Basic Features of Accumulators

Since early last year, a number of prestigious private bankers in Hong Kong began to peddle a kind of structured product called “Accumulator” to their clients. The basic features of the Accumulators are that:-

- The client (buyer) undertakes contractually to buy a certain quantity of a specified stock (usually one of the hot stocks at the time or a blue chip such as HSBC) from the seller (usually the private banker’s parent or associated company) every trading day for a year at a price which is slightly below the spot price (the accrual price).

- If that stock rises to above a certain level (usually not more a few percentages above the spot price), the contract will be ‘knocked-out’, ie, it will be terminated and neither the buyer nor the seller will be bound to buy and sell any longer. However, if the price remains below the ‘knock-out’ price, the buyer must continue to buy the stock at the accrual price until the expiry of the contract.

The Legal Issues

Many buyers have now learnt that the Accumulators are a kind of extremely risky instrument. Not only that, the upside and downside are completely disproportionate. It is disproportionately in favour of the seller.

Saddled with great loss, and with blood bleeding every day for another eight or nine months, many buyers have asked “Is there a way out? Am I legally bound to buy that beaten down stock every trading day until the end of the contract?”

The sad answer to this question is: “Yes, you are bound!” unless you fall into one of the following situations.

Misrepresentation

If the private banker selling you the accumulator has made misrepresentation to you in the course of selling, it may be open for you to argue that you are entitled to rescind the contract and/or claim compensation for losses arising from such misrepresentation. This will be the case even though the relevant contract has expressly stated that there is not any oral representation made or that the written contract contains the entire terms of the agreement. If an oral misrepresentation is proved to be made, under section 4 of the Misrepresentation Ordinance (Cap 284, Laws of Hong Kong), the exemption clauses or entire agreement clauses in the contract will not exempt the liability for misrepresentation unless the private banker or the seller proves that such clauses are ‘reasonable’. The test of reasonableness is laid down in the Control of Exemption Clauses Ordinance (Cap 71, Laws of Hong Kong).

Many buyers of accumulators complain that their private bankers painted a most rosy picture about the accumulators and described them as a low risk product. (The common Chinese translation of accumulator: 低價累積is particularly misleading.) However, that may not be enough to establish a claim for misrepresentation. Normally, for a legal action to be founded on misrepresentation, it must be a statement of fact, rather than just an opinion. Moreover, very often the buyers would have been provided a copy of the accumulator contract for perusal before they signed or confirmed the contract. In such case, the claim of misrepresentation may be difficult to make out.

In any event, it is a question of fact whether the particular transaction will be tainted by misrepresentation. Full consideration of the detailed facts leading up to the signing of the contract would need to be investigated before a definite view could be reached.

Negligent Advice

If misrepresentation could be established then the buyer may be entitled to rescind the accumulator contract or claim damages. However, even if misrepresentation could not be established (because, e.g., what has been told to the buyer is just a matter of opinion), it is possible that the private banker may be liable for giving negligent

advice to his clients for advising the client to buy accumulator contracts without very serious warning to the clients for the inherent risk of such contracts.

Again the client agreement between the private banker and his clients will be full of exemption clauses exempting his liabilities. Such exemption clauses may not help the private banker if he fails to satisfy the ‘reasonableness test’ under the Control of Exemption Clauses Ordinance. However, one uncertainty in this regard is that the Control of Exemption Clauses Ordinance does not apply to “any contract so far as it relates to the creation or transfer of securities …” Yet it is arguable that the contract between the private banker and his clients is not such a contract. It is a contract for the private banker to advise their clients in managing their wealth, not a contract for the clients to buy securities from the private banker.

Misconduct

Even if there is no legal remedy against the private bankers or sellers of the accumulator contracts, it is not unlikely that in peddling the accumulator contracts, the private bankers may have committed professional misconduct. The following provisions in the Code of Conduct issued by the Securities and Futures Commission (May 2006 edition) may be relevant (they are not meant to be exhaustive):-

Clause 2.1Where a licensed or registered person advises or acts on behalf of a client, it should ensure that any representations made and information provided to the client are accurate and not misleading.

Clause 3.4 When providing advice to a client a licensed or registered person should act diligently and carefully in providing the advice and ensure that its advice and recommendations are based on thorough analysis and take into account available alternatives.

Clause 3.10 A licensed or registered person should act in the best interests of its clients in providing services or recommending the services of an affiliated person to its clients.

Clause 5.2 Having regard to information about the client of which the licensed o registered person is or should be aware through the exercise of due diligence, the licensed or registered person should, when making a recommendation or solicitation, ensure the suitability of the recommendation or solicitation for that client is reasonable in all the circumstances.

Clause 5.3 A licensed or registered person providing services to a client in derivative products, including futures contracts or options, or any leveraged transaction should assure itself that the client understands the nature and risks of the products and has sufficient net worth to be able to assume the risks and bear the potential losses of trading in the products.

In elaborating the requirement under clause 5.2, the SFC further advises (in a FAQ) that:-

Investment Advisers should

(a) know their clients;

(b) understand the investment products they recommend to clients (Product due diligence);

(c) provide reasonably suitable recommendations by matching the risk return profile of each investment product with the personal circumstances of each client to whom it is recommended;

(d) provide all relevant material information to clients and help them make informed investment decisions;

(e) document and retain the reasons for each product recommendation made to each client.

It should be emphasized that a complaint to the SFC against the relevant private bankers would not result in the any legal remedy for the buyers. The worst that could happen to the person being complained is that his licence with the SFC may be revoked. However, if an investment advisor breached the above provisions, it would tend to support a claim of negligence against him in a civil legal action.

Conclusion

The legal issues pertaining to the accumulator contracts are very complicated. This article should not be treated as an exhaustive discussion thereof and should not be relied upon by any person without full consideration of facts of his/her case and the relevant legal issues.