From losses to litigation: Client’s lawsuit against broker explained

Will brokers face higher expectations for the standard of care that they provide to consumers?

A recent court case saw a client of Forex Capital Markets Limited (FXCM) looking to recover losses and substantial damages arising from trading oil CFDs in 2020. The case is particularly interesting with the Consumer Duty on the horizon and the prospect of brokers facing higher expectations for the standard of care that they provide to consumers.

The trading losses experienced by the client were amplified by extraordinary volatility in the underlying futures market.

Crude oil futures

In April 2020, the WTI crude oil futures contract made headlines when it plummeted into negative territory for the first time in history. This unprecedented event occurred due to a combination of factors, including a sharp drop in global oil demand caused by the Covid-19 pandemic and a lack of available storage capacity.

As the expiration date of the May 2020 contract approached, traders holding the contract faced the challenge of either taking physical delivery of the oil or rolling over their positions to future months. However, due to limited storage options and reduced demand, traders were willing to pay buyers to take the oil off their hands, resulting in negative prices.

According to the case summary, the client lost £1.86m ($2.4m) from spreadbets placed on FXCM’s platform. The bets were CFDs on the price of the WTI futures contract traded on the New York Mercantile Exchange (NYMEX).

Claims from the client

The client was a successful businessman with no formal qualifications. He alleged breaches of the FCA Conduct of Business Sourcebook (COBS) and FXCM’s terms of business. The claims focussed on three areas, alleging that FXCM:

  1. failed to carry out the required appropriateness assessment and wrongly assessed that its service was appropriate for the client; and
  2. failed to provide confirmation in a durable medium of the relevant expiry dates; and
  3. failed to give prior notice that its system could not handle trading in the relevant contracts and it would close them if the market price was zero or negative.

In summary, the client claimed that if FXCM had assessed that its service was not appropriate for him, or had not given him misleading expiry date information, he would not have traded and suffered a loss.

The Court’s analysis

The court dismissed all claims, providing the following context:

  • FXCM was entitled to infer that the client possessed relevant knowledge based on “a great deal of practical experience of trades with a high risk profile (leveraged trades)”;
  • “there is nothing in COBS 10A or in COBS 10A.2.6EU which suggests a continuing duty to review appropriateness”;
  • COBS 16A.3.1EU required FXCM to provide the client with essential information (in a durable medium), but COBS does not explain what information is “essential” suggesting that the firm has a degree of latitude in its interpretation. The court was satisfied with FXCM’s explanation that it only ever offered one US Oil CFD contract at a time. It follows that there was only one possible expiry date, and that expiry date was signposted and available to the client; and
  • FXCM was entitled to close any or all open contracts upon the occurrence of an exceptional market event under FXCM’s terms of business.

Lessons for brokerages

Compliance controls offer protection from claims and complaints

In this case, the process FXCM followed and documented to assess appropriateness was a key part of its defence. Brokerages can gain comfort in this area by assessing procedures against the relevant COBS rules, and carrying out periodic process audits to ensure the procedures are being followed.

One comment from the Judge in this case was particularly interesting: “Very many people who lack a formal education will fully understand the risks inherent in trading CFDs. Equally very many people who have a university education will not.” This cuts both ways. It is a useful warning to any CFD providers out there relying on the academic profile of young investors as a cornerstone of their appropriateness assessments.

Acting in the client’s best interest

Firms and clients both need to understand that neither the client’s best interest rule nor the upcoming Consumer Duty are designed to protect clients from all harm. The following quotes from the Judge in this case and the FCA will be of come comfort to retail brokerages on this topic.

“If the argument is that a client lost a lot of money and so judged with the benefit of hindsight it would have been in his best interests to stop him trading, the argument is untenable.”

“A consumer may suffer an adverse outcome if such a risk materialises. For example, investments may carry a risk of capital loss, and secured lending may put a consumer’s home at risk if they do not keep up with repayments. We do not expect firms to protect their customers from risks that they reasonably believed the customer understood and accepted.”

Reporting information to clients

The Judge in this case acknowledged that the purpose of providing the information in the account statements was to ensure that the client knew what he had already done, not to inform his future investment decisions. However, the fact that FXCM only offered a single US Oil CFD contract at a time appeared to be a key factor in arriving at this decision.

Brokerages should ensure that the reporting requirements under COBS 16 and COBS 16A are being met, and review this periodically. It is not a straightforward process, particularly for brokers offering a wide range of products. Information that is deemed non-essential for one product may be essential for another.

Lewis Gurry, director at C & G Regulatory Solutions, has experience managing and delivering complex regulatory change projects as an executive and group compliance officer in FICC markets. Lewis is an expert in finding practical solutions to regulatory issues within a commercial environment.