In 2004 the Claimant, Forsta AP-Fonden, a Swedish pension fund (AP), entered into a Global Custody Agreement and a Securities Lending Authorisation Agreement with the Bank of New York Mellon (BNYM).
Pursuant to that arrangement, BNYM agreed to manage AP’s investments on a discretionary basis, including lending its securities to third parties. Those agreements permitted BNYM to re-invest the cash collateral it received when lending AP’s securities.
In 2007, BNYM invested approximately US$35m of cash collateral it had received for AP’s securities in two tranches of medium term notes issued by Sigma Finance Inc, an approved issuer and, at that time, the world’s largest structured investment vehicle.
During the course of 2008 Sigma began to suffer financial difficulties. BNYM communicated with AP in May 2008 in relation to risks arising from Sigma’s financial position.
In September 2008, at the height of the financial crisis, Sigma failed. As a result, the notes issued by Sigma lost almost all of their value.
In November 2010, AP issued a claim against BNYM alleging:
- that BNYM should not have acquired the Sigma notes in the first place, on the basis that they were not a suitably conservative investment for AP’s portfolio. AP alleged that the acquisition exposed AP to investments which were illiquid and therefore that decision was made in breach of the agreed investment guidelines
- that having acquired the notes, BNYM should not have held on to them when their value began to fall. AP alleged that, by doing so, BNYM had acted outside of its authority, in breach of contract and negligently, and
- that BNYM’s communications with it in May 2008 regarding the risk associated with the investment in Sigma, were so inadequate that BNYM was negligent, misrepresented the position and/or acted in breach of its fiduciary duty.
In his judgment, Mr Justice Blair held that BNYM was not liable for either acquiring or retaining the Sigma notes. He concluded that those claims were made by AP with the benefit of hindsight, and that the notes were seen as appropriate cash collateral investments before the global financial crisis.
Mr Justice Blair also accepted that BNYM did not owe fiduciary duties to AP to make a “full disclosure” of the information it held regarding Sigma; and that BNYM did not need to communicate its concerns to AP immediately.
Nevertheless, the Commercial Court did find in AP’s favour in relation to its claim regarding BNYM’s failure to communicate risks which it had identified in May 2008. The judge held that, as lending agent, BNYM was under a duty to communicate a fair view of the risk of default and loss if there was a serious risk of loss in respect of securities held as collateral for a client’s account.
Although the facts showed that BNYM contacted AP in May 2008, Mr Justice Blair explained that those communications misleadingly conveyed the message that BNYM was confident of repayment, and that the notes should be held by AP to maturity.
Mr Justice Blair stated that the view that BNYM presented to AP was “opposite, and irreconcilable” to the impression it had presented to some of its other clients; referring to specific letters where BNYM had expressed its belief that there was a significant likelihood of a default by Sigma and, in some cases, had even suggested alternatives to holding the Sigma notes. Those alternatives were not presented to AP.
Mr Justice Blair concluded that BNYM, by stating to AP that it remained confident that the notes would be repaid in full on maturity, had negligently misrepresented its position to its client and had acted in breach of its contractual and common law duties to act with the care, skill, prudence and diligence. The judge said that, based on the evidence, he was convinced that, had AP known of BNYM’s risk assessment, and been given the option to dispose of the notes, they would have done so by way of an asset swap, even though that would have meant relaxing the agreed Investment Guidelines that it had in place with BNYM at the time.
The judgment provides a useful reminder of the importance of ensuring that identified investment risks are adequately and transparently communicated to investors, so as to allow them to make informed decisions regarding their investments.