District Judge Hickman:
- The hearing in this case took place on 2nd November and it has taken me rather longer than I would have wished to prepare this judgment, partly because the trial bundle with which I have had to wrestle is one of the most awkwardly compiled and badly paginated that I have seen for some time. I am reminded of Lord Justice Sedley's (ironic) "First Law of Documents":
Documents may be assembled in any order, provided it is not chronological, numerical or alphabetical.
- In November 2008 the Claimant Mr Petrie transferred a substantial pension fund from another provider to the Defendant Standard Life. Not all of that fund concerns me in this case. As is helpfully set out in Standard Life's Defence, some of the monies were applied in paying a fee to Mr Petrie's financial adviser, some monies were deposited into a Royal Bank of Scotland account and further monies were deposited into a Standard Life Self-Invested Pension Plan account. I note in passing that the financial adviser in question, Mr Christopher Petrie, is in fact the Claimant's son, but in my judgment nothing turns on that.
- A balance of £541,805.40 was transferred on 18th November into a Standard Life Fund called the "Sterling One Pension Fund".
- Mr Petrie's intention was to "park" these monies for a short time while arrangements were made for tranches of money to be deposited in various banks. Understandably he wished to deposit no more than £50,000 in any one bank, that being the limit to which bank deposits were underwritten by the Government. I need to remember what turmoil the financial markets were in at that time. There had been a run on Northern Rock the previous year, the first run on a major UK bank since Overend Gurney in 1866. Lehman Brothers had collapsed in September 2008 and Landsbanki had failed on 7th October.
- The description of the Sterling One fund is at the heart of this dispute. What appears (though as to this see paragraphs 23 and 24 below) to have been the current description at that time appears at tab 6, appendix 5 and is dated November 2008 (probably 25th November, certainly after 24th November, as that is the date to which historical data is given):
Fund Objective:
to invest not only in bank/building society deposits but also holds other short-term sterling assets. The Fund is designed for investors who are looking for a temporary home for their money when the short-term outlook for equities, bonds and property is uncertain. Some of the cash investments that the Fund may hold are not 'guaranteed' in the same way as High Street Bank or Building Society Accounts are. Therefore, in extreme circumstances, it is possible that the value of the Fund may fall.
- At the hearing before me, Mr Lilly emphasised the fact that the fund is also described as "Sector – ABI Money Market".
- It is also common ground that the fund was marketed as "a cash fund".
- Mr Petrie was highly disgruntled when within the space of a few days there was an appreciable fall in the value of his investment. His adviser sought an explanation. This was forthcoming in emails of 28th November (tab 6, appendix 11) and 31st December (tab 32). What had happened, as explained by Mr Ryan Leiper, SIPP Operations Manager, in the email of 31st December, was that
"…an investment holding in Granite Master Trust, a mortgage based investment issued by Northern Rock reduced due to a revaluation of this investment and this created the biggest price decrease between 21st and 24th November…."
Mr Leiper continued:
"…Although the recent mark down should turn out to be temporary, this temporary loss works in exactly the same way as a loss in any of our other funds. If you were to invest in an equity fund which fell in value and then disinvested before a market rebound, you could not expect to receive a return on the loss incurred following the rebound…."
- Mr Petrie argues that the investments contained in the fund were not as described. Specifically, he complains about the inclusion in the fund of asset-backed securities.
- It is accepted that as well as bank deposits and bonds, the fund contained floating rate notes. I was referred to a definition of these in Wikipedia in the following terms:
Floating rate note
From Wikipedia, the free encyclopedia
Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for that day and adding the spread. A typical coupon would look like 3 months USD LIBOR +0.20%.
Issuers
In the U.S., government sponsored enterprises (GSEs) such as the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are important issuers. In Europe the main issuers are banks.
Variations
Some FRNs have special features such as maximum or minimum coupons, called capped FRNs and floored FRNs. Those with both minimum and maximum coupons are called collared FRNs.
FRNs can also be obtained synthetically by the combination of a fixed rate bond and an interest rate swap. This combination is known as an Asset Swap.
Risk
FRNs carry little interest rate risk. An FRN has a duration close to zero, and its price shows very low sensitivity to changes in market rates. When market rates rise, the expected coupons of the FRN increase in line with the increase in forward rates, which means its price remains constant. Thus, FRNs differ from fixed rate bonds, whose prices decline when market rates rise.
As FRNs are almost immune to interest rate risk, they are considered conservative investments for investors who believe market rates will increase. The risk that remains is credit risk.
Trading
Securities dealers make markets in FRNs. They are traded over-the-counter, instead of on a stock exchange. In Europe, most FRNs are liquid, as the biggest investors are banks. In the US, FRNs are mostly held to maturity, so the markets aren't as liquid. In the wholesale markets, FRNs are typically quoted as a spread over the reference rate.
Example
Suppose a new 5 year FRN pays a coupon of 3 months LIBOR +0.20%, and is issued at par (100.00). If the perception of the credit-worthiness of the issuer goes down, investors will demand a higher interest rate, say LIBOR +0.25%. If a trade is agreed (and who wouldn't) the price is calculated. In this example, LIBOR +0.25% would be roughly equivalent to a price of 99.75. This can be calculated as par, minus the difference between the coupon and the price that was agreed (0.05%), multiplied by the maturity (5 year).
See also
Inverse floating rate note
- Mr Lilly was somewhat scathing about the use of Wikipedia but it seems to me that while it is inappropriate to use Wikipedia or similar internet resources as a source of quasi-expert evidence, it is perfectly appropriate and proportionate to use such a resource to find an explanation for an unfamiliar expression, just as it is accepted practice to refer to a reputable dictionary.
- Mr Christopher Petrie said to me:
"'Asset backed' means that money is being loaned against things like books of mortgages… This is what went wrong when the mortgage market fell apart. We realised they [Standard Life] had not been trading in short-term FRNs, but in asset-backed FRNs, a totally different and more risky thing. They should have explained that…"
- Mr Petrie says that he is fortified in his position by the decision of Standard Life to reimburse their investors in the Sterling Fund for the loss sustained by them on 14th January 2009, when the value of the fund fell by something of the order of 4.8% (see tab 6 appendix 7) as a result of losses on other asset-backed securities.
- He also draws attention to the fact that Standard Life changed the description of the fund. The description of the Fund Objective (tab 6 appendix 4) now says:
…The Fund is intended to provide market leading returns from a portfolio of money market instruments and invests not only in bank and building society deposits but also in a variety of other money market instruments such as Certificates of Deposits (CDs), Floating Rate Notes (FRBNs) including Asset Backed Securities (ABSs) where, when purchased, repayment is typically expected within 3 years. The fund price is not guaranteed by Standard Life and there could be circumstances where the fund price may fall. A fall might happen if, for example, there is a default by one of the banks where some of the money is held or where there is an adverse market movement in the value of one or more of the securities held due to for instance a credit event or where the anticipated repayment term of an asset is extended.
- The breakdown of investments at 5th January 2009 included cash deposits of 18.7%, floating rate notes 7.6% and "floating rate notes – asset backed" no less than 44.3%.
- Standard Life say, of course, that the fact that they amended their literature does not mean that it was previously incorrect. It is right that it does not necessarily mean that. But it is striking that a reference to "short-term sterling assets" is replaced by a reference to "assets where repayment is expected within three years"; and the indication that in extreme circumstances it is possible that the value of the Fund may fall is replaced by an open ended statement that "there could be circumstances where the fund price may fall".
- Standard Life produced a witness statement from Gordon Lowson, who describes himself as head of Money Markets and Foreign Exchange at Standard Life (Tab 8). He said:
"…If I were to be asked as to whether I consider the current circumstances in the economy to be extreme, I would say absolutely… We have had a run on a UK bank [Northern Rock] and a major American investment bank going bust, therefore I would call these circumstances extreme…"
He also ventured the opinion that
"…I would expect that a sophisticated investor would understand that an FRN has various subsets below it and that ABS is one of them. I do not consider that any IFA would make an assumption that an FRN does not equate to ABS. The safer assumption would be that if a fund factsheet or any documentation referred to FRNs it could be to any of the various types of FRN. My opinion is that any adviser who is advising on a fund should know what an FRN is and what the subsets of FRNs are. I wouldn't sell a car if I didn't know how it worked."
- This received the mordant riposte from Mr Petrie senior, a retired engineer:
"…If one really wanted to waste time defending such a comment I would say, should the car salesman know if the pistons in the engine were made of aluminium or a grade of alloy containing an element of aluminium…"
- While I would not take issue with Mr Lowson's comment:
"…If I were to be asked as to whether I consider the current circumstances in the economy to be extreme, I would say absolutely…"
it appears to be advanced on the basis that because conditions are extreme, an investor can by definition have no complaint against Standard Life however badly his investments perform. If that is the basis on which it is advanced, it goes too far.
- Mr Lowson was not cross-examined – the position is that I am quite content to accept his factual account of what happened and indeed of why it happened, but I am not obliged to accept his interpretation of terms used in his company's documentation, or his view as to what an investor or adviser should have understood or should have done, and in certain respects I do not do so.
- The historical background to the Sterling Fund is that in December 2007, as indicated in the fact sheet exhibited to Mr Christopher Petrie's evidence (tab 9), the investment of the Fund was 100% in cash. Mr Petrie junior understandably, perhaps, had that in mind when recommending the fund to his father as a safe temporary haven for his funds.
- Had Mr Petrie junior seen the revised fact sheet which became available at about the same time that Mr Petrie senior made his investment, he would have been made aware that floating rate notes were included in the asset mix. Standard Life's position is that had he known that, he ought to have realised that some of those FRNs could be asset-backed. I think the relevant fact sheet appears at appendices 5 and 2 to Tab 6.
- Now, there is a curious inconsistency between that fact sheet and the extract quoted in Standard Life's letter of 2nd July (Appendix 3, page 65), which includes the rubric about
…Floating Rate Notes (FRNs) including Asset Backed Securities (ABSs) where, when purchased, repayment is typically expected within three years…
which I quote in paragraph 14 above.
- That purports to state the fund objective which was being made known to advisers - such as Mr Petrie junior - from 22nd October 2008. Yet it is quite clear from the fact sheet at appendices 5 and 2 that as late as 25th November 2008 no explicit mention was in fact being made of the inclusion of ABSs. I regret to say that I can accordingly place no reliance on what Standard Life tell me about what they made publicly known, and when, save where it is corroborated by contemporaneous documentary evidence.
- Mr Petrie junior also quotes from marketing literature relating to the Sterling Fund as at 1st November (appendices 9 and 10):
Conditions within the credit and money markets have been difficult for the best part of the last twelve months. With the start of the credit crunch, spreads on some FRNs, particularly those backed by mortgages, widened significantly and a lack of appetite for these assets in the market has resulted in little bidding and some deals going through at discounts to par…
The Pension Sterling Fund continues to offer a well-diversified portfolio. Currently the Fund has around 50% invested in short-dated assets; around £1 billion. This level is expected to increase as, to be prudent at the current time, we are reinvesting maturing floating rate notes into more liquid, short-dated assets. As such, we do not expect the Pension Sterling Fund to be a forced seller of any of its floating rate notes and we will continue to hold them until they mature, when we will receive par value…
- Given what one now knows about the investments which were comprised in this fund, it is possible to see clues to the presence of asset-backed securities in the fund. I do not accept that this would be readily apparent without hindsight, and there is certainly nothing to alert one to the fact that over 44% of the fund is invested in asset-backed securities (as shown on Appendix 4).
- Should Mr Petrie junior (and through him, his client) have realised that the investment mix in the Sterling One Fund contained ABSs - and in truth as much as 44.3% of them by 5th January, as we have seen? Until the investment breakdown of 5th January 2009 Standard Life did not differentiate between floating rate notes generally and ABSs.
- Bearing in mind the underlying stated purpose of the fund, I think it is expecting far too much to expect an adviser to read into what was overall very uninformative documentation that a substantial part of the fund was actually made up of ABSs. I do not accept that, absent hindsight, it is reasonable to expect an adviser or an investor to reason:
"Irrespective of anything that is said about the objective of the fund, and irrespective of how this fund has been marketed, and irrespective of how this fund has historically been invested, this fund is classified as 'ABI Money Market' and therefore may include ABSs. Indeed, and again irrespective of the objective of the fund, nearly half of the fund may actually be so invested."
The adviser, and the investor, were and are entitled to consider the documentation as a whole, and to consider all of the representations made by Standard Life, not just those which in retrospect support Standard Life's position.
- Mr Lilly sought to focus on the "underlying sector" classification of "ABI Money Market" and argued in effect that this trumped everything else. If an investment was permissible within ABI guidelines (and it is clear that ABSs are permissible within those guidelines – see the document at tab 37 – though there is also a stipulation about the average weighted maturity of the assets, which was not specifically discussed before me), that was that.
- I do not consider that is a permissible approach. Clearly if an investment is not within ABI guidelines then it is impermissible; but the detailed description which was applied to this fund at the relevant time was, as I have indicated
to invest not only in bank/building society deposits but also… other short-term sterling assets. The Fund is designed for investors who are looking for a temporary home for their money when the short-term outlook for equities, bonds and property is uncertain.
- The inclusion of ABSs, and certainly of such a substantial proportion of them, was apt to give rise to precisely the problem which Mr Petrie faced – that if an investor has to recoup a fall in the market price of an asset by hanging on to maturity of the asset, this is fundamentally inconsistent with the stated purpose of the fund which was to provide a temporary home for the investor's money.
- If Standard Life had made it clear that nearly half of this fund was actually made up of ABSs, what would have been the likely reaction of the average investor or indeed the average financial journalist? I bear in mind that this was over a year after the run on Northern Rock and the start of the American sub-prime mortgage crisis. I suspect that that reaction would have been similar to the unkind observation in the Times of 5th August 2009, which was included in the trial bundle at tab 6, appendix 12, page 95:
"…investors had been promised that their investments were safe and liquid only to have the value of the fund slashed because much of it had been invested in toxic debt…" (Emphasis added)
It is possible that a fear of such an adverse reaction may have prompted the cautious and uninformative drafting which Standard Life initially adopted, though that is a matter of speculation.
- It would seem that Granite, a mortgage based investment, was a long term investment and (given Granite's connection with Northern Rock) a risky one. It is not immediately apparent how its inclusion in the asset mix was legitimate given the stated fund description, and the stated objective of the fund, in November 2008. The Defence at paragraph 5.3 refers to
…the unforeseen instability of Northern Rock Bank and its affiliates…
This is a surprising comment. But I do not need to ask whether investment in Granite was actually a breach of contract. The test, as Mr Lilly correctly says, is whether the nature of the fund was misrepresented. And I regret to say that I find that it was.
- The Sterling Fund was represented as a cash fund, containing short term assets, and suitable as a temporary home for monies. It had (correctly) been represented as being invested 100% in cash the previous year.
- The furthest that Standard Life in fact appear to have gone in updating that representation was to make available a fact sheet [Tab 6, appendix 2] indicating that 49.6% of the Fund was in floating rate notes but not differentiating between FRNs and ABSs and also not differentiating between short term and long term investments. It is noteworthy that the marketing literature of 1st November gives the impression that the liquidity of the fund was increasing
…as, to be prudent at the current time, we are reinvesting maturing floating rate notes into more liquid, short-dated assets…
- The furthest Standard Life are able to go in their defence is at paragraph 5.1:
It is denied that Mr Petrie did not know that some of the FRNs in the Fund were asset-backed. The Fund factsheet provided to the IFA gave sufficient information for an investment professional such as himself to determine the content of the Fund and the nature of those Funds
- In other words, Mr Petrie junior ought to have been able to read between the lines of Standard Life's marketing literature. For the reasons I have given, I consider that Mr Petrie, along with other advisers and investors, should have been given clear and complete information by Standard Life. He was not. In no way was the information made available to Mr Petrie junior
"sufficient...to determine the content of the Fund and the nature of those Funds"
- Mr Lilly sought in the pleaded defence to rely on the email of 28th November by which Mr Petrie junior was explicitly informed that the Fund contained ABSs, and to say on the basis of that email that Mr Petrie
"…decided to remain in the Fund for almost a month thereafter. Accordingly Mr Petrie was content to invest in the Fund with the knowledge that it contained asset-backed securities."
- This seems to me to be a hopeless argument given that the Fund had fallen by about 0.55% between the 21st and the 24th November and the email was in response to Mr Petrie's enquiries as to what had gone wrong. In truth, after 28th November, so far from being "content", Mr Petrie sought to get his money out of the fund as rapidly as was practicable given his over-riding desire not to put more than £50,000 of his eggs in any one basket.
- Mr Petrie's letter of 15th December 2008 (Tab 35) sets out the value of the fund on each working day between 17th November and 15th December and in tabular form these are as follows:
| Date |
Value of fund |
Change in value of fund |
Percentage change |
| 17/11/2008 |
135.639648 |
|
|
| 18/11/2008 |
135.691039 |
0.051391 |
0.03788789 |
| 19/11/2008 |
135.711232 |
0.020193 |
0.014881602 |
| 20/11/2008 |
135.726489 |
0.015257 |
0.011242253 |
| 21/11/2008 |
135.648085 |
-0.078404 |
-0.05776617 |
| 24/11/2008 |
134.902086 |
-0.745999 |
-0.54995174 |
| 25/11/2008 |
134.78722 |
-0.114866 |
-0.08514768 |
| 26/11/2008 |
134.780248 |
-0.006972 |
-0.0051726 |
| 27/11/2008 |
134.819519 |
0.039271 |
0.029137059 |
| 28/11/2008 |
134.767079 |
-0.05244 |
-0.03889644 |
| 01/12/2008 |
134.77191 |
0.004831 |
0.003584703 |
| 02/12/2008 |
135.89425 |
1.12234 |
0.832769974 |
| 03/12/2008 |
134.856904 |
-1.037346 |
-0.76334797 |
| 04/12/2008 |
134.846836 |
-0.010068 |
-0.00746569 |
| 05/12/2008 |
134.844603 |
-0.002233 |
-0.00165595 |
| 08/12/2008 |
134.845367 |
0.000764 |
0.000566578 |
| 09/12/2008 |
134.884216 |
0.038849 |
0.028810037 |
| 10/12/2008 |
134.894554 |
0.010338 |
0.007664351 |
| 11/12/2008 |
134.930323 |
0.035769 |
0.026516267 |
| 12/12/2008 |
134.940755 |
0.010432 |
0.007731398 |
| 15/12/2008 |
134.863094 |
-0.077661 |
-0.05755192 |
- There are three large movements. The fund increases in value on 2nd December and decreases in value the next day. These movements appear broadly to cancel one another out, and they are also not shown to relate to investments such as Granite. The downward movement of 0.549951737% on 21st-24th November, however, coincides with Granite being marked down, and the value of the fund being marked down with it.
- If one ignores those three movements, the average daily movement of the fund is ... 0.024804624%, a figure perfectly consistent with the description of the fund as having a low volatility. I do not think Mr Petrie can properly complain about a daily movement of that magnitude. But I think he is entitled to complain about the downward movement in excess of that figure. I think he demonstrates that he suffered a loss of 0.525147114% of his investment by reason of the fund not being what he quite properly understood it to be.
- At 21st November Mr Petrie had £541,805.40 invested in the Sterling One Fund. He is entitled in my judgment to recover 0.525147114% of that figure, or £2,845.28, and I shall award him interest on that award at 8% per annum from 25th November 2008, which amounts to £227 up to Monday 23rd November, with a daily rate of £0.62.
- Mr Petrie also seeks interest on his investment, asserting that:
his investment in a cash fund would normally have generated interest exceeding £1,303 but he is limiting his claim to that amount…
- I do not believe this aspect of his claim can succeed. He simply did not invest in a guaranteed interest fund. It is true that, so far from providing "market leading returns" (Appendix 6, tab 4) the Sterling One Fund appears to have performed lamentably, figuring in the fourth quartile over three months (-1.3% against a sector average of +0.6%), one year (0.4% against 3.9%), three years (8.9% against 12.9%) and five years (17.3% against 21.5%). It may well be that Mr Petrie could echo the comments of Lord Justice Leggatt in the Court of Appeal in Nestle v National Westminster Bank where he said
"No testator, in the light of this example, would choose this Bank for the effective management of his investment."
- But that cannot entitle Mr Petrie to a retrospective yield on his investment which Standard Life did not undertake to pay.
- The only costs Mr Petrie seeks are his court fees, and he is entitled to these. These, I believe, total £443. I observe in passing that I proposed dealing with the case on written submissions and Mr Petrie was content with this approach, but Standard Life insisted on an oral hearing in respect of which a hearing fee became payable.
- I should also observe that in the course of correspondence Standard Life in their letter of 7th July 2009 sought to frighten Mr Petrie off with hints of adverse orders for costs under CPR 27.14. That was regrettable. Even if Mr Petrie's case had failed, it was plainly arguable and one which it was reasonable for him to advance, and for large organisations to attempt to bully litigants in person in this way is unattractive. Mr Lilly was quite right not to pursue any such suggestion at the hearing before me.
