Complex Structured Investments – Caveat emptor!

A recent case in the English courts has passed very firmly to investors in structured note products the responsibility to review for themselves all relevant legal documentation. The court said that investors should be bound by the terms of the final (i.e. executed) contract documentation even where those documents contradicted the transaction termsheet previously reviewed by the investor.

Indeed, the court went further and inferred that the arranging bank would have no positive duty to draw attention to the fact that a material change had been made to the transaction between the stages of termsheet and final documents.  

The case (Peekay Intermark Limited v Australia and New Zealand Banking Group Limited) involved a claim by an investor in respect of a structured Note sold to it by ANZ Bank Group in 1998.  The investor was originally informed that the Note would carry some kind of proprietary right in a specified amount of Russian GKOs (Russian Government Bonds) and the indicative term sheet confirmed this.  Subsequently, the transaction structure was changed so that the principal of the Note was linked to the performance of the GKOs.  This change was not specifically brought to the attention of the investor.  When the GKOs became subject to a Russian Government moratorium later in 1998, the Notes redeemed at a tiny proportion of their face value.  The investor claimed that ANZ had misrepresented an essential feature of the transaction and that, had the Note actually been secured on GKOs as originally stated to it, then the recovery would have been much higher.

Initially, the lower courts in the UK passed judgment in favour of the investor.  However, in April 2006, the Court of Appeal reversed this decision and found against the investor.  It has been reported that the investor does not intend to appeal and, accordingly, for the time being, the judgment of the Court of Appeal must be considered to be settled law.
The judgment is an important one for institutions investing in structured products that are governed by English law. It is now incumbent on those institutions to ensure not only that they have read and understood the termsheet but also that they have read the final contract documents to ensure that they reflect the termsheet.

(1) PEEKAY INTERMARK LIMITED(2) HARISH PAWANI - Claimants/Respondents
- and -
AUSTRALIA and NEW ZEALAND BANKING GROUP LIMITED - Defendant/Appellant

The facts of the case

Peekay was a company trading from an address in Dubai. It was used as an investment vehicle by its shareholders who included the second claimant, Mr. Pawani. The company traded in a variety of investments including bonds, bills, emerging market instruments and derivatives, as well as bullion and currencies. Investment decisions were taken by Mr. Pawani and his fellow directors. The judge in the original trial found that Mr. Pawani was a man of substantial means who has considerable investment experience.

In early February 1998, ANZ contacted Mr Pawani to describe a new opportunity to invest in Russian Government bonds (“GKO”s) with a US dollar hedge. As a result of their discussions Mr. Pawani acting on behalf of Peekay told ANZ that he wished to invest US$250,000 in the product that had been described to him, that is, the GKO-linked deposit. A document containing what were described as final terms and conditions ("FTCs") of the investment was sent to Mr. Pawani for signature on behalf of Peekay and a draft letter of instruction to the bank to transfer the funds needed to make the investment. Mr. Pawani knew from his previous dealings with ANZ that it would be necessary to sign a document of this kind, but apparently he regarded it as a mere formality.

The investor looked over the documents briefly but did not read them, assuming that they reflected what he had told by ANZ about the investment. He did notice that the FTCs were headed "USD Hedged Russian Treasury Bill", but he regarded that as consistent with the description of the product that he had been given originally. Together with one of Peekay's employees he initialled each page of the documents and signed the Risk Disclosure Statement which he returned to ANZ. The Risk Disclosure Statement ran to over five pages and contained detailed warnings to investors of the risks associated with various kinds of investments in emerging markets including derivatives in the form of structured notes and other debt instruments.

In August 1998 the Russian government announced a moratorium on certain of its debt obligations, including those arising under GKOs, and as a result GKO No. 21110 to which Peekay's deposit was linked was not paid on its maturity date. The obligation was virtually worthless. ANZ implemented the default procedure set out in Appendix 2 of the FTCs and as a result the amount recovered by Peekay on the maturity of its investment was US$5,918.06. It is not suggested that the default procedure was operated in any way improperly.

The investor’s claim

The essential grounds of Peekay's claim was that it had been led to expect that it would obtain an interest in the GKO itself and that it would not have made the investment on its behalf if he had realised that it would obtain no interest in the underlying GKO because that would give it no room for manoeuvre if there were a default by the Russian government.

The judgment given at the original trial

The judge in the original trial found that, in the course of the various conversations that Mr. Pawani had had with ANZ, the bank had misrepresented the nature of the investment that it was offering to its clients by giving him the impression that investors would obtain a proprietary interest of some kind in a GKO. The judge went on to find that the product the Peekay had actually been offered was very different from that which ANZ had originally described, being a financial derivative in the form of a structured deposit which gave the depositor no interest in the underlying GKO and no say in how the investment was to be liquidated in the event of a sovereign default. The court had decided that Peekay had been induced by that misrepresentation to make the investment. The court therefore awarded Peekay damages in the amount of its loss under section 2(1) of the Misrepresentation Act 1967. ANZ appealed against that judgment in the Court of Appeal.

Should the investor be entitled to rely on the original Term Sheet?

In the lead judgment in the Court of Appeal, Lord Justice Moore-Bick said: “If he [i.e. Mr. Pawani] had read that document [i.e. the FTCs], he would have seen that the investment was described as a note linked to GKO bonds, rather than a share in the bonds themselves”. So the main point at issue in the case was whether Peekay was entitled to rely on the arranging bank (ANZ) to bring a major structural change specifically to its attention. The Court of Appeal reviewed the relevant cases on misrepresentation and concluded that whether a person has been induced to enter into a contract by a misrepresentation is in each case a question of fact. As such, the Court said, it is always open to the defendant to show, if he can, that since the claimant was aware of the true facts, he was not induced by the misrepresentation to act as he did. For that purpose, however, it is not enough to show that the claimant could have discovered the truth, but that he did discover it.

However, the Court of Appeal distinguished the precedents from the present case on the basis that none of the precedents “concerned a misrepresentation which was "corrected" (if that is the right expression) by the express terms of the very contract to which the claimant put his signature” (as was the case with Peekay). Moreover, the Court, in seeking to justify its view that it was reasonable to expect the investor to read the final documents in order to discover the true nature of the transaction, pointed out that the change to the structure was not buried in a mass of small print but appeared on the face of the documents as part of the description of the investment product to which the contract related. Accordingly, the Court decided to allow the appeal by ANZ and overturned the earlier decision that Peekay had been induced to enter the transaction by a material misrepresentation.

Some conclusions

The judgment of the Court of Appeal appears to be designed to send an emphatic message to the institutional investor community that transaction legal documentation needs to be read in full and understood, and that investors will not be allowed claim misrepresentation if they rely on the descriptions of the transactions they enter into, but where the final documentation corrects any ambiguity or misrepresentation previously earlier conveyed to them.

However, there may reasons to believe that the Court of Appeal decision is not as clear cut as it may first appear. Firstly, the Court did distinguish between important terms of the transaction that were “buried in a mass of small print” and those that “appeared on the face of the documents”. Was it the Court’s intention to infer that important terms insufficiently highlighted could be regarded as being incapable of reversing a misleading representation given at an earlier stage to the investor?

Sccondly, the Court pointed out that the FTCs were the first and only opportunity that the investor had been given to satisfy itself that the nature of the investment and the terms relating to it were consistent with the broad description it had been given and that it was satisfactory in all other respects. It may perhaps be inferred from this that the Court might have taken a different view in circumstances where the investor had read a first draft of the term sheet but had not necessarily read every subsequent version of that document but had relied instead on the arranging bank to keep them informed of material changes to the transaction as it developed. However, it is not possible to be sure of the answer to this question and it may be unwise, for the time being, for any investor to rely on such an assumption.

Further questions

If you are, or represent, an investor and would like to discuss any part of this article in more detail, please email: info@daviddoble.com