Odds not in favour of investors in 'forward accumulator' court cases
David Smyth of Smyth & Co, in association with Reynolds Porter Chamberlain, consider disputes arising out of 'forward accumulators'
Why are forward accumulators in the news?
Forward accumulators are making headlines because of a number of high profile disputes working their way through the courts. These disputes have their origins in losses incurred by investors as a result of investing in certain structured investment products during the "bull market" run that preceded the 2008 financial crash. The underlying investments are usually shares.
The disputes tend to take two forms. First, the investor sues the financial institution (usually a bank) to recoup significant losses that the investor blames on the bank and its staff.
The investor's usual modus operandi is to claim that the bank breached its contractual duties or assumed a responsibility to advise the investor before some of the losses were incurred. For good measure, the investor may claim the bank and its staff committed regulatory breaches.
Second, some disputes involve the bank suing the investor to recover substantial losses over and above the security held by the bank and/or the amount held on deposit by the investor with the bank.
What are forward accumulators?
In short, they are "investments" in shares. Pursuant to each forward accumulator the investor agrees to buy a specific number of shares in a listed company at specific intervals during the period of the contract; for example, each trading day for up to one year. The investor buys the shares at a discount to the market price as at the contract date, known as the "strike price".
The forward accumulator comes to an end if the share price hits a "knock-out price", which caps the seller's losses.
At that point, the seller (the financial institution) is not obliged to sell any more shares and the investor is relieved of any further obligation to buy. The investor gains on the difference between the strike price and the market price for each lot of shares acquired and sold.
So far so good, in a rising market.
However, the sting in the tail is if the share price falls below the strike price. The investor is obliged to keep buying the shares at the strike price and by a certain multiplier until the market price resumes the strike price; for example, "doubling-up" the number of shares each trading day. In a falling market there is no knock-out price to protect the investor. The investor will incur substantial losses during the life of the forward accumulator, unless the market dramatically turns. To unwind their positions some investors have incurred losses of tens of HK$ millions.
Can the investor blame the bank?
The investor can try but few (if any) appear to succeed. The bank will almost certainly be protected by the contractual documents which usually specify that the bank is only executing the trade and acting on the investor's express instructions - on an "execution" basis. Unless the bank acted egregiously (such as undue influence or misrepresentation) or specifically advised on a trade (which is unlikely to be the case) the investor will usually have no remedy. It is no excuse that the investor did not read the contract terms or did not understand the transactions. The sorts of investors entering into forward accumulators could be described as "professional investors", rather than consumers such as some elderly "mini-bonds" investors.
Is there anything else to be aware of?
A few things come to mind (for now).
Forward accumulators are clearly not for everyone. A simple search of the regulators' websites will give investors an insight of the risks.
An investor will often enter into a number of forward accumulators, with different strike and knock out prices. In one recent case an investor apparently entered into some 350 forward accumulators over an approximate four-year period. It appears some investors gained a liking for forward accumulators until the market turned in 2008.
Besides holding security and deposits, the bank may well ask for guarantees to protect its position and to provide support for the investor's risk exposure.
There are also investments known as "forward decumulators", whereby the investor sells shares at a strike price. In effect, the investor is betting on the market going down. However, if the market price exceeds the strike price and the investor does not have the shares to sell, then the investor has to buy them at market price and sell at a loss. They are another form of speculation. One does not have to be a clairvoyant to foresee more lawsuits.
Warren Ganesh also contributed to this article
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