operational range of fiduciary duties depends on the degree of discretion of the fiduciary. It follows that even a presumed fiduciary relationship such as agency may impose very limited or no fiduciary duties;¹²⁵ for instance, if an agent’s task is limited to mere execution of a contract on behalf and at the direction of a principal, the agent has no discretionary authority and accordingly, the fiduciary duties are limited.

4.58  The imposition of controls is not limited to those who exercise discretion in the context of executory tasks. Advice involves the use of professional judgment and discretion in the selection of available options. An investment advisory relationship, in usual circumstances, is a relationship of trust and confidence in which one party is reasonably entitled to expect that the other party will act in his/her interest, exclusively, when advising on the investment options.¹²⁶

4.59  The fact that an advisory relationship may be fiduciary in nature, however, does not mean that, inversely, equity will imply advisory duties in a relationship that is not otherwise advisory in nature. In Springwell, Gloster J observed:¹²⁷

In the absence of any contractual agreement for Chase to provide investment advisory services to Springwell, or any other common law acceptance of an obligation to do so (as I have fond the position to be), I do not see how what was essentially a commercial banking relationship between Chase and Springwell could give rise to extensive fiduciary duties on the part of Chase contended for by Springwell. In effect, Springwell relied on the same facts to support its case that Chase owed investment advisory obligations as it did to support the existence of a fiduciary relationship.

In other words, for fiduciary duties to be implied the relationship must have a degree of trust and confidence that subverts the starting point that the relationship is at arm’s length. The offeror, in this case a banker, is selling a product, which means that recommendations must be treated as representations and not as advice that must be based on a consideration of a wider context. Equity only operates if the relationship moves beyond the confines of marketing and sales into the realm of (p. 180) investment advice. That crossing may result from agreement or from an assumption of responsibility. In such a case, equity will operate to imply, in addition to duties of care and skill in contract or at law, fiduciary duties that will restrict the freedom of the offeror to make recommendations in the context of conflicting interests. But the simple fact that investment recommendations were made to a client by a financial services professional does not in itself lead to that type of relationship.

4.60  Academic writing has referred to MiFID’s client’s best interest rule as ‘fiduciary-style’ duties.¹²⁸ Is MiFID’s best interest rule fiduciary in nature? To rephrase that question in legal rather than regulatory terms, is it a ‘blunt tool’ aimed at ring-fencing the interest of the investor when the investment firm exercises discretion? There are elements of a fiduciary nature in the body of rules compiled in Article 24: the prohibition on inducements in subparas 7(b), 8, and 9 seek to restrict payments that could be characterized both as a secret profit and as a potential conflict, which would constitute a breach of equitable fiduciary duties. These rules, together with the remuneration rules,¹²⁹ are unmistakably aimed at ensuring that the investment firm’s nor its employees’ self-interest is at play in the context of the performance of the investment service. On the other hand, the product governance, suitability, and appropriateness duties of Articles 24 and 25 of MiFID II belong to the realm of duties of care. These rules address the scope of the responsibilities of an investment firm; they do not seek to ring-fence the exercise of control.

4.61  Consequently, the best interest rule—as drafted—appears to be of a mixed character. The rule is dominated by ‘fairness’ or ‘good faith’ motivated Henderson-style duties of care that impose responsibilities to investigate the investor’s understanding, purpose, and situation, and to inform the investor in that context about the investment service or product. Product governance, suitability, and appropriateness duties belong to that realm.¹³⁰ The best interest rule also includes a (p. 181) selective set of control-style duties aimed at mitigating the conduct risks associated with conflicts of interest. Restrictions on inducements and remuneration belong to that realm. These may be characterized as ‘fiduciary-style duties’ that, in the words of DeMott, seek to restrict the investment firm’s freedom ‘to exploit [gaps] in a fashion that is either self-interested or oriented to serving interests other than those of the principal’,¹³¹ although as will be seen below,¹³² the conflict management rules in equity are much less forgiving than the regulatory conflict management rules.

4.62  It is not clear why MiFID II mixes certain conflict-risk management rules into Article 24’s ‘best interest rule’, but not other conflict rules, which are exclusively grouped under Article 23 (Conflicts of interest). In the interest of framing principle-based rules such as the best interest rule in the context of a conceptually coherent legislative rationale and purpose, the fiduciary-style rules currently comprised in Article 24 would have been better grouped exclusively under Article 23, and not, as they are now, dual-grouped in Articles 23 and 24.¹³³ That would have left the scope of the best interest rule, true to its nature and character, singularly directed at fairness, or ‘good faith’, responsibilities. The conflicts framework in MiFID II, much as it is in equity, should be framed as a body of rules that is designed purposefully to clear the work of the investment firm from conflicts independent from duties of competence and care.

4.63  The ordering of best interest and conflict rules in MiFID II ought to have recognized the different nature and character of conflict rules as internal control-type risk management rules. A breach of risk management rules is caused by a failure to put the right risk management framework in place around the conflicting interest, that is, internal and external controls. A question of breach of risk management rules is independent, and, in fact, unrelated to the question whether the risk that the framework seeks to mitigate has materialized. In other words, breach of a conflict rule does not mean per se, or at least in a logical and consistent framework ought not to mean per se that a breach of the best interest rule has occurred. The conflict rules and the best interest rules operate as complimentary investor protection rules. The conflict rules impose a control framework to mitigate a specific category of conduct risk, that is, the risk that the investment firm or its staff or agents do not exercise their responsibilities independently due to a conflicting interest. The best interest rule imposes duties of care that aim to move the conduct (p. 182) requirements beyond mere competent and skilful supply of the investment service or product. It requires the investment firm to use its skill and knowledge to consider the investor’s interest in the context of the investor’s purpose and situation when offering or supplying the investment service or product. It is not helpful to conceptually blur the line between the prohibitive fiduciary notion of control that is abuse agnostic and operates near-mechanically to restrict movement if a conflict occurs, and normative notions of due care, diligence, and good faith, that operate additively to expand the scope of the duty of care.

4.64  As discussed in section B1 above, an investment firm must put the investor’s interest at the heart of its service. That is the—uncontentious—starting point. But what does that mean when potential interests that are not investor interests come into play? As Keith Clark posits poignantly:¹³⁴

Human affairs generally are laden with conflicts of interest. None of us lives in a world of simply owing duties to a single person. Life is multifarious, and we are all conscious of the different levels of responsibility we have in relation to conflicts of interest in our private lives. Some of these responsibilities are buttressed by the power of law, some by moral and ethical standards, some by social customs and sometimes we have to make difficult personal decisions. The same is true for the business world. And over time the boundaries between the acceptable and unacceptable behaviour have shifted.

4.65  The fact that another interest exists is not wrong per se. It does not follow that the investor’s interest is compromised. In fact, without, for instance, the self-interest of the investment firm to derive revenue from the investment service, the service would not be. Grundmann and Hacker put it as follows:¹³⁵

[M]any conflicts of interest in general contract law remain fairly untouched by mandatory or even default law. They form part and parcel of the bargaining process which is often entrusted to work as a balancing device between parties … Therefore, the core question is: What distinguishes a conflict of interest worth regulating from one which solution is left to bargaining?

4.66  It is a matter of perimeter. In a relationship where a person who possesses special skills and knowledge undertakes by way of business to use that special skill and knowledge to serve the interest of a client, an interest other than the interest (p. 183) of the client becomes objectionable if there is a risk that the other interest may potentially interfere with the performance of the service to the disadvantage of the interest of the investor. In that vein, MiFID II Delegated Regulation (EU) 2017/565 describes the population of objectionable non-investor interests as follows (emphasis added):¹³⁶

The circumstances which should be treated as giving rise to a conflict of interest should cover cases where there is a conflict between the interests of the firm or certain persons connected to the firm or the firm’s group and the duty the firm owes to a client; or between the differing interests of two or more of its clients, to each of whom the firm owes a duty. It is not enough that the firm may gain a benefit if there is not also a possible disadvantage to a client, or that one client to whom the firm owes a duty may make a gain or avoid a loss without there being a concomitant possible loss to another such client.

4.67  These are the ‘classic’ categories—firm interest versus client interest, and client interest versus client interest—the regulation of which has been long established in equity in the context of fiduciary relationships.¹³⁷ Importantly, though, MiFID limits the scope of objectionable other interests to those who could result in the case of a firm interest versus client interest in a ‘possible disadvantage’ to the client, and in the case of a client interest versus client interest in a ‘concomitant possible loss’ to another client. In other words, the mere concurrence of interests is not a matter for regulation. A potential conflict, more precisely, a potential for disadvantage must exist.

4.68  Consequently, the filter for objectionable other interests in the regulatory realm differs from the filter in equity. In equity, the concurrent existence of a conflict is enough to cause a breach of fiduciary duty should the fiduciary act notwithstanding the existence of that other interest. Actual or potential disadvantage to the beneficiary is not the key. The seminal case demonstrating that the test is not whether there is an actual conflict or potential disadvantage but whether the fiduciary is subject to a concurrent interest, is Boardman v Phipps.¹³⁸ Three trustees held 25 per cent of the shares in a textile company on a trust established pursuant to a will. The trust could not legally purchase the remaining 75 per cent, as the terms of the will did not permit it. The solicitor of the trustees, together with one of the beneficiaries, purchased the remaining 75 per cent at their own expense. In arriving at their investment decision, they relied on information they received from the company whilst acting as proxies of the trustees in their capacity as holders of 25 per cent of the share capital. Prior to concluding the transaction, the solicitor and the beneficiary in question disclosed their plan to the trustees and the other beneficiaries, who did not raise objections. Not only could the trustees (p. 184) not legally purchase the remaining 75 per cent, the trust assets also did not provide the means to do so.

4.69  After the transaction had been completed and it had become clear that it had been a profitable transaction, one of the beneficiaries sued successfully for breach of fiduciary duty. The courts found at each instance that the solicitor and the co-acting beneficiary, as intermediaries and negotiators between the trustees and the company, had placed themselves in a position of trust and confidence to the trustees. Accordingly, they were liable to account for the profits to the trustees, even though the trustees would not have been able to acquire the shares themselves and notwithstanding the fact that the transaction was disclosed to the trustees and the beneficiaries and not objected to.¹³⁹ Lord Cohen placed the operative dynamic of the equitable fiduciary concept in plain sight:¹⁴⁰

I desire to repeat that the integrity of the [solicitor and co-acting beneficiary] is not in doubt. They acted with complete honesty throughout and the [complaining beneficiary] is a fortunate man in that the rigour of equity enables him to participate in the profits which have accrued as the result of the action taken by the [solicitor and co-acting beneficiary] in March, 1959, in purchasing the shares at their own risk.

4.70  Article 16(3) of MiFID II requires a firm to ‘maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest as defined in Article 23 from adversely affecting the interests of its clients’ (emphasis added). Article 23 of MiFID II requires that a firm (emphasis added):

[T]ake all appropriate steps to identify and to prevent or manage conflicts of interest between themselves, including their managers, employees and tied agents, or any person directly or indirectly linked to them by control and their clients or between one client and another that arise in the course of providing any investment and ancillary services, or combinations thereof, including those caused by the receipt of inducements from third parties or by the investment firm’s own remuneration and other incentive structures.

(p. 185) 4.71  Article 33 of MiFID II Delegated Regulation (EU) 2017/565 provides further guidance to identify conflicts of interests that ‘may damage the interests of a client’. At a minimum, investment firms must consider in respect of ‘the investment firm or a relevant person, or a person directly or indirectly linked by control to the firm’, whether the following circumstances occur:

1. (a)  the firm or that person is likely to make a financial gain, or avoid a financial loss, at the expense of the client;

2. (b)  the firm or that person has an interest in the outcome of a service provided to the client or of a transaction carried out on behalf of the client, which is distinct from the client’s interest in that outcome;

3. (c)  the firm or that person has a financial or other incentive to favour the interest of another client or group of clients over the interests of the client;

4. (d)  the firm or that person carries on the same business as the client;

5. (e)  the firm or that person receives or will receive from a person other than the client an inducement in relation to a service provided to the client, in the form of monetary or non-monetary benefits or services.

4.72  Accordingly, an investment firm must be careful to cast the net wide and trawl its business effectively to identify a catalogue of concurrent interests and to determine which of those concurrent interests potentially conflict with, in the sense that there could be detriment to, a client’s interest. Firms must keep a record of the identified conflicts.¹⁴¹ The analysis must go beyond interests at firm level and include interests of individuals employed or otherwise controlled by the firm. Particularly, an investment firm must consider financial and other incentives that influence behaviour in the context of product manufacturing and distribution, including, according to Article 33(a) and (e) of MiFID II Delegated Regulation (EU) 2017/565, staff remuneration and ‘inducements’.¹⁴²

4.73  The experience-infused words of Sir Howard Davies, former Chairman and CEO of the United Kingdom’s Financial Services Authority, serve as a reminder of the complexity of the system and the resulting challenges to identifying the causes and consequences of conflicts of interest in financial firms:¹⁴³

The most important and difficult questions in this area relate to the structures of markets and firms. Some of the issues related to the behaviour of individuals, while they make good press copy, are far easier to handle at least at the level of principle. (p. 186) Of course it is wrong to allow one’s personal judgment to be influenced by a kickback or a charitable donation. There may be difficulties in identifying these conflicts, and publicising them, but few of us would find it hard to say which behaviours were acceptable, and which not. In the case of a firm structure, however, the answers are far more complex. Do particular structures of firms create conflicts which, in themselves, represent opportunities for corruption, or at least the temptation to modify objective judgments, in a way which may not always be obvious to people involved? Have we developed a set of markets, and firms, in which conflicts are so inevitable, and unmanageable, that we need to consider wholesale restructuring, perhaps mandated by regulators?

4.74  In conclusion, an investment firm’s primary regulatory responsibility according to art 23(1) of MiFID II is to avoid the conflict. If that is not possible, the subsidiary responsibility according to art 16(3) of MiFID II is to mitigate the risk that the conflict poses to the interest of the investor by ‘maintain[ing] and operat[ing] effective organisational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest as defined in Article 23 from adversely affecting the interests of its clients’. If such mitigating measures are insufficient ‘to ensure, with reasonable confidence, that risks of damage to client interests will be prevented’ the investment firm must disclose the relevant facts to the client,¹⁴⁴ much in the way informed consent operates in equity. However, express regulatory proviso insists that investment firms should only use disclosure as ‘measure of last resort’.¹⁴⁵ Notwithstanding the disclosure, the investment firm remains responsible for ensuring that it acts in accordance with the best interest rule of Article 24(1) of MiFID II.

4.75  A firm’s conflict governance framework must be set out in a specific policy.¹⁴⁶ Importantly, the operation of the MiFID II conflicts rules is client category agnostic. Recital (46) of MiFID II Delegated Regulation (EU) 2017/565 observes:

Conflicts of interest should be regulated only where an investment service or ancillary service is provided by an investment firm. The status of the client to whom the service is provided—as either retail, professional or eligible counterparty—should be irrelevant for that purpose.

4.76  Article 24(9) of MiFID II introduces a general prohibition on investment firms to pay fees or commissions or to provide non-monetary benefits to ‘any party’, or to receive fees, commissions, or non-monetary benefits from ‘any party’, unless the payment or benefit ‘(a) is designed to enhance the quality of the relevant service to the client; and (b) does not impair compliance with the investment firm’s (p. 187) duty to act honestly, fairly and professionally in accordance with the best interest of its clients’. Again, the regulatory rule permits a margin not allowed in equity. According to Boardman v Phipps, any profit must be accounted for.¹⁴⁷

4.77  Article 11(2) of Delegated Directive (EU) 2017/593,¹⁴⁸ identifies the characteristics that a benefit must have to be ‘designed to enhance the quality’ of the investment service within the meaning of Article 24(9)(a). The benefit must be linked to increased service levels to the client (eg access to a wider range of investment options, asset allocation optimization, or value-added tools),¹⁴⁹ the investment firm or its connected persons must not receive a direct benefit without the client receiving a ‘tangible’ benefit,¹⁵⁰ and if the benefit received by the firm is continuous, then the benefit to the client must match that continuity.¹⁵¹ The prohibition, therefore, essentially reduces any services or goods an investment firm may receive free of payment in the conduct of its investment business, to goods and services that can be linked directly to an increase in service levels to the client. Similarly, an investment firm may not make payments or provide benefits to another investment firm if that inducement does not benefit the underlying client. Given that the question of benefit is entirely subjective, in practice it is not straight-forward to determine whether a benefit has been designed to add value.¹⁵² Firms will have to take a view based on their own judgment, and custom and practice.

4.78  The inducement rules affect particularly the commercial relations between product providers and product distributors. Distributor business models often rely on rebates or other payments made by the product provider. In EU jurisdictions that do not, unlike the United Kingdom and The Netherlands,¹⁵³ ban rebates or other payments between manufacturers and distributors outright, distributors will have to demonstrate enhanced services such as enhanced reporting, market insight services, or value-added tools.

4.79  Article 24(8) of MiFID II introduces a ban on receipt of inducements from any ‘third party’, except for ‘minor non-monetary benefits’, for independent investment advisers and portfolio managers. Accordingly, in providing these investment services, investment firms must not accept and retain benefits from third parties, (p. 188) which includes group companies,¹⁵⁴ in the context of an investment service provided to a client. Recital 74 of MiFID II refers specifically to benefits provided by issuers or other product providers. The words ‘must not accept and retain’ implies that benefits may be received, if they are passed on to the client.¹⁵⁵

4.80  Pursuant to Article 24(9), an infraction of the prohibition on inducements is deemed to be a breach of the best interest rule in Article 24(1) as well as a breach of the conflicts rule of Article 23 of MiFID II. Interestingly, Article 24(8) lacks such a provision. It is sensible to link the prohibition on inducements to those benefits that establish an interest that could potentially interfere with an investment firm’s ability to act in the best interest of the client. Nevertheless, as noted,¹⁵⁶ it is helpful to frame a breach of the prohibition on inducements as an infraction of both the best interest rule and the conflicts rule. The best interest rule defines an expectation of good faith behaviour. Conflict rules prescribe internal controls that aim to avoid or mitigate the risk that service levels are breached due to the existence of a conflicting interest. Risk management and internal control-oriented rules and duties to act in good faith, however, serve different purposes. The existence of a conflict may mean that the conflict rules have been breached, but a breach of the conflict rules does not mean that the client’s best interest has been compromised.

4.81  Commission Recommendation 2009/384/EC on remuneration policies in the financial services sector recommended that ‘Member States should ensure that financial undertakings establish, implement and maintain a remuneration policy which is consistent with and promotes sound and effective risk management and which does not induce excessive risk-taking’.

4.82  Article 74(1) of CRD IV implements the Commission’s Recommendation by requiring that firms subject to CRD IV¹⁵⁷ must establish ‘remuneration policies (p. 189) and practices that are consistent with and promote sound and effective risk management’.¹⁵⁸ Articles 92 to 97 of CRD IV place responsibility for remuneration policies in the hands of the management body, and where size and complexity of the firm requires it, a remuneration committee, and are prescriptive as to the structure of remuneration for ‘senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on their risk profile’.¹⁵⁹

4.83  The remuneration provisions of CRD IV are aimed at the management of balance sheet risk-taking. The rules in MiFID II focus on provision of investment services and aim at the management of conduct risk, more specifically, the risk that staff of an investment firm might not act fairly and in the best interest of a client due to a personal interest because of the interference of a conflicting interest caused by the remuneration structure. Accordingly:

1. (a)  art 9(3)(c) of MiFID II requires the management body to implement remuneration policies that apply to ‘persons involved in the provision of services to clients’ and which aim ‘to encourage responsible business conduct, fair treatment of clients as well as avoiding conflict of interest in the relationships with clients’;

2. (b)  Article 27 of Delegated Regulation (EU) 2017/565 prescribes further detailed requirements, in particular, Article 27 requires that remuneration policies and practices must be designed to avoid creating ‘a conflict of interest or incentive that may lead relevant persons to favour their own interests or the firm’s interests to the potential detriment of any client’, and ‘remuneration and similar incentives shall not be solely or predominantly based on quantitative commercial criteria’, but must take ‘appropriate qualitative criteria reflecting compliance with the applicable regulations, the fair treatment of clients and the quality of services provided to clients’ into account.

4.84  In summary, investment firms must take a close look at the way those staff who may impact client’s interests are remunerated to determine to what extent such a (p. 190) member of staff is put in a position where s/he must postpone their own interest in remuneration to serve the client’s interest. A sales force cannot be remunerated such that revenue is the only incentive, which increases the risk that a client ends up investing in an unsuitable or inappropriate investment product. Similarly, investment advisers and portfolio managers must not be remunerated such that it would potentially be detrimental to their objective to focus on the best possible investment for their clients. All such actors must be as independent as reasonably possible when they are dealing with client affairs.