No fraudulent misrepresentations made in sale of RMBS-linked notes
The claimant (L30) alleged that the defendants (together Credit Suisse) had made fraudulent misrepresentations during the sale of a synthetic CDO in 2007, including misrepresentations as to the construction of the debt portfolio and the conduct of Credit Suisse’s RMBS business, which led to a $100m loss when the 2008 financial crisis hit.
Cockerill J roundly dismissed the case, primarily on limitation grounds specific to the facts in issue. However, the judgment should reassure financial institutions by providing a helpful illustration of the difficulties claimants face constructing implied misrepresentation cases in the face of clear financial documents.
L30 bought into the CDO at a cost of US$100m in 2007. The CDO was linked via a credit default swap to the credit of a reference portfolio of 100 underlying RMBS. Seven of the reference obligations were RMBS that Credit Suisse entities had securitised, packaged or underwritten.
The value of L30’s investment was lost in full in 2010. It sought to unwind the transaction on the basis that Credit Suisse had made implied fraudulent misrepresentations that induced it to purchase the Notes. It alleged systemic fraud and misconduct in the selling of RMBS, which tainted the Notes. And it alleged that Credit Suisse had been aware of this when selling the Notes and had fraudulently misrepresented that it was unaware of any such problems.
To make out a case in fraudulent misrepresentation, the claimant must show that the defendant (i) made a false representation; (ii) knew the representation was false, or did not believe it was true; (iii) intended the representation should induce the claimant to enter into the contract; and (iv) in fact induced the claimant to enter into the contract.
At trial, L30 pursued a sophisticated case based on nine implied representations. These were grouped into three ‘honesty representations’, four representations around the subject of credit ratings, one representation that a prospective investor would be able to make an informed determination of the value and credit quality of the reference obligations in the Notes, and one representation that Credit Suisse acted in good faith in preparing, approving and supplying the draft Series Memoranda and did not knowingly put forward information therein that was likely to mislead.
The judge concluded, for a variety of reasons, that Credit Suisse did not make any of these representations.
The honesty representations were each said to relate specifically to the RBMS in the reference portfolio that Credit Suisse had structured (the CS RMBS). But the CS RMBS were only seven out of one hundred reference obligations. It was not plausible that implied representations were made specifically about these seven obligations alone. The CS RMBS were simply never treated or discussed distinctly from the other 93 reference obligations.
Two of the honesty representations were said to concern the completeness and accuracy of the publicly available prospectus documents for the Reference Obligations. However, there were clear disclaimers in the Termsheet Important Notices and the Series Memorandum that Credit Suisse made no representation as to the completeness of the information provided, nor did Credit Suisse accept any responsibility for any omissions, and investors must make their own, independent assessment of credit quality. The judge pointed out that similar disclaimers had been found to be fatal in previous case law – as they were here.
Two further points are worthy of mention on the honesty representations.
- The judge was very clear that although L30 placed considerable reliance on evidence from Credit Suisse’s witnesses as to what investors would have assumed, the "subjective opinions of witnesses as to what investors would have assumed is both irrelevant and inadmissible for these purposes."1
- The judge rejected any suggestion that Credit Suisse’s CDO team had access to information about the CS RMBS that L30 did not. She found that a Credit Suisse witness’ comments on "the unthinkableness" of a breach of the information barrier between the two teams displayed "obviously genuine astonishment".
Two of the four credit rating representations were dismissed in short order because they were said to relate only to the CS RMBS. Therefore the same reasoning applied as for the honesty representations – there were no representations specifically about the CS RMBS separately from the other 93 reference obligations.
For the final two credit rating representations, L30 alleged that express representations which it admitted were literally true carried additional implied representations. But the judge found that these would fall foul of the requirement that a representation must be clear, and that there was no logic to support the idea that the express representations contained any additional implied content, especially in the detailed terms alleged by L30.
L30 argued that the statement that an investor must make its own determination of the value and credit quality of the RMBS necessarily implied that such an independent determination was possible. As such, it was implicit that Credit Suisse was representing that it did not know of anything which would disable an investor from making such an informed assessment.
While the judge acknowledged this could seem plausible, she concluded that it was wrong. She found that Credit Suisse was justified in submitting that L30 was seeking to transform an express warning into a positive representation. In fact, if one read the "Important Notices" section of the offering documents and considered the documentation holistically, it was clear no such representation could arise. To find otherwise would mean the Termsheet was overflowing with additional implied representations.
The judge gave short shrift to the argument that in preparing, approving and supplying the draft Series Memoranda Credit Suisse had knowingly put forward information that was likely to mislead. This argument could not get off the ground since the Series Memoranda were documents of the Issuer, not Credit Suisse.
In addition, on L30’s own case the Series Memoranda were not supplied until after L30 had approved its own entry into the transaction. As such, it could not possibly contain representations to be relied upon.
As mentioned above, in fact the claim failed because it was time-barred.
It is not surprising that limitation should be a key defence to a claim arising out of a transaction which took place in 2007. The claim was started in 2018, so as the judge put it in the opening of her judgment, there was an "elephant in the room" that on the face of it, L30’s claims in fraudulent misrepresentation, negligence and unlawful means conspiracy were time-barred.
s.32 Limitation Act 1980 provides for the start of the usual six-year limitation period to be postponed in case of fraud, concealment or mistake until such time as the claimant either discovers the fraud or could have discovered it with reasonable diligence. There is extensive case law on the meaning of "reasonable diligence" in this context.
L30’s arguments that s.32 should apply were entirely unsuccessful. The judge found that the claimant had sufficient information to plead its case much sooner than it did.
Fraudulent misrepresentation is a challenging cause of action. L30’s case relied on a complex scheme of implied representations, said to have arisen out of narrow, carefully considered documentation which, as is typical, made very clear that the investments were suitable only for sophisticated investors who have the necessary risk appetite and are able to assess matters for themselves. It was necessary for L30 to make allegations going well beyond a general implied representation that the documents had been put forward honestly and in good faith.
Reassuringly, the Court seems to have regarded the case as artificial and overly sophisticated. Instead, it upheld the common-sense meaning and effect of the documents entered into, which made their liabilities clear. It is reassuring news that financial institutions can expect those warnings and documents to be effective.