Even as banking regulators in the United States are moving more over-the-counter derivative contracts to exchanges and/or otherwise guaranteed settlements, recent weeks have witnessed a spate of reports in the global media about court cases against banks and brokers relating to large losses sustained by clients. Some of the arguments advanced do give a sense of déjà vu when one looks at the many cases in India.
One class of cases involves losses sustained in margin-trading. Margin trading is obviously speculative but the cases seem to focus on incorrect information about the state of the trading portfolio and/or the balance of the margin account, given by broker/bank to its client. In a case in London (Case No: 2006 FOLIO 855) that was recently decided, the court ruled against the broker through whom margin trading was conducted, and has ordered him to pay as much as £20 million to the client.
There is a similar case in Singapore filed against Citigroup by a client doing currency trading through the bank. The client has claimed that he had a $100 million surplus margin with the bank, but in late October, the bank told him that he was in deficit, forcing him to close his positions at a huge loss. In another case, this time in Jakarta, the client has sued Merrill for losses sustained when Merrill sold the shares held by it, at a loss, to recover the money owed by the client (Apparently, the client lost a similar case in Singapore and has now taken the dispute to a Jakarta court).
Incidentally, in the London and Jakarta cases, the clients involved seem to be people of Indian origin: Are we more prone than others to speculative trading? This apart, I find it somewhat curious that, in the London and Singapore cases, the trader was not aware of his own position/profits/losses and, therefore, the actual state of the margin account. Surely, they should have been keeping track of their trading on a spreadsheet, and marking-to-market the positions regularly, as any normal trader would have. This point was not argued in the London case.
An increasing number of cases involving derivatives seem to be going to courts in different parts of the world — one is tempted to report them as many of the issues seem to be common to the cases in India as well. There are a few hundred cases in Korea involving knock-in and knock-out derivatives, which have led to huge losses for end-user clients, after the plunge of the Korean won last year against the US dollar. Many of the cases seem to have gone in favour of the clients, at least in the lower courts, on the grounds that they violated the so-called “equity principle”. The court also ruled that the banks did not ensure the contracts really suited the companies’ needs, and failed to disclose the risks. As part of their standard documentation of derivative contracts, banks often take an averment from the client that he is not relying on the bank as an adviser and is undertaking the transaction on his own volition, making his own independent decision. The Korean courts do not seem to have given much weight to such clauses in the circumstances of the disputed cases.
In another case in Indonesia, the client company has claimed that “There are a lot of products that were sold to (us), there were forward contracts with knock-outs; target-redemption forwards; cancelable forwards; American knock-out, … they sold it as a hedging instrument but, in fact, these products by nature are very speculative.” (Asia Risk — April 2009). Speculative products sold as hedges is the issue in many disputes in India as well.
More From This Section
There are many other cases, particularly involving local authorities and municipalities in Italy and Germany, against various banks who were counterparties to the derivative contracts. Here again, the allegations are similar: Mis-selling of complex products, without explaining the risks properly. In one case (The Economist, May 2) reported in an Italian newspaper, the official of a municipal council has contended that “The banks’ representatives always presented every operation to me as being in the council’s best interests, always underlining — now I realise — only the profitable short-term aspects.” Many Indian companies have probably had similar experiences. Apart from municipal councils, one case in Austria involves the state-owned railways against Deutsche Bank. The problem seems to be equally virulent in China where the State-owned Assets Supervision and Administration Commission (SASAC) has come out with new hedging rules for state-owned enterprises (SOEs).
All these may ultimately prove to be just the tip of the proverbial iceberg. Chances are that the largest number and variety of cases have probably been filed in that most litigious society — namely the United States. The difference would be that the disputes probably relate more to credit derivatives rather than interest rates or currency derivatives. Whatever the results of the court cases, one can never over-emphasise the need for caveat emptor (buyer beware).