Q&A: Financial services disputes
October 2022 | SPECIAL REPORT: FINANCIAL SERVICES
Financier Worldwide Magazine
October 2022 Issue
FW discusses financial services disputes with Nathan Willmott at Ashurst, Susy Bullock at Gibson, Dunn & Crutcher LLP and John Rhie at Quinn Emanuel Urquhart & Sullivan LLP.
FW: How would you describe the level of disputes involving financial services (FS) firms over the last 12 months or so? To what extent have you seen an increase in conflict in this sector?
Willmott: Banks and investment firms are facing a high volume of disputes, covering both retail and wholesale activities. The coronavirus (COVID-19) lockdowns triggered a massive increase in fraud-related issues, while more recently the Russian invasion of Ukraine led to a significant flow of disputes arising from the termination of client relationships and handling trades that were not able to be completed lawfully because of the imposition of broad new sanctions. Of course, the increase in claimant law firms in the UK and the gradual shift toward a greater use of class actions and other multi-party mechanisms has also fuelled this increase in litigation against financial services (FS) firms.
Rhie: In Hong Kong, disputes involving FS firms have remained steady over the past 12 months. In recent years, Asia has also continued to take the lead in the number of initial public offerings (IPOs). Further, Asia IPOs accounted for nearly half of all IPOs that took place globally in 2021. Further, Asia-Pacific has seen high volumes of private equity (PE)-related transactions, including high profile investment exits in the past few years. As a result, the potential for disputes involving banks, PE or FS firms will probably remain high and steady in the near future.
Bullock: FS firms remain a frequent target of claimants and litigation funders, with a steady stream of litigation over the past 12 months and a growing body of group claims in the English High Court and Competition Appeal Tribunal, together with disputes pursued through arbitral tribunals and non-judicial fora. While it is difficult to quantify the level of conflict, in recent years it appears that FS firms have seen conflicts crystallise in respect of more areas of their business, and are seeking to attribute more responsibility and liability to FS firms for the acts of clients or third parties.
“Asking the right questions early on will also help focus the discussion on what needs to be addressed, and how to tailor a strategy to fit the party’s dispute resolution needs.”
FW: What types of disputes are typically embroiling FS firms? Are there any particular issues giving rise to liability and litigation risk?
Bullock: Fraud claims continue to be a prevalent cause of disputes involving FS firms, with some law firms reporting that almost half of civil banking litigation claims in the English courts relate to allegations of fraud. Environmental, social and governance (ESG) considerations permeate the entire operations of each FS firm from the board down, from reporting obligations to appropriate product information and disclosures, to composition of ESG funds or indices, to mandatory human rights and environmental due diligence obligations. As stakeholder scrutiny of these considerations has increased exponentially, so too has the litigation risk attached to ESG matters. While not litigation per se, it is illustrative to note that FS has consistently been one of the leading sectors facing complaints before National Contact Points – agencies which offer a grievance mechanism for disputes arising under the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises – over recent years.
Willmott: A broad range of potential liability risks are crystallising for banks and investment firms. In addition to liability for third-party fraud against customers, which has become a significant issue for banks, we are seeing regular disputes in relation to derivatives and structured products, protection of sensitive data and technology outsourcing disputes – particularly as margins are increasingly squeezed on long-term contracts. We have also seen an increase in disputes and investigations relating to the development and marketing of cryptoassets, issues relating to COVID-19 business support lending, improper use of private messaging systems by bank employees, protection of inside information, the implementation of block trades, and issues arising from failings in systems and controls for the management of financial crime risks.
FW: How have evolving rules and regulations led to increased scrutiny of FS firms in recent months? To what extent is this dynamic leading to a rise in disputes?
Rhie: Hong Kong regulators have continued to issue further guidelines on the regulation of virtual assets and crypto-related products. Specifically, Hong Kong’s anti-money laundering (AML) and counter-terrorist financing (CTF) legislation is due to be amended in the near future so that all virtual assets, including cryptocurrency exchanges, will need to obtain licensing from the Securities and Futures Commission (SFC), subject to a number of exceptions. It is therefore expected that exchanges which deal in virtual assets, including cryptocurrency, will continue to face pressure from regulators locally and worldwide. Already the number of virtual asset-related disputes has risen sharply, mainly due to the growth of investing in cryptocurrency and also the turbulence that the cryptocurrency market has faced. Likely disputes in this area will continue, especially as some of the ‘landmark’ cryptocurrency cases which were brought during the pandemic may resolve in the next year or two. In turn, these results may encourage more crypto investors to bring disputes.
Willmott: The standards expected of FS firms operating in the UK continue to rise as the Financial Conduct Authority (FCA) imposes ever more demanding obligations on FS firms. Firms have a regulatory duty to put in place effective systems and controls to manage each individual and diverse risk that they face across the business, and a failure to do so can lead to very significant fines against firms and their officers and employees. For firms that serve retail customers and small and medium-sized enterprises (SMEs), the FCA’s new ‘consumer duty’ rules covering product governance and the requirement to ensure that firms provide ‘fair value’ in relation to the products and services that they offer, will undoubtedly be used as a springboard for class actions and other multi-claimant disputes. Separately, FS firms are facing increased risks as they get to grips with the employee-related requirements under the Senior Managers & Certification Regime (SM&CR).
Bullock: With evolving rules and regulations inevitably comes increased scrutiny of FS firms, in particular when regulators move into areas previously untouched. For example, the FCA recently announced that regulation of the ESG ratings industry “is coming, and coming quite quickly”. This could have a significant impact on FS firms, given the numerous ways in which they are informed by, or are themselves judged according to, ESG data and ratings.
“It is perhaps stating the obvious but tackling cross-jurisdictional disputes in a cohesive manner across offices and teams is critical to success.”
FW: In your opinion, how important is it for financial services firms to reduce the cost, time and reputational impact of a dispute? Depending on the nature of the dispute, what resolution options should they consider?
Bullock: Disputes are a time consuming and expensive diversion for any business. Litigation should be a last resort, and FS firms can benefit from actively exploring alternative resolution mechanisms where appropriate. Openness to creative solutions and remedy can be particularly valuable when disputes are between counterparties that would otherwise have an ongoing business relationship. However, a pragmatic approach will only take FS firms so far if the claimant is unwilling similarly to ‘lean in’ as a result of constrictive litigation funding arrangements.
Willmott: In many cases, there is a real window of opportunity for potential disputes to be resolved quickly and without the need for formal dispute resolution mechanisms, which can make a huge difference to the cost, management time and reputational impact of litigation. For FS firms that are particularly concerned about the reputational impact of claims against them, the use of arbitration clauses in their standard contracts has become increasingly common. These are particularly effective in bilateral firm and client relationships where it is unlikely that other parties will need to be involved in the resolution of a dispute. The real benefit of arbitration is that the firm will not be required to settle the claim early to avoid negative publicity and so can defend its position robustly without fear that the allegations will be repeated across the financial press.
Rhie: Most FS firms will want to reduce their exposure to costs, time and reputational impact. Part of what makes a conflict resolution process effective is to consider the firm’s priorities early on. For instance, if reputational concerns or minimising publicity are paramount priorities, arbitration generally affords more privacy and confidentiality than litigation. If personal relationships are at stake, be it purely commercial or even familial, parties may find that mediation is a suitable forum to start. These are the types of questions that legal advisers should ask early on. The timing of when to implement a certain strategy is also critical. If there is a good chance of settlement and this is what the party wants, it will need to consider how much it wants to spend on formal proceedings such as arbitration. Starting and maintaining formal proceedings may step up the pressure on the other side and therefore increase the chance of a successful settlement, but if this point comes too late in time, the party may be commercially better off seeing the dispute through until the end, even if this will ultimately mean that the dispute lasts longer.
FW: In a cross-jurisdictional dispute, how should FS firms go about managing the range of complex issues they are likely to encounter?
Willmott: Cross-jurisdictional disputes create much greater complexity in the handling of disputes, but equally they can provide significant strategic benefits for the client in areas including the appropriate forum to pursue a claim, the collection of evidence and the availability of interim relief. Across different jurisdictions it is important to identify the opportunities and the challenges that are presented from litigation procedures, so that the issues can be identified at an early stage and an optimal litigation strategy developed. These opportunities and challenges vary from jurisdiction to jurisdiction and span a wide range of issues, including the availability of injunctive relief and the ability to seize assets as an interim measure, the extent of the duties of disclosure of documents of the parties, the scope and availability of legal privilege, and data privacy issues. Each of these issues needs to be understood and assessed to ensure that the best possible decisions are made.
Rhie: Early input from legal advisers is critical. The point is to ask the right questions with the aim of narrowing down the range of issues that are likely to crop up and assess how complex the situation looks to be. Which jurisdictions are involved, and to what extent? Does the client risk potential parallel proceedings in different jurisdictions? If so, do you need a local lawyer? Is there likely to be an insolvency element? Do the cross-jurisdictional issues concern regulatory or even criminal aspects? Asking the right questions early on will also help focus the discussion on what needs to be addressed, and how to tailor a strategy to fit the party’s dispute resolution needs.
Bullock: It is perhaps stating the obvious but tackling cross-jurisdictional disputes in a cohesive manner across offices and teams is critical to success. This applies equally to in-house and external legal counsel. Such disputes can present unique concerns, such as questions over location and local legal treatment of data and evidence, and strategic questions, such as appropriateness of jurisdictional challenges, not to mention regulatory concerns and the importance of mastering the complex issues themselves. A joined-up and streamlined approach, informed by a team with experience in the industry and cross-border litigation, is critical.
“There is no sign of the FS disputes landscape quietening down over the months ahead. Existing topics will continue to keep firms busy for some time.”
FW: What advice would you offer to FS firms on identifying the risks they face so that they may mitigate, as far as possible, the financial and reputational costs associated with a potential dispute?
Rhie: Reputation is a subject that FS firms are increasingly identifying as a point of concern. This is not particularly surprising given that FS firms, like banks and other corporates, are increasingly coming under the spotlight of regulators as well as the media. It is often advisable to first discuss these matters with external counsel as this may permit the client to benefit from attorney-client privilege or litigation privilege early on. This may help to contain the spread of information. Depending on the specific concerns at stake, it may be advisable to hire an external PR firm or manager during the early stages of a dispute, or even before. PR managers can map out what an FS firm might need to be cautious about and help devise prevention strategies. It is also often cheaper to focus on early prevention, rather than putting out fires.
Bullock: When it comes to identifying litigation risks, a close partnership between general counsel, the business, and the compliance and risk teams, is key so that concerns or issues can be flagged and navigated pre-emptively. This opens the door for proactive dialogue to ‘heat map’ litigation risks across the firm, in a privileged manner, and manage them accordingly. Internal training and education can be invaluable in this regard. Close collaboration is the bedrock of a successful team, should disputes move into litigation or arbitration. External counsel should be an extension of that dynamic.
Willmott: It is always surprising that FS firms find it difficult to secure the budget to invest in enhancing their existing systems and processes to ensure that they get things right, when compared with the cost of having to investigate and remediate problems when they have happened. With some notable exceptions, FS firms generally do not get the balance right and would benefit from investing more in front-end processes to help them avoid problems. However, many FS firms are better than other corporates at conducting periodic reviews of the risks they face to ensure that they are properly identified and assessed, and that the systems and controls in place at the firm are designed appropriately and working effectively to manage each of those risks. To get the most out of this, the process needs to be led by fully engaged individuals from the business who have the best feel for the risks that the firm faces because of its activities. When done properly, this can be an effective way of identifying new and emerging risks that need to be protected against through enhanced systems and procedures. In addition, we would urge firms to get out and talk to those who are representing their peer firms in litigation and investigations work, as this is also an effective way to identify new or latent risks to which the firm is exposed, and emerging priorities of the regulators.
FW: What are your predictions for the FS disputes landscape over the months ahead? What key issues are likely to drive disputes in this sector?
Willmott: There is no sign of the FS disputes landscape quietening down over the months ahead. Existing topics will continue to keep firms busy for some time, but we can see three areas which will be the source of increasing workloads for those handling disputes at firms going forward. First, we anticipate a significant increase in insolvency-related litigation during the final quarter of this year, as greater numbers of businesses fail due to increasing costs and consumers and other businesses tighten their belts. Insolvencies inevitably drive disputes as liquidators seek to recover from third parties to maximise the assets available to creditors. Second, the massive increase in energy costs and other costs for consumers will result in vulnerable customers becoming ever more exposed to scams and fraud. This, in turn, will lead to claims against firms that were involved in fund or asset transfers without detecting the fraudulent nature of the activities. Finally, the gradual but irreversible development of ‘opt out’ class actions will continue to change the litigation landscape in the UK, with specialist claimant law firms investing significant time and resource to identify potential claims that can be pursued on behalf of individuals within the class who may well have little idea that they have suffered loss. Firms are high priority targets for these claims, and they will need to gear up to defend increasing numbers of class actions covering a range of issues such as mis-selling, data privacy, ESG-related disclosure and commitments, market manipulation, prospectus liability, improper administration of products and failure to treat customers fairly more generally. The real battle for these claims is often at the certification stage, at which point the court decides whether to allow the claimant law firm to pursue the claim on behalf of the class. Given all these factors, the coming year looks to be a busy one for litigation lawyers at FS firms.
Bullock: A focus on climate change and greenwashing will continue in the coming months, particularly as regulators become more involved and FS firms seek to navigate the extensive, and often varying, rules and regulations addressing these issues across jurisdictions, together with enhanced disclosure obligations. Data privacy and cyber crime remains a hot topic for the banking sector, particularly given the focus of claimant law firms. We may well see an increase in disputes in this space in the years to come.
Rhie: Given the notable volumes of PE trading and activity in Asia-Pacific between 2020 and 2022, disputes are likely to arise from past deals that have been concluded even if rising concerns about inflation or geopolitical uncertainties may mean we see fewer overall investments or smaller-scale deals in 2022.
Nathan Willmott is a partner in Ashurst’s dispute resolution practice. He specialises in representing financial institutions, listed companies, trade associations, regulatory bodies and individual members of senior management on disputes, investigations and other complex regulatory and legal issues. He can be contacted on +44 (0)20 7859 2036 or by email: nathan.willmott@ashurst.com.
Susy Bullock is a partner in Gibson, Dunn & Crutcher’s London office. She co-chairs the firm’s transnational litigation practice group and the environmental, social and governance (ESG) practice. She has extensive experience in commercial litigation in the English and Cayman courts, including complex transnational litigation and financial services disputes. Prior to joining Gibson Dunn, she was head of litigation for Europe, the Middle East and Africa at UBS. She can be contacted on +44 (0)20 7071 4283 or by email: sbullock@gibsondunn.com.
John Rhie is managing partner of Quinn Emanuel’s Hong Kong office and the head of the international arbitration practice in Asia. He specialises in international arbitration, both commercial and investment treaty, as well as cross-border litigation and white-collar crime. In relation to international arbitration, he has acted as counsel and arbitrator in arbitrations under most arbitral institutions, such as the HKIAC, ICC, ICSID, KCAB, LCIA and SIAC, as well as ad hoc arbitrations around the world. He can be contacted on +852 3464 5602 or by email: johnrhie@quinnemanuel.com.
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