Draft Financial Services Act to Expand Clients’ Enforcement Rights vis-à-vis Financial Services Providers, Leaves Key Questions Unaddressed

While the draft Financial Services Act (FinSA) primarily has a regulatory purpose, it also contains provisions set to effect the private law relationship between providers of financial services and clients. The proposed measures include a claimant-friendly rule regarding the allocation of costs in litigation proceedings, stricter requirements for financial services providers regarding documentation, information and disclosure of documents for the purpose of enforcement of clients’ rights, and a quasi-mandatory ombuds system for all disputes arising out of financial services contracts, including loan contracts, insurance contracts and all normal retail client bank relationships.

By Thomas Werlen / Jonas Hertner (Reference: CapLaw-2016-4)

1) Legislative History

On 4 November 2015, the Swiss Federal Council adopted the Dispatch on the draft Financial Services Act (FinSA), sending it to parliament for consideration. Among the purposes of the bill is to strengthen the rights of clients, retail clients in particular, vis-à-vis financial services providers (FSP). Work on the bill began in early 2012, when the Federal Council tasked the Department of Finance (DoF) to draft a set of comprehensive rules for the regulation of financial products and services on the basis of a 2012 discussion paper by the Swiss Financial Market Supervisory Authority (FINMA). FINMA notably called for the improvement of enforcement options of retail clients’ claims against financial services providers, stating that, under the current law, high costs and uncertainties prevent clients from litigating their claims and effectively enforcing their rights. The preliminary draft of the FinSA then provided for extensive provisions in relation to judicial protection for clients, including reversals of the burden of proof in favor of the client, proposals for collective redress mechanisms, a procedural costs fund and an arbitration court. In March 2015, the Swiss Federal Council dropped the most far-reaching of these provisions after fierce criticism in the course of the public consultation proceeding. With regard to the enforcement of clients’ rights, three elements remained in the draft or were newly introduced: (1) a stricter disclosure obligation of FSP to provide documentation to clients, (2) an obligation of FSP to become affiliated with a certified ombuds body, and (3) new rules governing the allocation of costs in financial market litigation. These proposals are discussed below.

2) Proposed Measures

a) Providers’ Obligation to Produce Documents and Clients’ Right to Information

The first element of the proposed measures reflects the argument that clients are routinely underdocumented when litigating claims against FSP. Under the current law, FSP have a contractual obligation to document the client relationship and to produce documentation upon client’s request based on the provisions on the simple agency contract (article 400 of the Swiss Code of Obligations (CO)). FSP are also required to disclose all information concerning the client under article 8 of the Federal Act on Data Protection (DPA). When litigating claims against financial services providers, clients have increasingly resorted to filing DPA disclosure requests to obtain documentation for assessing chances of success and evidence purposes. Such requests have been found admissible even when filed to obtain evidence to be used in a compensation claim (‘pre-trial discovery’, as long as the disclosure request is filed separately and before a claim for damages). Claimants can further take advantage of the defendants’ obligation to produce documents based on the procedural duty to cooperate (articles 160 et seq. of the Code of Civil Procedure (CCP)) or might even initiate a precautionary taking of evidence pursuant to article 158 CCP (which however requires the claimant to designate or sufficiently describe the document he or she expects to be produced by the defendant).

The draft FinSA is set to add a further layer to the area of document production. First, article 17 requires FSP to keep documentation on a specific set of facts and events, namely: (1) content and scope of the financial services agreed upon with the client, (2) information collected on clients, (3) whether the client was informed that the FSP would not effect a so-called ‘suitability/adequacy test’ (in execution-only and reverse-solicitation contracts), or that the FSP informed the client that it either was not able to undertake the ‘suitability/adequacy test’ for lack of sufficient information or that it considers the specific financial instrument unsuitable or inadequate, and (4) all financial services provided to the client. If the client relationship involves wealth management or investment advice, FSP must additionally keep records of clients’ investment requirements and needs as well as the reasons for every recommendation resulting in a decision to buy, hold or sell.

Draft article 18 then requires FSP to produce the information referred to in article 17 to the client. In addition, FSP are required to regularly inform clients on (1) services agreed and executed, (2) portfolio composition, valuation and development, and (3) all costs and expenses incurred in connection with the services. Disclosure timing and minimum content of the additional information would be laid out in an ordinance of the Federal Council. With the disclosure obligation being a regulatory duty, the FSP is not entitled to charge the client directly for the production of documents within the scope of article 17.

As an addition to the existing bases for document production claims, articles 75 and 76 of the draft FinSA allow the client to directly request documentation and information. In accordance with article 75, the FSP must produce, upon client’s request, a copy of the client file (paper and electronic), including all information detailed in article 17 and further documents prepared in the context of the client relationship. Production of documents must occur within 30 days of the client’s written request and at no additional cost to the client (article 76). If the FSP does not produce the documents requested within the 30-day time limit, the client can file a claim in summary proceedings and have a positive decision enforced pursuant to the general provisions of Swiss civil procedure. Article 76 (4) further provides that the refusal of a FSP to comply with the disclosure request can be taken into account by a court in subsequent proceedings on a client’s substantive claims if such claims were brought by the client in good faith.

The scope of the obligation to document the client relationship derives from regulatory provisions (articles 17 and 18 of the draft FinSA) as well as from the rules governing the agency contract and the relationship between FSP and client. While it may be argued that articles 17 and 18 further concretize the scope of the obligation, it is difficult to see why the provisions governing the agency relationship in the Swiss Code of Obligations on the one hand, and the disclosure obligations under the Data Protection Act on the other hand would not be a sufficient basis for enforcing production requests. At any rate, as is the case today, purely internal documents such as preparatory studies, notes and drafts used for the internal decision making process would not have to be disclosed under the draft FinSA, based on the assumption that they are not required to assess whether an FSP has complied with its contractual and statutory obligations.

The obligation to document, inform and disclose is linked to the question of the burden of proof in situations where the client incurs damage as a result of a breach of these obligations. In its Dispatch, the Federal Council regrets the overwhelming negative response in the consultation proceeding to the proposed reversals of the burden of proof, which would have required an FSP to prove that it complied with its documentation and information obligations (Dispatch of 4 November 2015, p. 21). At the same time, the Federal Council notes that not implementing the initial proposals would not alter the status quo significantly given the current case law of the Federal Tribunal. This is correct insofar as pursuant to article 400 (1) CO, the agent is required to comprehensively inform the principal on the execution of the mandate, and in light of the Federal Tribunal’s jurisprudence to require a lowered standard of evidence in certain situations where documentation is lacking. However, it must be noted that the requirement to prove a causal link between damage and breach of obligation will continue to be critical and routinely difficult to demonstrate for claimants – an issue that the draft FinSA does not directly address.

b) Ombuds System

As it is proposed under the draft FinSA, the ombuds system is in line with the principle of Swiss civil procedure law that litigation shall be preceded by an attempt at conciliation (article 197 CCP). The draft FinSA requires all FSP to affiliate themselves with certified independent ombuds bodies and to inform clients of the possibility that claims can be brought to the ombuds body before FSP and client enter into financial services contracts as well as in every instance in which a FSP rejects a client’s claim. These bodies will, as is the case today, not have the competence to decide individual disputes nor would they substantially inform ordinary civil proceedings. Yet, under the draft FinSA, the conduct of the parties in a dispute before an ombuds body could be taken into account by a civil court in ordinary proceedings with respect to the allocation of costs to the parties.

Article 78 provides that the ombuds proceeding must be unbureaucratic, fair, quick, impartial and that the client pursuing a claim either must not incur expenses for the proceeding or only have to bear a minimal fee. It further states that, except for the final recommendation (which may include an assessment of facts and law by the ombuds body), the ombuds proceeding would be confidential, each parties’ submissions would, as a rule, not be shared with the other party, and that parties’ correspondence generally could not be used in other proceedings such as before an ordinary civil court.

The ombuds body will be competent to hear not only disputes on substantial claims but also on other claims such as document production requests. It will deem a claim admissible if (1) the claim is submitted using an official form, (2) the client can show that he or she has informed the FSP of the claim and made a reasonable effort to reach an agreement with the FSP, (3) the claim is not an evident abuse of rights and an identical claim was not brought to the ombuds body before, and (4) the claim was not brought in another forum, such as before a conciliation authority or a state or arbitration court, before.

The definition of procedural rules would largely fall within the competency of each ombuds body. Notably, the draft FinSA does not require ombuds bodies to hear both parties in an in-person negotiation. It merely requires that, absent an agreement between the parties, the client could choose in which official language the ombuds proceeding would take place. To conclude the proceeding, an ombuds body could adopt an assessment of the dispute and include it in the notification to the parties that would serve as a conciliation proposal. The proceeding would end either (1) with the withdrawal of the claim, (2) an agreement between the parties, (3) the refusal of the conciliation proposal by at least one party, or (4) the dismissal of the claim by the ombuds body if the request constituted an abuse of right or if one of the parties had initiated ordinary proceedings in the same matter. If the result of the ombuds proceeding were rejected by one party, claimant could file a claim in ordinary civil proceedings without being required to initiate another conciliation proceeding (new article 199(2)(e) CCP).

The ombuds system as proposed will require FSP to inform clients of the conciliation system and to participate in a proceeding if it is instituted by a client. The proceeding will be independent of ordinary proceedings and would notably not have an effect on the question of jurisdiction. Hence, if an FSP were to file a claim with the ombuds body, the client would not be required to participate but could, for instance, file a civil claim irrespective of the stage of the ombuds proceeding.

The draft FinSA proposes to secure financing the ombuds system through contributions by affiliated FSP in accordance with the ombuds body’s respective by-laws. Ombuds bodies will be free to require FSP to directly cover individual proceedings and/or to set flat or relative sum contributions. The draft FinSA does not require the ombuds proceedings to be completely free of costs for clients. However, ombuds bodies would have to ensure that costs charged to clients are not prohibitory.

As prerequisites for certification as ombuds body, article 87 of the draft FinSA provides a set of criteria: (1) impartiality and independence of the body and the individual ombudspersons employed by it, (2) the individual ombudspersons must be adequately qualified and have specific knowledge in the field of financial instruments and services, finance and capital markets, as well as conciliation/negotiation experience, and (3) the ombuds body must have organizational by-laws ensuring efficiency and operational capability as well as rules on procedure and costs, all of which must meet the FinSA prerequisites. If an FSP were to repeatedly disregard its obligations under the ombuds system, the ombuds body could exclude that FSP and cancel its affiliation. As a result, the FSP would be required to reapply for affiliation with the same or a new ombuds body. In accordance with the draft FinSA, the FoJ will publish a list of certified ombuds bodies. The FoJ may force ombuds bodies to accept affiliation with a specific FSP if required. All ombuds bodies will be required to publish an annual report on their activities.

c) Allocation of Litigation Costs

The draft FinSA recognizes the difficulties damaged clients face in bringing claims against financial services providers, notably the potential total costs which in many scenarios exceed the actual amount in dispute. To mitigate the cost risk, the draft FinSA proposes three measures which include partially abandoning the basic rule of ‘costs follow the event’ or ‘loser pays’.

Pursuant to a new article 114a CCP, retail clients in the sense of article 4(2) of the draft FinSA (as opposed to qualified and professional investors) will be freed from paying advances of court costs and security for party costs and legal fees of the opposing side. In addition, an FSP would bear its own legal costs irrespective of the outcome of the proceedings if all of the following criteria are met (1) the retail client, acting as claimant, has brought the contentious matter to a certified ombuds body with which the respective FSP is affiliated, (2) the claimant does not have ‘extraordinarily good’ financial resources, (3) the amount in dispute does not exceed CHF 250,000, and (4) the claimant has not brought the matter to the ombuds body maliciously or in bad faith. If the FSP is not affiliated with a certified ombuds body, requirement (1) would not apply.

If the retail client, as claimant, does not succeed with his or her claim, the court may diverge from the loser pays rule and allocate court costs at its discretion, if (1) based on the outcome of the ombuds proceeding, the retail client is acting in good faith when filing a claim, (2) the claimant has reasonable grounds to file a claim based on the FSP’s conduct, (3) the claimant does not dispose of of ‘extraordinarily good’ financial resources, (4) or allocating the full court costs would prove incompatible with the aim of customer protection. Decisions on costs in financial market disputes pending at the time of entry into force of FinSA would be decided in accordance with the new law (new article 407c CCP).

It must be noted that as proposed in the draft FinSA, application of these provisions will not be restricted to disputes arising out of financial services contracts but also take effect in connection with mortgage or other loan contracts, insurance contracts and all normal retail client bank relationships (the article’s marginal note reads ‘litigation proceedings in disputes arising in connection with services in the financial market’). As a consequence, claimants filing a claim with a certified ombuds body will be privileged over those filing a claim with the ordinary conciliation authority. This measure reiterates a focus on specialized dispute resolution bodies which, in sum, is to be welcomed.

3) Outlook and Commentary

The provisions in the draft FinSA regarding the protection and enforcement of clients’ rights follow an international trend. Looking at measures implemented in other countries, which are often more far-reaching, the proposals contained in the draft FinSA appear humble and uninspired. Even if one ambition of the draft FinSA is to further a specialized court system for complex financial disputes, the bill does little to address this. As the draft FinSA recognizes that specialized ombuds bodies will indeed be better suited to potentially resolve complex matters between clients and FSP, it would be a missed opportunity not to pursue this proposal further, looking not least at the activities, for instance, of the ombudsman scheme under the UK Financial Services and Markets Act 2000 or the arbitration and mediation proceedings under auspices of the Financial Industry Regulatory Authority (FINRA) in the United States.

One of the most ambitious of the initial ideas – the introduction of a collective redress mechanism – has not found its way into the current draft. Rather, further legislation will be proposed on the basis of the Birrer-Heimo motion (no. 13.3931). It is to be expected that in parliamentary debate, questions will be raised as to the interaction of FinSA with the efforts to introduce such mechanisms. This is especially so as the original impetus to strengthen the rights of retail clients in the financial services industry was the occurrence of high profile cases such as the insolvency of the Lehman group which resulted in a large number of small investors with compensation claims too small to litigate in civil courts – because potential costs of pursuing litigation often exceeded the amount in dispute. The draft FinSA does not respond to this challenge directly. Even with the proposed measures, damaged clients will be required to individually litigate claims in connection with standardized financial products sold to a large number of clients, and the risk of incurring high costs in litigation is still there, if somewhat mitigated. The debate revolving around the benefits of a collective redress mechanism, however, is one not to be had in the context of financial services alone.

Against this background then, legitimate questions as to the necessity of the proposed provisions relating to the enforcement of clients’ rights in the draft FinSA arise, given that already today (1) a client can request full documentation and information from an FSP based on the provisions governing the agency contract and based on article 8 DPA, (2) the banking ombudsman hears client claims in a conciliatory proceeding at no cost to the client, and (3) a court can allocate costs in proceedings at its discretion on the basis of article 107 CCP while the client can file a partial claim with a view to reducing the cost risk.

Thomas Werlen (thomaswerlen@quinnemanuel.com)
Jonas Hertner (jonashertner@quinnemanuel.com)