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Day v Forex Capital Markets: Guidance on the COBS appropriateness assessment

The topline

Day v Forex Capital Markets is particularly interesting because the Commercial Court delivered a rare judgment on the appropriateness assessment required to be conducted under the Conduct of Business Sourcebook (COBS) in the Financial Conduct Authority Handbook. The decision offers valuable guidance for in-scope firms on the courts’ approach.”

Andrew Northage

Andrew Northage, Partner at Walker Morris

Walker Morris Regulatory & Compliance Partner and financial services expert Andrew Northage considers the judgment [1] and the key takeaways.

London-Financial-District-elevated-view-to represent Day v Forex Capital Markets

What’s Day v Forex Capital Markets about?

The claimant, a financially successful businessman, lost over £1.8 million in a 70-day period placing spread bets on an online platform run by the defendant. The bets were contracts for difference (CFDs) concerning oil prices. They were placed at the early stages of the pandemic when demand for oil fell and prices slumped. The claimant was prepared to risk a considerable amount on oil prices rising but the risk didn’t pay off.

The claimant alleged the losses were caused by the defendant’s breach of contract and statutory duty in failing to comply with its terms of business and COBS, in particular the client’s best interests rule and COBS 10A. It was argued that the defendant didn’t do enough to carry out the required appropriateness assessment and wrongly assessed its service as appropriate for the claimant.

The court dismissed the claim in its entirety.

The key takeaways from Day v Forex Capital Markets

  • A firm has a certain degree of flexibility when assessing appropriateness.
  • The correct approach is to look at the questions put and ask if, overall, the firm complied with its obligations.
  • A firm is not under a strict obligation to ask about an applicant’s educational background and profession. Education and appreciation of risk are different things. 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 won’t.
  • COBS 10A.2.8G is clear that it may be appropriate to infer knowledge from experience.
  • Practical experience trumps formal knowledge.
  • A quiz is just one method for assessing knowledge.
  • There is no obligation to ask questions about bankruptcy.
  • A firm should look at vulnerability when deciding whether to allow a client to trade if they elect to after receiving a warning notice.
  • There is nothing in COBS to suggest the assessment is anything other than a one-time event.

What are the relevant rules?

One of the FCA’s operational objectives is to secure “an appropriate degree of protection for consumers”. When assessing what degree of protection is appropriate, the FCA must have regard to “the general principle that consumers should take responsibility for their decisions”. The court noted this is an important provision which ensures the FCA acts with due deference to the important right of autonomy.

The COBS rules are divided into binding rules, non-binding guidance [2] and provisions derived from EU legislative material.

COBS was revised as a result of changes introduced by EU legislation, MiFID II. One change was to introduce a new COBS 10A to deal with appropriateness assessments. It seemed clear to the court that, while firms would need to conduct appropriateness assessments for a greater number of products as a result of MiFID II, the way that assessment was carried out wouldn’t fundamentally change. The existing rules continued to provide guidance.

In Day v Forex Capital Markets, the claimant also relied on COBS 2.1.1R(1) which provides that a firm must act honestly, fairly and professionally in accordance with its client’s best interests.

The relevant rules, old and new, are set out in a schedule at the end of the judgment. The court also referred throughout to two helpful and relevant documents from the European Securities and Markets Authority (ESMA). The extracts from ‘ESMA 2017’ and ‘ESMA 2019’ are at paragraphs 39 to 41 of the judgment.

The rules as applied in Day v Forex Capital Markets

  • The defendant was required to seek information about the claimant’s knowledge and experience in the field of investments and then to determine from that information whether the claimant understood the risks involved in spread betting [COBS 10A.2.1R and 10A.2.3EU].
  • The defendant was under an obligation in particular to seek information about (a) the types of service and financial instruments the claimant was familiar with, (b) how often and with what frequency the claimant had previously traded and, to the extent appropriate, (c) the claimant’s education and profession [10A.2.4EU].
  • The defendant was entitled to rely on the information given by the claimant [10A.2.6EU] unless it was aware or ought to have been aware that the information was manifestly out of date, inaccurate or incomplete.
  • It was open to the defendant to place particular weight on a potential client’s relevant trading experience [10A.2.8G and ESMA 2017 dealing with 10.2.6G in similar form].

The appropriateness assessment in Day v Forex Capital Markets

The claimant provided information, designed to allow the defendant to assess the claimant’s “knowledge and experience”, by selecting answers from drop down menus on an online portal. The following warning was recorded twice; once before the applicant entered personal information, and once before employment status was requested:

“CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69.66% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take a high risk of losing your money.”

The defendant had an appropriateness policy, which it didn’t fully adhere to in terms of the questions asked, and which contained some notable omissions and errors. For example, it referred to COBS 10 rather than its successor COBS 10A, and there was no direct reference to MiFID II.

The policy also accepted that the defendant’s products and services were not necessarily appropriate for clients who had ever declared bankruptcy. If a new account application indicated that the applicant had declared bankruptcy, the policy provided that a high risk information notice would be given. The claimant had previously been made bankrupt but was not asked about bankruptcy and so didn’t receive a notice.

The court noted that both the policy and the assessment centred on experience, but that COBS 10A.2.8G makes clear it may be appropriate to infer knowledge from experience. The absence of any real investigation of knowledge wasn’t fatal to the process.

What did the court decide in Day v Forex Capital Markets?

It wasn’t helpful or necessary to undertake a detailed textual analysis of the questions put to the claimant. The better (and correct) approach was to look at the questions put and ask whether, overall, the defendant complied with its obligations.

The court regarded COBS 10A.2.4EU as central. It makes clear (as does ESMA 2019) that a firm has a certain degree of flexibility when assessing appropriateness. When read with ESMA 2019 (and ESMA 2017 to the extent it’s appropriate) the court was satisfied that the defendant didn’t act in breach of contract or contravene COBS by failing to obtain adequate information to assess whether the claimant had the necessary knowledge and experience to make it appropriate to engage in CFD trading.

The following reasons were given:

  • Answers to three of the questions made it clear that the claimant had a great deal of practical experience of trades with a high risk profile (leveraged trades).
  • Given the huge amount of experience the claimant had, the defendant was entitled to infer that the claimant possessed relevant knowledge.
  • Practical experience trumps formal knowledge.
  • The absence of any question about bankruptcy was irrelevant. Bankruptcy isn’t always a sign of an inability to understand risk. The defendant was perfectly entitled not to raise any question about it. COBS makes no mention of bankruptcy.
  • The absence of questions about formal education was also irrelevant. The defendant wasn’t obliged to ask.
  • The defendant’s appropriateness policy didn’t match its actual approach. While that was a matter the defendant should review and put right, it didn’t alter the fact the information gathering was perfectly adequate.
  • The absence of a quiz (which is just one method for assessing knowledge) was also irrelevant.
  • The defendant was entitled to rely on the claimant’s answers as truthful.
  • The ESMA guidelines were complied with.

If the court’s conclusions were wrong, the claim would still fail, for two reasons:

  • If the defendant had concluded that CFDs weren’t appropriate for the claimant, a high risk information notice would have been issued. The court had no hesitation in finding that had that been the case the claimant would have elected to trade. The claimant wasn’t easily swayed by others. The service of a notice would have made no difference because the claimant was well aware that trading CFDs was high risk.
  • If the defendant had conducted a thorough investigation into appropriateness, the products would have been assessed as appropriate for the claimant, a knowledgeable trader who fully understood all of the risks involved in trading CFDs.

The client’s best interests rule

In addition, there was no basis for saying that the defendant in Day v Forex Capital Markets had breached the client’s best interests rule, because its appropriateness assessment was unimpeachable.

If that was wrong, and if the claimant had elected to continue to trade after receiving a high risk information notice, there was no basis on which the defendant ought to have prevented the claimant from trading.

It wasn’t clear why such a refusal would, judged at the time, be in the claimant’s best interests. The argument couldn’t be that the claimant didn’t understand the risks – they accepted that they did, and that was absolutely clear from the evidence. If the argument was that the claimant lost a lot of money and so judged with the benefit of hindsight it would have been in their best interests to be stopped from trading, that argument was untenable. Their best interests were served by not interfering with their right to elect to trade.

ESMA 2019 makes it plain that a firm should look at vulnerability when deciding whether to allow a client to trade if they elect to after receiving a warning notice. There was no suggestion this claimant was vulnerable.

A continuing obligation?

Finally, the defendant argued that COBS 10A.2.6EU (which differs from the old rule with the additional words “ought to be aware”) supports the argument that there is a continuing obligation to assess appropriateness. The court disagreed. There’s nothing in COBS to suggest the assessment is anything other than a one-time event. The words “ought to be aware” make it plain that the firm’s consideration of whether information is manifestly out of date, inaccurate or incomplete will be judged objectively.

References in ESMA 2019 to “updating client information” didn’t assist the claimant either. In the court’s view, ESMA 2019 simply asks what arrangements there are to keep information updated without providing any positive guidance as to what those arrangements should be. It sounds a note of caution about updating without good reason.

Even if there was such a duty, there was nothing in any of the claimant’s dealings on the dates when there were major increases in their deposited funds to suggest that any of the information on which the appropriateness assessment was based had become manifestly out of date, inaccurate or incomplete; or that a completely new assessment at that point would produce a different outcome. The sums deposited, and whether they were greater than the sums initially anticipated, had nothing to do with appropriateness.

In any event, there was nothing to demonstrate that the defendant’s view of appropriateness on a reassessment would have changed. The claimant’s knowledge and experience were ample to allow them to trade. The claimant in Day v Forex Capital Markets simply made very bad decisions and joined the 69.66% of other clients for whom CFDs were “appropriate” in losing money.

How we can support you

Our Regulatory & Compliance experts have vast experience advising on FCA compliance issues. Please contact Andrew if you have any queries about the points raised in Day v Forex Capital Markets, or need advice or assistance, including with staff training or policy review and drafting.

[1] Robert Day v Forex Capital Markets Limited [2023] EWHC 1349 (Comm)

[2] While guidance isn’t binding and doesn’t need to be followed to achieve compliance with the relevant rule, compliance with the guidance will be sufficient to satisfy the rule to which it relates.