LI KWOK HEEM JOHN v. STANDARD CHARTERED INTERNATIONAL (USA) LTD (formerly known as AMERICAN EXPRESS BANK LTD)

HCA 498/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 498 OF 2010

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J U D G M E N T

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1. The plaintiff through the introduction of the defendant invested US$1,171,562.67 in August 2005 in a Fairfield Sentry Fund (“the FS Fund”). The FS Fund turned out to be one of the Ponzi schemes operated by Mr. Bernard L. Madoff (“Mr Madoff”).

2. A Ponzi scheme is a fraudulent investment scheme.  It has no investment and does not produce any profit or loss from any investment. It pays the returns and redemptions from existing capital and new capital from investors. Mr Madoff revealed his schemes at the end of 2008.  He was charged with securities fraud.  He pleaded guilty to the charges on 12 March 2009 and was sentenced to 150 years imprisonment.  That was the maximum sentence.  Since the FS Fund was just a Ponzi scheme, the plaintiff lost his investment money.  He now sues the defendant for his loss.

FACTUAL BACKGROUND

3. The following facts are taken from the written openings of the parties.  The plaintiff is a chartered accountant and former audit partner of PricewaterhouseCoopers (“PwC”).  He is also a businessman and a private investor. 

4. The defendant bank is and was at all material times a limited company incorporated in the U.S.A. and registered in Hong Kong under Part XI of the repealed Companies Ordinance (Cap 32).  Its name was changed to the present one on 16.1.2009.  It was a Registered Institution under s. 20 of the Banking Ordinance, Cap. 155 (“BO”) from 1.4.03 to 28.11.08. It was also registered with the Securities and Futures Commission (“SFC”) under s. 119 of the Securities and Futures Ordinance, Cap. 571 (“SFO”) as a Registered Institution to carry out the following Regulated Activities defined in SFO, namely, dealing in securities (Type 1), advising on securities (Type 4), advising on corporate finance (Type 6) and asset management (Type 9).

5. On or around 3.11.2000, the plaintiff approached the defendant and was attended to by Ms Amy Chau (“Ms Chau”), a relationship manager.  He opened an individual account by signing various account opening documents of the defendant. 

6. Through the defendant’s introduction, the plaintiff invested in a Market Neutral US Equity Fund (“the MN Fund”) in December 2000.  Regular contacts then took place between the plaintiff and Ms Chau (joined by her colleague Ms Corinna Yau (“Ms Yau”), an Investment Advisor since 11 September 2003) to review his account.

7. In or around August 2005, the MN Fund was liquidated and the proceeds distributed to the shareholders including the plaintiff. 

8. The plaintiff had a meeting with Ms Chau and Ms Yau on 17.8.05.  On their introduction, he applied US$1,171,562.67 in his account to subscribe shares in the FS Fund and to pay the distribution and servicing fees to the defendant.

9. After the meeting on 25.8.05, Ms Chau and Ms Yau had periodic client review meetings with the plaintiff until the end of 2008.  During the reviews in 2006 and 2007, the plaintiff was told that the performance of the FS Fund was good and was better than other funds.  They recommended him to keep his shares in it as an investment.

10. On or around 16 June 2008, the plaintiff signed a letter of consent to transfer the entire portfolio in his account with the defendant to the Private Bank Division of Standard Chartered Bank (Hong Kong) Ltd (“SCBHK”) as the assets and business of the defendant were to be taken over by Standard Chartered Bank.

11. In December 2008, Mr Madoff revealed that he and his broker-dealer company Bernard L. Mr Madoff Investment Securities LLC (“BLMIS”) had been running fraudulent Ponzi schemes and the FS Fund was one of them. 

12. On 13.12.08, the plaintiff called SCBHK to enquire on the valuation of his shares in the FS Fund.  He was latter advised that with effect from 22.12.08, SCBHK would adjust the net asset value of his shares in the fund to US$0.01.

13. The Plaintiff now claims the defendant to recover the amount he invested in the FS Fund.  He sues the defendant for: (1) misrepresentation and (2) breach of duty of care, in relation to his investment through the defendant in the fund.

PLEADINGS

The re-amended statement of claim

14. The plaintiff pleaded in his re-amended statement of claim that he had on 3 November 2000 opened an individual account with the defendant and deposited HK$8 million into the account.  He signed the account opening documents (“A/C Opening Documents”) on that occasion.  The A/C Opening Documents comprised the “Individual Account Mandate”; “General Business Conditions”; “General Security Agreement”; and “Risk Disclosure Statement”.  He also deposited US$1.1 million into this account. 

15. In December 2000, the defendant recommended that he should invest in the MN Fund.  He accepted the recommendation and invested the money in the account in that fund.

16. The MN Fund was liquidated in August 2005.  The proceeds were distributed to the unit holders. 

17. He had a meeting with Ms Chau on 17 August 2005.  He later agreed that Ms Yau was also present at the meeting. (For the matters pleaded in the re-amended statement of claim as having been said or represented to him by Ms Chau in all the meetings since 11 September 2003, he accepted that the same could have been said or represented to him by Ms Yau or both of them.)  They recommended to him to invest the proceeds of the MN Fund in the FS Fund.

18. They in making the recommendation provided him with two documents, namely, the FS Fund’s fact sheet dated June 2005 (“the Fact Sheet”), and its Semi-Annual Update dated 1 August 2005 (“the Update”). They represented to him via the Fact Sheet that the FS Fund’s investment objective was to achieve capital appreciation through consistent monthly returns.  They also represented to him via the Update that since the inception in November 1990, the FS Fund had produced consistent low volatility returns through the implementation of a market timing strategy called “the split/strike conversion strategy”. 

19. They told him that over almost 15 years, the fund had returned to clients a net compounded annual rate of 11.23% with a standard deviation of 2.6% and a Sharpe ratio of 2.65.  From January to June of 2005, the fund delivered a net return of 3% with no down month.  It outperformed the S&P 100 Index which had a loss of 2% over the same period.  The fund adhered to its investment policy of capital preservation, low volatility and long-term capital appreciation.  It delivered superior risk-adjusted performance across a number of market cycles.  For the first half of 2015, it generated about US$210 million gross profit.  The gains were from equities and US Treasury Bill interest.  The losses were from option positions. 

20. They also represented to him that the FS Fund was a low risk investment with moderate returns.  

21. He pleaded that by way of necessary implication, they had represented to him that the FS Fund was an authentic investment that had the characteristics mentioned in the Fact Sheet and Update.

22. In reliance of the recommendation and representations, he on about 25 August 2005 invested through the defendant US$1,171,562.67 to subscribe for shares in the FS Fund and to pay the defendant a distribution and serving fee at 0.5% per annum of the net value of the shares. 

23. He pleaded that in consideration of his instruction to invest and to pay a fee, the defendant agreed to and did manage his investment in the FS Fund and provided him oral advice on securities investment and analysis and review of the performance of the fund at least once a year from August 2005 to June 2008.  Owing to the fund’s steady growth of over 4% per annum between August 2005 and June 2008, Ms Chau and/or Ms Yau advised him that the performance of the fund was quite good in comparison with depositing the money in a fixed deposit and he should continue to keep the fund as an investment in his portfolio.  He in reliance on such advice decided in each year to keep his investment in the fund.

24. However, the defendant’s representations were false in that:

(1)   the FS Fund was not an authentic investment;

(2)   the FS Fund did not have any of the characteristics represented in the Fact Sheet and the Update or by way of their oral representations to him as aforesaid; and

(3)   the FS Fund was in fact part of a fraud used by Mr Madoff to raise funds to feed his illegal Ponzi schemes.

25. The plaintiff further pleaded that the defendant had made the false representations negligently as it had failed to make any or any reasonable inquiry on the truth or accuracy of the said representations before making them to the plaintiff. 

26. The plaintiff also pleaded that the defendant had failed to disclose to the plaintiff that Mr Madoff and his business BLMIS had been subject to multiple investigations and examinations by US authorities as referred to in the defence or that there were critical articles and reports concerning Mr Madoff and BLMIS.

27. In addition to the claim of misrepresentation, the plaintiff pleaded further or in the alternative that the defendant, in recommending the FS Fund to the plaintiff, owed the plaintiff a duty of care at common law and/or implied by the Supply of Services (Implied Terms) Ordinance, Cap 457.  The defendant, in advising the plaintiff to invest in the FS Fund and in failing to advice him to withdraw from it in each meeting before 1 July 2008, had breached such duty.  The plaintiff’s grounds are that:

(1)    the FS Fund was not appropriate for an investor who was not properly vetted and determined by the defendant as a professional investor;

(2)    the relevant standard pertaining to a bank’s procedures for properly vetting and determining an investor as a professional investor were those set out in the Code of Conduct for Persons Registered with the Securities and Futures Commission dated April 2003 (“the 2003 SFC Code”);

(3)    the defendant had not gone through the procedures stipulated in the 2003 SFC Code; or any other procedures which met the standards provided for in the code;

(4)    the defendant had not determined the plaintiff as a professional investor, whether properly or at all;

(5)    the defendant had failed to conduct any or any reasonable inquiry on the truth or accuracy of the said representations before making the same to him;

(6)    the defendant had failed to provide him with a copy of the written document required under section 175 of the SFO to enable him to gain a more detailed understanding of the fund;

(7)    the documents shown by Ms Chau to him relating to the fund, including the Fact Sheet, the Update, the Subscription Agreement for the fund and the fund’s Confidential Private Placement Memorandum (“the Placement Memorandum”), had not been authorized by the SFC pursuant to section 103 of the SFO.  The said documents contained, to the knowledge of the defendant, an invitation or offer to acquire an interest in or participate in, a collective investment scheme within the meaning of that section; and

(8)    the defendant had committed the negligent acts and omissions as pleaded in support of the misrepresentation claim.

28. The plaintiff also relies on section 108(1) of the SFO.  Sections 108(1) and (7)(c)(i) of the SFO provide:

“(1) Where a person makes any … or negligent misrepresentation by which another person is induced-

(a) …; or

(b) to acquire an interest in or participate in, or offer to acquire an interest in or participate in, a collective investment scheme,

the first-mentioned person shall, whether or not he also incurs any other liability (whether under this Part or otherwise), be liable to pay compensation by way of damages to the other person for any pecuniary loss that the other person has sustained as a result of the reliance by the other person on the misrepresentation.

(7)   For the purposes of this section-

(c) negligent misrepresentation (疏忽的失實陳述) means-

(i) any statement which, at the time when it is made, is false, misleading or deceptive and is made without reasonable care having been taken to ensure its accuracy;”

29. Finally, the plaintiff also relies on section 3 of Misrepresentation Ordinance, Cap 284 to claim damages for his loss suffered as a result of his reliance on the defendant’s misrepresentations.

30. As a result of the revelation in December 2008 that the FS Fund was part of Mr Madoff’s Ponzi schemes, the net asset value of his investment in the FS Fund was adjusted to US$0.01 on 22 December 2008.  He therefore claims from the defendant the investment sum of US$1,171,562.67 and the fees of US$18,748.65 paid to the defendant.  He also claims damages for misrepresentation and interest on the damages.

The re-amended defence

31. The defendant denied that it had given the plaintiff any advice or recommendation or, if the same had been given, that the plaintiff had relied on the same. 

32. Regarding the plaintiff’s investment in the MN Fund, the defendant denied that it had recommended the plaintiff to invest in it.  The defendant pleaded that it was on the basis of its understanding of the plaintiff’s investment objectives that it had suggested for the plaintiff’s consideration a number of investment products including the MN Fund.  It also provided the plaintiff with the information on the products.  The plaintiff then made his own decision to invest in the MN Fund.

33. The defendant also denied that Ms Chau or Ms Yau or anyone on behalf of the defendant had made to the plaintiff any representation via the Fact Sheet or the Update.  It further pleaded that any representations on the FS Fund were made by Fairfield Sentry Ltd (“FSL”) that owned the FS Fund and published the Fact Sheet and the Update.

34. The defendant further denied that Ms Chau or Ms Yau had represented to the plaintiff that the FS Fund was a low risk investment with moderate returns or that they had invited, solicited or recommended him to invest in the FS Fund. 

35. The defendant pleaded that Ms Chau and Ms Yau only suggested at the meeting of 17 August 2005 he could consider investing in one or more of a number of funds which had been selected on the basis of the defendant’s understanding of his investment objectives.  The funds were the FS Fund, Permal Global High Yield Holdings NV Fund and Permal FX, Financials and Futures Ltd Fund (“the two Permal Funds are hereafter referred to as “the Permal Funds””). 

36. The plaintiff, after being given the information on the funds, made his own decision to invest in the FS Fund.  He did not rely on any representation made by anyone on behalf of the defendant in making his investment decision.  The defendant only acted as an intermediary to facilitate his purchase of shares in the FS Fund. 

37. The defendant also did not admit that the plaintiff had not heard of the FS Fund hitherto.  It also denied that it had agreed to manage or had managed his investment or that any of its employees had given him oral advice on securities investment once a year between August 2005 and June 2008.  It pleaded that between August 2005 and June 2008, it had carried out a review of his portfolio and asked him whether he wished to make any change.  It was his own decision on whether to make any change.

38. The defendant further relied on the terms in the General Business Conditions (“Business Conditions”) and Risk Disclosure Statement (“RD Statement”), which were amongst the A/C Opening Documents that the plaintiff had signed, to argue that the plaintiff was not entitled to and should not have relied on any advice or recommendation given by it.  I will refer to these clauses in greater detail below when I discuss whether the defendant can rely on them.

39. The defendant denied in §30 of the re-amended defence that it had failed to conduct reasonable inquiry on the truth or accuracy of the representations that FSL had made.  It pleaded that from 2002 onwards, senior employees of one or more the defendant entities had meetings and discussions with representatives of Fairfield Greenwich Group (“FGG”) (or its member Fairfield Greenwich Ltd., the investment manager of the FS Fund, which is hereinafter also represented by the abbreviation “FGG”), on the FS Fund’s investment strategy and its operations.  These employees had also received and reviewed due diligence questionnaires prepared by FGG on the fund.  They had also reviewed 12 years of the fund’s financial statements audited by PwC.  These attested to the fund’s soundness.

40. Furthermore, the defendant was also informed by FGG of the due diligence and related activities that FGG had performed on Mr Madoff.

41. FGG also required complete transparency of trading by a fund (including the FS Fund) in which FGG’s funds invested.  Although the trades of the fund conducted by BLMIS were not cleared through an independent broker, FGG had employed a risk management team in Bermuda to review the daily trading records. The defendant had also confirmed this by interviewing the Bermudian team.

42. The defendant was aware that there were a number of other investigations into BLMIS which did not find anything inconsistent with the ongoing business operations at BLMIS.

43. The defendant also disagreed that any additional “reasonable enquiry” could have uncovered the Ponzi scheme.  The reasons are:

(a)   At all material times, Mr Madoff was a well-respected manager with an excellent reputation.  He was a former Chairman of NASDAQ.  His firm had been in existence since 1959.  His market-making business at times traded shares equal to at least 9% of the trading volume on the New York Stock Exchange.  In 1999, a leading hedge fund information source, MARHedge, had asked asset allocators to select the best managers, one allocator said, “Bernie Madoff continues to outshine everyone else”.

(b)   The FS Fund’s investment returns and consistent performance were not unusual.  Many well known investment vehicles provided investment returns and consistency similar to or better than those produced by the FS Fund.  With respect to total returns, for example, between 1 December 1990 and 31 August 2008, an investment in the FS Fund would have been outperformed by an investment in Berkshire Hathaway (Class A) or an index fund mirroring the Dow Jones Industrial Average.  With respect to consistency, many hedge funds produced positive returns as consistent as or more consistent than the FS Fund (i.e., reported positive returns in a similarly high percentage of months over similar periods of time).

(c)   Mr Madoff honoured over three billion dollars in redemption requests from the FS Fund during the course of the fund’s existence.

(d)   BLMIS was a regulated broker-dealer and investment advisor and was subject to regular on-site examinations by the US Securities and Exchange Commission (“SEC”), the National Association of Securities Dealers (“NASD”) (later renamed the Financial Industry Regulatory Authority (“FINRA”)).  Nevertheless, neither the SEC nor FINRA (or NASD) ever uncovered Mr Madoff’s Ponzi scheme.

(e)   In addition to the ordinary regulatory examinations to which BLMIS was subject, the SEC conducted multiple investigations into and examinations of BLMIS between 1992 and 2005, each of which failed to uncover Mr Madoff’s Ponzi schemes.  This was so despite the SEC was in the best position to detect Mr Madoff’s fraud than any investment professionals like the defendant and had access to far superior investigatory tools and much greater access to Mr Madoff and his operations:

Particulars

(i)    in 1992, the SEC’s Broker-Dealer Enforcement Group conducted its first “cause examination” of Mr Madoff. This cause examination of BLMIS and Mr Madoff did not result in any recommendation of enforcement action;

(ii)   in 2004 and 2005, the SEC’s Office of Compliance Inspections and Examinations in Washington, DC and the SEC’s North East Regional Office, respectively, conducted cause examinations of Mr Madoff.  These examinations were based on allegations in a complaint received by the SEC and a series of internal e-mails that the SEC had discovered.  These examinations did not result in any recommendation of enforcement action;

(f)   The SEC Office of Inspector General made a report dated 31 August 2009 (“Inspector General’s Report”) that Mr Madoff proactively used the government investigations as a way to establish credibility with investors and dispel any concerns that might arise from his secretive ways.

(g)   The Inspector General’s Report concluded that investors, who might have been uncertain about whether to invest with Mr Madoff, were reassured by the fact that SEC had investigated and examined Mr Madoff and found no evidence of fraud.

(h)   Other banks and sophisticated investors were among those who were deceived by Mr Madoff.  Some of the well known and respected financial institutions that reportedly lost money and/or whose clients lost money due to Madoff-related exposure are:

(i)    Banco Santander SA – Spain’s largest bank had an investment fund (Optimal) that had approximately US$3 billion in exposure to Mr Madoff.

(ii)   BNP Paribas SA – France’s largest listed bank said it had a potential US$431,170,000 in exposure to Mr Madoff.

(iii)   HSBC Holdings PLC – A banking and financial services group had US$1 billion in exposure to Mr Madoff.

(iv)   Ascot Partners – A hedge fund with US$1.8 billion under management had substantially all of its assets invested with Mr Madoff.

(v)   Bank Medici – An Austrian bank had two funds with US$2.1 billion invested with Mr Madoff.

(vi)   Royal Bank of Scotland Group PLC – A British bank had approximately US$493,000,000 in exposure to Mr Madoff through trading and collateralized lending.

(vii)  Access International Advisors – A New York based investment firm – whose co-founder committed suicide after losing US$50,000,000 of his personal wealth as a result of his investment with Mr Madoff – had approximately US$1.5 billion of exposure.

(viii)  Reichmuth & Co – A Swiss private bank had approximately US$327,000,000 in exposure to Mr Madoff.

44. The defendant also denied that the plaintiff’s alternative claim that the defendant had breached its duty of care to the plaintiff and the grounds thereof.

45. Regarding the claim that the defendant had failed to properly assessed the plaintiff as a professional investor and that the FS Fund was not appropriate for the plaintiff, the defendant pleaded that the plaintiff was a professional investor (as prescribed in rule 3(b) of the Securities and Futures (Professional Investor) Rules; Cap 571D (“Professional Investor Rules”)).  The reason being that at the time when the plaintiff invested in the FS Fund, he had a portfolio of not less than HK$8 million investment with the defendant.  The defendant further pleaded that the plaintiff had experience in investing in riskier assets such as equities since December 1990.  The FS Fund at the material time was considered liquid with more than US$7 billion assets under management.  It was more than appropriate for the plaintiff who was assessed in November 2000 as “a balanced investor with an emphasis on capital appreciation”.

46. Regarding the plaintiff’s allegation that the defendant had failed to comply with section 175(1) of the SFO by not providing the plaintiff a written document to enable the plaintiff to gain a more detailed understanding of the FS Fund, the defendant pleaded that the plaintiff had signed the Instructions to Purchase and confirmed that he had received the Placement Memorandum and the Subscription Agreement for the fund.  Alternatively, the defendant relied on sub-section 175(5) (aa) (i) and sub-section 175(5) (d) of the SFO which excluded the application of section 175 to a professional investor of which the plaintiff was one.

47. Regarding the plaintiff’s allegation that the defendant had breached section 103(1) of the SFO because the documents provided by the defendant to the plaintiff about the FS Fund contained an invitation to the public to acquire an interest in a collective scheme, but the issue of these documents had not been authorized by the SFC under section 105(1) of the SFO, the defendant pleaded in response that the documents were intended to be disposed of only to professional investors and by virtue of sections 103(2)(ga) and (3)(k), they were not subject to section 103(1).

48. Regarding the plaintiff’s charge that the defendant had not complied with §§15.3 and 15.4 of the 2003 SFC Code, the defendant pleaded that it did not have to comply with them as it had not waived any of the requirements in §15.5 of the code in respect of the plaintiff.

49. The defendant also denied that it was liable to the plaintiff under section 108(1) of the SFO as the defendant contended that it had not made any negligent misstatement.

50. The defendant further denied that the plaintiff had any claim against it under section 3 of the Misrepresentation Ordinance.

51. The defendant also denied of having managed the plaintiff’s investment in the FS Fund for the plaintiff. It pleaded that the plaintiff had maintained his own investment since 25 August 2005.

52. The defendant further pleaded that the plaintiff had decided by himself to transfer his portfolio from the defendant to SCBHK on about 16 June 2008.

The re-re-amended reply

53. The plaintiff disputed the defendant’s plea that sections 175(5)(aa)(i) and 175(5)(d) of the SFO had excluded the requirement under section 175(1) regarding the supply of a written document on the FS Fund to the plaintiff. 

54. Regarding the defendant’s allegation of the exclusion by sub-section 175(5)(aa)(i) of an offer of the FS Fund from section 175(1), the plaintiff pleaded that there was no such exclusion because the SFC had not published the necessary Gazette notice under sub-section 175(5)(aa)(ii) to exclude the offer.

55. The plaintiff further pleaded that the offer in the Subscription Agreement did not contain a statement or warning that it had not been reviewed by any regulatory authority under Part 3 of the 18^th Schedule to the Companies Ordinance which warning was required by §4(b) of the 17^th Schedule of that Ordinance.  But I note that the requirement of warning was for an offer subject to §4 of the 17^th Schedule whilst the offer in the Subscription Agreement was for professional investors and was subject to §1 of the 17^th Schedule.  Hence, this plea of the plaintiff has no merit.

56. Regarding section 175(5)(d)(i), the plaintiff had not pleaded any reason to explain why it was inapplicable except by repeating the averments in the re-amended statement of claim that the defendant had failed to comply with §§15.3 and 15.4 of the 2003 SFC Code.

57. The plaintiff disagreed that the documents of the fund were only intended to be disposed of to professional investors or for that reason they were excluded by section 103(3)(k) of the SFO from the application of section 103(1).  He pleaded that the Subscription Agreement and Placement Memorandum defined a professional investor as a person who signed a declaration that he had a net worth in excess of US$1 million whereas rule 3 of the Professional Investor Rules defined a professional investor as one who had a portfolio of not less than HK$8 million and not in excess of US$1 million.  But I do not see the relevance of the meaning of professional investor in the Subscription Agreement and Placement Memorandum as we are only concerned with the application of the SFO.

58. Regarding the defendant’s denial of negligence, the plaintiff pleaded that it was grossly insufficient for the defendant, in exercising its duties of diligence, merely to rely on the hearsay and anecdotal information set out in §30 of the re-amended defence when there were numerous warning signs which indicated to the defendant that the FS Fund was suspicious. The plaintiff further pleaded that the defendant should not have promoted the FS Fund without in-depth and first-hand research, analysis and investigations of all relevant information relating to Mr Madoff, BLMIS and the FS Fund.

59. The warning signs pleaded by the defendant are:

(1)   BLMIS reported returns that reflected a pattern of abnormal profitability in terms of consistency and amount.  That was not credible.

(2)   BLMIS’s practice of only charging commission for the trades that it executed was atypical in the trade, particularly where Fairfield’s role was merely to funnel money received from investors to BLMIS but received administrative fees and a share of the profits that would normally go to fund managers in the position of BLMIS.

(3)   BLMIS’ arrangement of its own roles both as investment manager and custodian of securities eliminated the protection of the investments in the fund by the common practice of using an independent custodian of securities.

(4)   BLMIS, while reputedly ran one of the world’s largest funds or groups of funds, had since 1992 to until around 2004/2005 been using David Friehling of Friehling & Horowiz as its auditors.  This accounting firm had only three employees and one of whom was semi-retired.  Fairfield merely knew that the firm had one employee and US$180,000 in annual sales.

(5)   Mr Madoff cloaked his and BLMIS’ operations in secrecy.  This aspect was publicly exposed inter alia in an article published in Barron’s on 27 May 2001 entitled “Don’t Ask, Don’t Tell: Bernie Madoff is so secretive, he even asked investors to keep mum”.  Barron’s is a widely-distributed financial publication.

(6)   The Barron’s article also raised the following serious concerns that the defendant never investigated, namely:-

(a)  It quoted a former investor as saying “Anybody who’s a seasoned hedge-fund investor knows the split strike conversion is not the whole story.  To take it at face value is a bit naïve.”  The defendant, however, never adequately investigated the split strike conversion strategy that Mr Madoff was purportedly executing.

(b)  It quoted a former investor as saying “What Mr Madoff told us was, ‘If you invest with me, you must never tell anyone that you’re invested with me.  It’s no one’s business what goes on here’ …  When he couldn’t explain how they were up or down in a particular month,” he added, “I pulled the money out.”  The defendant, however, never adequately investigated the reasons for the secrecy and lack of adequate explanation of the performance of the FS Fund.

(c)  Barron’s also noted Mr Madoff’s “returns have been so consistent that some people on the Wall Street have begun speculating that Mr Madoff’s market-making operation subsidizes and smooth’s his hedge-fund returns.”  The defendant, however, never questioned the consistency of Mr Madoff’s returns and the reasons behind his smooth returns and performance.

(7)   Earlier in May 2001, MAR Hedge Fund Report, another widely-distributed financial publication, published an article entitled “Mr Madoff tops charts; skeptics ask how”.  It raised a number of serious concerns that the defendant never investigated. They are:

(a)  “Experts ask why no one has been able to  duplicate similar returns using the strategy and why other firms on Wall Street haven’t become aware of the fund and its strategy and traded against it, as has happened so often in other cases.”

(b)  “Skeptics who marvel at the seemingly astonishing ability to time the market and move to cash in the underlying securities before market conditions turn negative; and the related ability to buy and sell the underlying stock without noticeably affecting the market.”

(c)  Like Barron’s, MAR raised the fact that “most of those who are aware of Mr Madoff’s status in the hedge fund world are baffled by the way the firm has obtained such consistent, non-volatile returns month after month and year after year.”

(8)   Even FGG did not have a clear understanding of the BLMIS’ investment strategy.  The Securities Division of the Office of the Secretary for the Commonwealth of Massachusetts conducted an investigation and put basic due diligence questions to FGG’s executives, who were unable to answer such questions.  These were questions which any basic exercise of due diligence by the defendant on the fund should have included and which, if asked, would have raised serious alarms as to the reliability or adequacy of the information on the fund provided by FGG.  The problems are:-

(a)  FGG could not explain Mr Madoff’s trading strategy, particularly as to Mr Madoff’s split/strike conversion, in any or any coherent terms.

(b)  FGG could not tell who was involved in implementing or executing the trading strategy.

(c)  FGG had never seen Mr Madoff’s operations in executing the split/strike conversion strategy.

(9)   Having regard to some or all of the above, many banks, industry advisors and participants, who had made an effort to conduct reasonable due diligence, refused to do business with BLMIS or advised their clients to withdraw money invested with Mr Madoff.  These included Credit Suisse and JPMorgan Chase.  The defendant cannot rely on the failure of other banks to conduct adequate due diligence as an excuse or defence for its failure, or to lower the standard of the duties of care it owed to the Plaintiff.

(10)  Mr Madoff and BLMIS were not registered investment advisors with the SEC until September 2006, and were therefore not subject to the type of SEC supervision that would be appropriate for the investment management services that Mr Madoff was providing through Fairfield.

(11)  Mr Harry Markopolos, an individual with a Master of Science degree in finance, and with no access to Mr Madoff or inside diligence concerning BLMIS, managed to uncover the Ponzi scheme and reported it to the SEC in as early as 2000, and in explicit details in 2005.

60. Regarding the plaintiff being a professional investor as prescribed by rule 3(b) of the Professional Investor Rules, the plaintiff pleaded that the defendant could not rely on that for relieve from the duty not to be negligent or not to make negligent misrepresentations to him.

61. The plaintiff further repeated §§3.4, 5.1(a) and 5.2 of the 2003 SFC Code as pleaded in §§13 to 15 of the re-amended statement of claim.  These paragraphs in the code required the defendant to act diligently and carefully in providing advice and recommendations to the plaintiff and to ensure that the recommendation or solicitation is reasonably suitable for the plaintiff in all circumstances.

THE PLAINTIFF’S OPENING

62. Mr Mok SC and Mr Maurellet in their opening submissions for the plaintiff identified the main issues as:

(1)    what, if any, representations, express or implied, Ms Chau and/or Ms Yau had made to the plaintiff before he invested into the FS Fund?

(2)    what, if any, representations, they had made to the plaintiff in the course of the annual reviews that resulted in the plaintiff’s decision to hold onto the shares of the fund instead of redeeming them?

(3)    if representations had been made, did the plaintiff rely on them in investing into the FS Fund and in deciding not to redeem them?

(4)    if the representations had been made, were they false?

(5)    if the representations were false, whether they were made by the defendant negligently.  Or in terms of section 3(1) of the Misrepresentation Ordinance, whether the defendant had reasonable grounds to believe and did believe up to the time when Mr Madoff revealed his Ponzi schemes that the misrepresentations were true.  Alternatively, if the representations were false, had the defendant, in making them to the plaintiff, breached its common law duty of care and the duty of reasonable care and skill implied by the Supply of Services (Implied Terms) Ordinance owed to the plaintiff?

(6)    The final issue is whether the defendant, if it was negligent and had breached its duties to the plaintiff in making the misrepresentations, could rely on the provisions in the A/C Opening Documents in defence of the plaintiff’s claim?

63. The pleadings on professional investor, the 2003 SFC Code and the alleged breaches of sections 103 and 175 of the SFO have not been mentioned in the plaintiff’s opening submissions.  I also do not think the plaintiff’s pleadings on professional investor, the 2003 SFC Code and sections 103 and 175 of the SFO need be considered.  These are matters of law and the defendant has answered them already in its re-amended defence.  The crux is the plaintiff’s categorization by rule 3(b) of the Professional Investor Rules as a professional investor.  That disposes of the dispute over these matters.  I cannot see how the defendant can be made liable to the plaintiff’s claim by reference to these matters.

64. There is however a submission in the plaintiff’s closing submissions that the Placement Memorandum had not been provided to the plaintiff. That submission at most was linked to the issue that the plaintiff was thus unaware of the link between the FS Fund and Mr Madoff.  That is a separate issue which will be dealt with below.  Shorn of this issue, the Placement Memorandum itself has no significance.

EVIDENCE ON THE ALLEGED REPRESENTATIONS

Evidence of the plaintiff

65. The plaintiff himself is his only witness of fact. He has made three witness statements.

66. He said in his 1st witness statement that he practised as a Chartered Accountant in Hong Kong from 1980 to 1999 mainly in audit.  He had been an audit partner of PwC.  Apart from the accounting qualification, he also has a B. Sc. in chemical engineering and an MBA.

67. He had also served as an independent non-executive director of several listed companies.  He agreed that he had the title of financial adviser of a solicitors firm, but asserted that that was a mere title and he had no work to do under that title.  There is nothing to challenge his assertion.  Furthermore, one wonders what service would the clients of a solicitors firm require from a financial adviser.

68. In 2000, he was invited to apply for an Amex Centurion card.  He was told that if he opened an account with the defendant, the defendant would waive the annual fees he would otherwise have to pay for the card.

69. He opened an account with the Private Banking Department of the defendant on 3 November 2000.  He signed the A/C Opening Documents and arranged US$1.1 million to be deposited into the account.

70. In December 2000, Ms Chau suggested that he should invest the money for a better return than interest on fixed deposit.  On his request, Ms Chau recommended the MN Fund to him.  He accepted the recommendation and invested in the fund.

71. In November 2004, Ms Chau went through with him an Investment Questionnaire of the defendant for assessing his needs, investment objective and risk tolerance.

72. Before that meeting, he already had experience in investments for fixed income, stocks, shares and real estate for over 20 years.

73. The defendant later sent him a letter dated 30 November 2004 advising him that based on the information he provided in the questionnaire, the defendant determined his “Investment Suitability Profile Rating” as “a balanced investor with an emphasis on capital appreciation”.

74. He also said that he had never been a speculator and been very passive and inactive in making investments.  He did only about 10 transactions per year on the average and would leave the investments to grow for several years before deciding whether to change them.

75. He counted on the recommendations of bank officers. He had made it clear to Ms Chau that he preferred to make investment decisions with the defendant’s advice.  Such preference was indeed recorded in the Investment Questionnaire.

76. Further Investment Questionnaires were completed for the plaintiff in November of 2005, 2006 and 2007.  On each occasion, it was said that the plaintiff preferred making investment decision with the benefit of the defendant’s advice.

77. The MN Fund was liquidated in August 2005.  Ms Chau and/or Ms Yau advised and recommended to him the FS Fund, a collective investments scheme.  He had not heard of this fund before.  In oral evidence, he confirmed that the Permal Funds were also introduced to him in the meeting on 17 August 2005.

78. In that meeting, they presented to him a copy each of the Fact Sheet and Update for January to June 2015.  They referred him to the investment objective of the FS Fund in the Fact Sheet which was to achieve capital appreciation through consistent monthly returns.

79. They also referred him to the Update which stated that since the inception in November 1990, the FS Fund had produced consistently low volatility returns through the split/strike conversion strategy.  Over the almost 15-year period, the fund had returned to clients a net compounded annual return of 11.23% with a standard deviation of 2.6% and a Sharpe ratio of 2.65.  The strategy was to purchase a basket of large-cap US equities and the implementation of an options collar with long index put options and short index call options.  For the first six months in 2005, the net return was 6% with no down month.  The S&P 100 index posted a loss of 2% for the same period.  The fund made profits in equities and Treasury bill interests but suffered loss in option positions. 

80. They told him that the principles of the fund were for capital preservation, low volatility and long term capital appreciation.  It provided superior risk-adjusted performance over a number of market cycles.

81. They also advised him that the fund was a low risk investment with moderate returns.  It met with his investment objectives.  They recommended that it was an investment suitable for him.

82. He had no knowledge of the fund.  He, in reliance of their recommendation and representations, agreed to apply US$1,171,562.67 to subscribe for shares in the fund.

83. They also promised to manage the investment in his account for him and give him oral advice on securities investment and oral analysis and review of the performance of the fund at least once a year.

84. He was asked to sign Subscription Agreement of the fund but was not asked to pay any attention to any clause therein.  He denied of having been given the Placement Memorandum despite his written acknowledgment of receipt of the same.  He thought the memorandum was the same as the Subscription Agreement.

85. In 2006, there was a meeting for the annual review. They gave him the same oral analysis and advice, showed him information sheets on the performance of the FS Fund and concluded that the performance of the fund was good and was better than keeping the money in monthly fixed deposit.  They recommended him to keep the shares of the fund as an investment.  He accepted and acted on the recommendation.

86. There was another review meeting in 2007.  He again accepted and acted on their recommendation and kept the shares of the fund.

87. He subsequently learnt in about November 2011 from the documents disclosed in this action that there were 19 requests by the clients of the defendant for redemption of shares of the FS Fund totalling some US$9 million in July and August 2007, but the defendant did not disclose this to him.  He said that it was unfair for the defendant to have withheld such information from him. He further said that if such information had been disclosed to him in July or August 2007, he would also have redeemed his shares in the FS Fund and put his money back in monthly fixed deposit as he was a prudent investor.

88. On 16 June 2008, he signed a letter of consent to transfer his investments with the defendant to SCBHK as SCBHK was taking over all the assets and business of the defendant.

89. In December 2008, Mr Madoff revealed that he and BLMIS had been running fraudulent Ponzi schemes.  On 13.12.08, the plaintiff called SCBHK to enquire on the value of his shares in the fund.  A client service manager of SCBHK advised him that with effect from 22.12.08, SCBHK would adjust the net asset value of his shares to US$0.01.

90. In oral evidence, he said Ms Chau and/or Ms Yau had spent more than half of the time in the meeting of 17 August 2005 to explain the fund to him.  They compared the fund with the Permal Funds and strongly recommended the fund to him as it was a low risk fund with moderate returns that fit his investment objectives and that it was very similar to the MN Fund that had been liquidated. He understood low risk to mean that the principal of his investment would not be affected.

91. In cross-examination, he said he expected the defendant to recommend a product that was most suitable for him on the basis of the information he had provided to the defendant.  But if he should disagree with the recommendation, he was not obliged to accept it and he could have said no to it (day 2, p 52, line 10).  However, he had never seen or heard of these investment funds.  His choice had to be based on the defendant’s recommendation which he had accepted and acted on (day 2, p 95, line 17 and p 103, line 23).

92. Regarding the introduction of the FS Fund to him, he reiterated what he said in oral evidence.  He said Ms Chau drew his attention to the Fact Sheet and pointed out to him the fund’s investment objective (day 2, p 79, line 21).  She also referred him to the Update and went through certain parts of it with him (day 2, p 84, line 11).  The defendant’s internal risk rating of the fund was 2 out of 5 with 1 being the lowest and 5 the highest.  The MN Fund had the same rating (day 2, p 85, line 8).  They kept saying to him that this fund fit his investment profile and he should invest in it (day 2, p 94, line 20).

93. He agreed that if everything stated in the Fact Sheet and Update was true, this fund was suitable for him (day 2, p 85, line 20).

94. He was not told that this fund was in any way connected with Mr Madoff or BLMIS.  There is no dispute on this.

95. He also confirmed that whilst working as an audit partner of PwC, he had been involved in the IPOs of companies that wanted to go public.  He was aware of the need of a prospectus or placement memorandum for an IPO (day 2, p 29, line 15).

96. He agreed that PwC was a prestigious international accountants’ firm with an excellent reputation.  He also acknowledged that PwC had a good audit procedure both internally and externally and a high standard of work (day 2, p 15, line 21).

97. Regarding his signing of the A/C Opening Documents, he said he signed them without reading the terms in detail (day 2, p 89, line 24). But he admitted in cross-examination that with his professional experience and general experience in dealing with banks, he understood that the terms in the documents governed his relationship with the defendant (day 2, p 48, lines 20 - 25).  Hence, nothing really turns on the lack of explanation of terms by Ms Yau to him.

Evidence of Chau Wing Hang Amy

98. Ms Chau is a relationship manager with SCBHK.  She joined the defendant at this post in 1991.  She changed to SCBHK on 1 July 2008 when SCBHK took over the defendant’s assets in Hong Kong.

99. In her role as a relationship manager, she was responsible for implementing the clients’ investment decisions.  She also answered the clients’ questions about their investments and portfolios.

100. She first met the plaintiff in a meeting on 3 November 2000.  The plaintiff signed the A/C Opening Documents in this meeting.  A copy of these documents should have been sent to the plaintiff as it was the defendant’s standard practice to do so and she should have asked her assistant to do so.

101. In that meeting, the plaintiff agreed to invest US$1.1 million in the defendant’s in-house MN Fund.  The investment was implemented in December 2000.

102. The plaintiff made a further investment in July 2001 in another fund through another account with the defendant which was opened in the name of Cosmopolitan Services Ltd (“Cosmopolitan”).  The plaintiff was a beneficial owner of Cosmopolitan.

103. From 2000 to 2005, Ms Chau met the plaintiff at least once a year.  From 2003 onwards, Ms Corinna Yau, an investment adviser of the defendant also joined the meetings.  The first meeting that Ms Yau joined was on 11 September 2003.  She reviewed the plaintiff’s portfolio and suggested to him to hold on to his investments.  He did so.

104. In the next review on 28 July 2004, Ms Chau and Ms Yau suggested to the plaintiff to liquidate the profit of Cosmopolitan’s investment. But the plaintiff preferred to maintain the status quo.  Hence, there was no change to Cosmopolitan’s portfolio.

105. Ms Chau also completed the defendant’s Investment Questionnaire on the plaintiff on about 8 November 2004.  She gave the plaintiff the rating of “a balanced investor with an emphasis on capital appreciation”.  Ms Yau agreed with this rating.  The plaintiff was then notified by a letter dated 30 November 2004 that based on the information he supplied to Ms Chau, his investment suitability profile rating was determined as “a balanced investor with an emphasis on capital appreciation” and that “his primary objective is maximizing capital growth and he is willing to tolerate more than one year of negative returns”.

106. Regarding the meeting with the plaintiff on 17 August 2005, Ms Chau said that it was for reviewing the plaintiff’s portfolio.  Since the MN Fund was closing, she also discussed with the plaintiff on how he would invest the proceeds from that fund.

107. Prior to the meeting, she had discussed with Ms Yau on the plaintiff’s portfolio.  They also discussed other investments as options for him to consider.  In the light of their understanding of his risk profile, the nature of the investment he was holding (including that held by Cosmopolitan) and that the MN Fund was a hedge fund with a risk rating of 2 as at July 2005, they decided to discuss the FS Fund and the Permal Funds with him as possible investment options.  The risk ratings of these funds were similar and were consistent with his risk profile and investment objectives.  Furthermore, the FS Fund was, like the MN Fund, a hedge fund invested in US equities.  The defendant’s risk ratings for both funds were at 2.

108. Ms Chau also said in oral evidence that a risk rating of 2 meant that the risk was relatively low and the FS Fund was suitable for most of the clients (day 3, p 81, line 22).

109. For the two Permal Funds, their risk ratings were at 2 and 3.  They were funds of hedge funds and each had more than one manager and one strategy.  The FS Fund was a single manager and single strategy fund.

110. At the meeting, they presented the Fact Sheet and Update of the FS Fund and the fact sheets of the Permal Funds to the plaintiff and went through them with him.  Ms Yau explained to the plaintiff the detailed history and past performance of the FS Fund, its investment strategy and rationale and how it worked.  She also explained to him the subscription and redemption requirements of the FS Fund.  They spent a significant amount of time with the plaintiff in discussing the FS Fund as it had a similar risk rating as the MN Fund and also invested in US equities.  They also told him that the returns of the FS Fund were moderate.

111. Ms Chau also said that when discussing with clients about the FS Fund, they had the practice of telling clients that it was a single manager/single strategy fund.  Hence, its risk was higher than a multimanager fund as for example the insolvency of the single manager may result in the loss of the whole investment in the fund. 

112. This was however a misstatement.  The defendant’s third witness Mr Friedman clarified that the defendant would encourage clients to invest in a fund of funds.  The reason being that for a single manager fund, the manager risk that the defendant was most concerned about was that the manager’s investment strategies could work for several years and then stop.  In that event, the single manager fund could suffer a substantial loss (day 5, p. 30 line 22 to p. 32 line 14).

113. After discussing the FS Fund with the plaintiff, Ms Chau and Ms Yau discussed the Permal Funds with him.  After the discussions, he decided to invest the proceeds from the MN Fund in the FS Fund.

114. Ms Chau denied of having pushed or otherwise recommended the FS Fund over the Permal Funds to him as she and Ms Yau had no personal gain of bonus when clients invest in any product.

115. After he had purchased shares in the FS Fund, they had several meetings with him to review his portfolio and discussed the market outlook with him.

116. In December 2008, Mr Madoff’s fraud was revealed. The plaintiff’s investment in the FS Fund was adjusted to a value of US$0.01.

117. On 6.3.09, Ms Chau and Ms Yau, who were then with SCBHK together with one Mr Wellington Ong met with the plaintiff. They explained to him the relationship between the defendant and FGG and the relationship between the FS Fund and Mr Madoff.

118. Regarding the plaintiff’s case that the defendant had not advised him of the several investigations and examinations by US authorities on Mr Madoff and BLMIS and the critical articles on them, Ms Chau said in her supplemental witness statement that she was not aware of these matters until she read about them in the witness statement of Mr Friedman.  But I do not think her knowledge about them is relevant.  If the defendant had the obligation to advise the plaintiff about these matters, Ms Chau’s ignorance about them would not exonerate the defendant from liability.  It simply means that the defendant should have advised Ms Chau of the same so that she could have relayed the same to the plaintiff.

119. Mr Chau also agreed in cross-examination that she was permitted by the defendant to give advice to clients as to what action they should take concerning their investments (day 3, p 12, lines 11 to 14).

120. She also agreed that the plaintiff would take her advice into account in deciding what to invest in (day 3, p 57, line 1). 

121. She also trusted the Fact Sheet provided by FSL and the due diligence done by the defendant on the FS Fund (day 3, p 85, line 4).

122. She also said that her assistant should have carried out her instruction to send the plaintiff a copy of the Placement Memorandum as it was the defendant’s standard procedure to do so (day 3, p 28, line 5).

Evidence of Yau Yuet Wah Corinna

123. Ms Yau is a Senior Director of the Investment Advisory Group of SCBHK.  Prior to 1 July 2008, she was an Investment Adviser of the defendant. She had the duty to understand the defendant’s investment products, their features and investment objectives.  She also had to understand the client’s risk profiles and objectives.  She would consider with the Relationship Manager which of the defendant’s investment products could be introduced to the client.  She also had to explain to the client the risks, historical performance and other characteristics of the products and how they would fit into the client’s portfolio.

124. She also had to discuss with the client on how his/her investments were performing and, based on the defendant’s in-house view of the market, provide her opinion on what action, if any, the client should take in relation to his/her investments.

125. Regarding the FS Fund, she had studied its fact sheets, presentation and quarterly reports as provided by the fund manager FGG since 2003 when the fund was introduced to the defendant’s family of funds.  The FS Fund appeared to her to be a reasonably good investment as it had a long track record, consistent returns and low volatility.  It was endorsed at the group level of the defendant. It was regularly discussed at weekly Investment Advisers’ meetings.  She recalled that the other Investment Advisers also regarded the fund as quite a good product.

126. Ms Yau first met the plaintiff in the meeting on 11 September 2003 together with Ms Chau.  The meeting was to review the performance of the plaintiff’s portfolio as held in his own name and in the name of Cosmopolitan. After the review, she advised him to hold on to the investments and he took that course.

127. In the next review meeting on 28 July 2004, Ms Yau advised the plaintiff to liquidate the profit accumulated in Cosmopolitan’s investment, but he did not act on the advice and maintained the status quo.

128. On around 29 November 2004, Ms Yau evaluated the Investment Questionnaire of the plaintiff as prepared by Ms Chau.  She assigned the plaintiff an “Investment Suitability Profile Rating” of “a balanced Investor with an emphasis on capital appreciation”.

129. In the next meeting on 17 August 2005, she together with Ms Chau presented the plaintiff with the FS Fund and the Permal Funds as investment options for him.  The three funds were selected for presentation to the plaintiff because they were consistent with his risk profile and investment objectives.  They selected the FS Fund because it was a hedge fund with a risk rating of 2 which was the same for the MN Fund.  Both funds invested in US equities.  They also selected the Permal Funds because these were hedge funds with multi-managers and hence provided diversification.  At the meeting, they presented the Fact Sheet and Update of the FS Fund to the plaintiff.  They also presented him with the latest fact sheets for the Permal Funds.

130. Ms Yau also explained to the plaintiff the details of how the FS Fund worked, its investment rationale, strategy, past performance and risk factors including the fact that it was a single manager/single strategy fund.  It had relatively consistent historic returns.  They also discussed the Permal Funds with the plaintiff.  The plaintiff then decided to re-invest the proceeds from the MN Fund into the FS Fund.

131. After the 17 August 2005 meeting, they had another 3 or 4 review meetings with the plaintiff. 

132. Ms Yau also updated herself on the performance of the FS Fund on an ongoing basis by reading the monthly fact sheets and internal communications on it.  The performance of the fund was in line with its track record. There was nothing unusual.  In the light of these observations, Ms Yau did not advise the plaintiff to redeem his shares in the fund.  I take this to mean that she had advised the plaintiff not to redeem the shares in the fund and the plaintiff acted accordingly.

133. Ms Yau said in her 2nd witness statement that she was not aware of the investigations, reports, news articles or other publications relating to Mr Madoff or BLMIS.  However, as I have remarked above in relation to Ms Chau’s evidence, Ms Yau’s ignorance of these matters would not exonerate the defendant if the defendant should have the obligation to advise the plaintiff of the same. 

134. Ms Yau also recalled that at some time prior to March/April 2006 (as she clarified in oral evidence (day 4, p 17, line 10)) there were discussions amongst the Investment Advisers on whether there was a conflict of interest within Mr Madoff’s business and on an issue about the custodial arrangement of the FS Fund’s assets.  There were also regular discussions on how the FS Fund could have achieved consistent returns despite market volatility.  She thought that these queries were adequately addressed to by the representatives of FGG when they visited the defendant and held discussions with the Investment Advisers and also by the regular e-mail updates both internally and from FGG.

135. In oral evidence, Ms Yau agreed that the plaintiff was seeking the defendant’s advice on his investment strategies (day 4, p 24, line 24 to p 25, line 20).  She also said that the plaintiff would listen to their advice before making his decision (day 4, p 27, line 9 to p 28, line 24 and B1, 272). The call report prepared by Ms Chau after the review meeting on 11 September 2003 (B1, 268) also recorded that Ms Yau had made a recommendation to the plaintiff to hold on to his investment and the plaintiff agreed to do so (day 4, p 30, line 16 to p 31, line 18).

136. Ms Yau also agreed that she had spent more time to introduce to the plaintiff the details of the FS Fund than the Permal Funds.  She highlighted the FS Fund to the plaintiff as she regarded it similar to the MN Fund in many ways (day 4, p 52, lines 7 to 24).  She also explained to him that the FS Fund was a single manager fund and there were the risks of the manager performing badly or acting without integrity (day 4, p 83, line 15 to p 84, line 21).  This statement should now be qualified by Mr Friedman’s statement referred to above. Ms Yau, however, had not mentioned to the plaintiff that BLMIS was a sub-custodian of 95% of the assets of the FS Fund.

137. Regarding the 19 redemptions of the FS Fund totalling about US$9 million in July and August 2007, she agreed that she had not told the plaintiff about it.  She thought that the cause of these redemptions as suggested by the internal communications was the failure of the Bear Stearns High Grade Structured Credit Fund.  That fund involved US sub-prime related securities and borrowing with leverage.  That was different from the FS Fund.  As a result of the redemptions, a telephone conference was arranged between a partner and chief security officer of FGG and the defendant’s investment advisers.  One of the concerns raised by the advisers at the conference was whether Mr Madoff was retiring soon and, if so, who would be his successor (day 4, p 118, line 9 to p 122, line 13).

138. Regarding her introduction of the FS Fund to the plaintiff, Ms Yau agreed that she expected the plaintiff to gain the impression that it was a low risk fund (day 4, p 48, line 21 to p 49, line 1).

DID THE DEFENDANT MAKE REPRESENTATIONS TO THE PLAINTIFF?

139. In considering this issue, I would rely on the defendant’s evidence which is not in serious conflict with that of the plaintiff.

140. The defendant had a team of staff bearing the title “Investment Adviser” and Ms Yau was one of them.  Ms Yau’s duties were to understand the defendant’s investment products including their features and objectives and also to understand the client’s risk profile and investment objective.  She would in conjunction with the client’s Relationship Manager consider which of the many investment products could be introduced to the client.  At the introduction, she had to explain to the client the characteristics of the chosen investment product(s) including the historical performance and risks and how the product(s) would fit into the client’s portfolio.  She also reviewed with the client on the performance of the client’s investments and provided her opinion to the client on what action, if any, the client should take on the investments.

141. She also confirmed in oral evidence her understanding that the plaintiff was seeking the defendant’s advice on his investment strategies and he would take the defendant’s advice before making his decision.

142. Ms Chau agreed in cross-examination that she was permitted to give advice as to what action the clients should take concerning their investments.  She further agreed that the plaintiff would take her advice into account in deciding what to invest in.

143. From the evidence of Ms Chau & Ms Yau, it is clear that the plaintiff was seeking advice before deciding what investment decision he would make.  There is no dispute that advice in the form of representations as to the characteristics, performance and risk of funds had been given.  The dispute is whether such advice and representations were made by the defendant or that the defendant had merely served as the conduit for the representations of the fund managers to be relayed to the plaintiff.

144. Mr Jat, leading counsel for the defendant submitted in the opening submissions that when Ms Chau and/or Ms Yau was presenting the Fact Sheet and Update of the FS Fund to the plaintiff and drew the plaintiff’s attention to parts of the contents therein, she was only quoting these documents and not purporting to speak from independent knowledge.  She was not adopting the contents as her own representations.

145. Mr Jat further submitted that when a person A handed to another person B a document issued by a third person C, the contents of the document were given by C and not A.  It also cannot be inferred that A was adopting or otherwise repeating C’s statements as his own.  He further drew an illustration of a customer who asked a salesperson of a home appliances store for a dehumidifier of certain characteristics like energy efficiency, the salesperson then gave the customer a brochure on a model from a reputable manufacturer and pointed to some stated characteristics on the brochure.  He submitted that in such situation, no one would expect the salesperson to have personal knowledge of or the engineering expertise to validate the matter in print and that the salesperson was only saying that the reference in the brochure was the manufacturer’s representations as to the energy efficiency of the dehumidifier. He also submitted that the plaintiff was aware that the Fact Sheet and Update were from FSL and the statements in them were made by FSL and not by the defendant (Opening §§65 to 69).

146. Mr Jat also referred to Resolute Maritime Inc v Nippon Kaiji Kyokai [1983] 1 WLR 857 where Mustill J (as he then was) held that an agent making innocent misrepresentations on behalf of the principal was held not liable to the victim even if the agent had no reasonable basis to believe the representations to be true.  This view was endorsed in Aktieselskabet Dansk Skibsfinansiering v Wheelock Marden & Co Ltd (CACV 107 of 1997, 12 June 1998 at §78 per Godfrey and Liu JJA and §98 per Le Pichon J (as she then was). However, that decision was on the effect of section 2(1) of the Misrepresentation Act 1967 which is the same as section 3(1) of the Misrepresentation Ordinance. Mustill J decided that any liability arising out of the operation of the Misrepresentation Act rested with the principal as a contacting party vis-à-vis the victim and not with the agent.  Hence, the decision of Mustill J as endorsed by the court of appeal only protected Ms Chau and Ms Yau who were agents of the defendant.  The defendant cannot rely on it as it was not the agent of FSL.

147. Mr Jat repeated these submissions in the closing submissions.  He referred to the plaintiff’s evidence and then said that even on the plaintiff’s evidence, Ms Chau and/or Ms Yau was only quoting the Fact Sheet and Update and their providing the documents was not adopting the contents as her/their own representations.  He further submitted that it was obvious that Ms Chau and Ms Yau did not have independent knowledge of the matters stated in the documents (Closing §§139 to 145).

148. The effect of Mr Jat’s submissions is not to deny that representations as contained in the Fact Sheet and Update on the FS Fund and contained in other materials on the other funds had been made to the plaintiff. He only argued that the representations were made by those fund managers who printed and updated the fact sheets and other documents on the funds but not by the defendant. The crux is whether Ms Chau and/or Ms Yau had adopted and repeated the representations to the plaintiff thereby making them the representations of the defendant as well.

149. I think Mr Jat’s submissions on whether Ms Chau and/or Ms Yau had indeed made representations on behalf of the defendant to the plaintiff are too simplistic.  Whether A is merely relaying the representations of C to B by referring B to the contents of a document issued by C depends on how and why A does so and against what circumstances.  I refer to the statement of Lord Hoffmann in Customs & Excise Commissioners v Barclays Bank Plc [2007] 1 AC 181 at §36:

“… the question of whether a defendant has assumed responsibility is a legal inference to be drawn from his conduct against the background of all the circumstances of the case, it is by no means a simple question of fact.”

150. In the present case, Ms Chau confirmed that she trusted the Fact Sheet of the FS Fund and the defendant’s due diligence on the fund.

151. At the 17 August 2005 meeting, she and Ms Yau gave the Fact Sheet and Update to the plaintiff.  Ms Yau explained to the plaintiff the detailed history, past performance, investment strategy and rationale of the fund and how it worked.  They spent a significant amount of time to discuss the fund with him including its low risk rating and that it also invested in US equities like the MN Fund that the plaintiff had invested in.

152. Ms Yau also said that she and Ms Chau selected the FS Fund and the Permal Funds for presentation to the plaintiff because these funds were consistent with the plaintiff’s risk profile and investment objective.  Ms Yau explained to the plaintiff how the FS Fund worked, its investment rationale, strategy, past performance and risk factors.  She expected the plaintiff to gain the impression from her presentation that the fund was a low risk fund.  She spent more time with the plaintiff on this fund than the Permal Funds.  She highlighted the fund to the plaintiff as she considered it similar to the MN Fund in many ways.

153. There is no doubt that Ms Yau’s presentation and explanations of the FS Fund above were based on the materials in the Fact Sheet, the Update and possibly from other materials from FGG that she had learnt since 2003.  She must have relied on the information in the Fact Sheet and Update and in particular on the past performance of the fund when making the presentation to the plaintiff.  She knew that the plaintiff wanted her advice before deciding what to do.  She was endorsing the representations in the Fact Sheet and Update when conveying the same to the plaintiff.  She made the presentation on the basis that they were truthful and reliable. She wanted the plaintiff to rely on them.  She relied on them in advising and recommending to the plaintiff that the fund was a low risk fund with moderate returns.  She wanted the plaintiff to have such an impression on the fund.  It was her advice and recommendation that the fund was appropriate for the plaintiff’s risk profile and investment objective.

154. In the premises, I hold that the plaintiff has proved on a balance of probability that the representations about the FS Fund, as contained in the Fact Sheet and Update and later updated versions of the same, that had been conveyed by Ms Yau to the plaintiff at the 17 August 2005 meeting and subsequent review meetings were not just made by FGG, but had been adopted and made by Ms Yau on behalf of the defendant to the plaintiff.  Hence, they were also representations of the FS Fund made by the defendant to the plaintiff.

DID THE PLAINTIFF RELY ON THE REPRESENTATIONS?

155. Ms Yau confirmed that the plaintiff wanted the advice from the defendant before deciding what to do.  Ms Chau also agreed that the plaintiff would take her advice into account in deciding what to invest in.  The Investment Questionnaire prepared by Ms Chau for the plaintiff also recorded that the plaintiff preferred to make investment decisions with the defendant’s advice.

156. The plaintiff opened his account with the defendant in November 2000.  He then put money into the account and invested it in the MN Fund in line with the defendant’s recommendation.  He later opened an account for Cosmopolitan with the plaintiff in July 2001 and made an investment in this account also in line with the defendant’s recommendation.  There was at least one annual review meeting between the plaintiff and Ms Chau since 2001.  Ms Yau joined them in 2003.  In each review, Ms Chau and/or Ms Yau would advise the plaintiff on what to do with the investments in the two accounts.  The plaintiff then decided what to do or not to do with the investments in each of the accounts.

157. From 2000 to 2008, the plaintiff had made 17 investment decisions.  These decisions included his decisions to subscribe for the shares of the FS Fund in 2005 and not to redeem the same in the years of 2006 to 2008.  Save and except his decision on 28 July 2004 not to liquidate the profit in the Cosmopolitan account, all the other 16 decisions were in line with the recommendations given by the defendant. 

158. With particular regard to his decision to invest in the FS Fund, he said he had not heard of the fund before and had no knowledge about it.  There is nothing to contradict this evidence.  I accept this evidence.

159. Both Ms Yau and Ms Chau regarded the FS Fund as appropriate to the plaintiff’s risk profile and investment objective.  This fund was in many ways similar to the MN Fund that the plaintiff had invested in previously.  Hence, they spent more time with the plaintiff on this fund than the Permal Funds.  The plaintiff then invested in this fund.  He said that he did so in reliance on the representations by the defendant. 

160. The above evidence shows clearly that the plaintiff had relied on and followed the defendant’s recommendations in investing his money. I accept the plaintiff’s contention on a balance of probability.

ARE THE REPRESENTATIONS FALSE?

161. The plaintiff’s case is that when the defendant recommended the FS Fund to him on 17 august 2005 as a low risk fund with moderate returns, the defendant was impliedly representing to him that this fund was an authentic investment that had the characteristics as mentioned in the Fact Sheet and Update (and as mentioned in the updated versions used in subsequent meetings as well).  However, this was a misrepresentation as the fund was not an authentic investment but a Ponzi scheme which did not have any of the characteristics mentioned in the Fact Sheet and Update (and later updated versions).  Furthermore, the defendant in making the misrepresentations had also breached its duty of care to the plaintiff. 

162. The defendant has no answer to this charge that the implied representation on the fund was false.  But the defendant, in answer to the charge of misrepresentation and breach of duty of care, pleaded that it had not been negligent in conducting the initial and on-going due diligence on the fund and had reasonable grounds to believe and did believe up to the time when Mr Madoff revealed his fraud that the representations were true.  It therefore was not negligent in making the misrepresentations and had not breached its duty of care to the defendant.

EFFECT OF THE TERMS IN THE BUSINESS CONDITIONS AND RISK DISCLOSURE STATEMENT – CONTRACTUAL ESTOPPEL

163. Before dealing with the issue of whether the defendant was negligent or had reasonable grounds to believe that the representations were true, I would deal with the issue of whether the defendant can rely on some clauses in the Business Conditions and RD Statement as detailed in the defendant’s opening submissions to resist this claim in the event that I should hold against it on the first issue.  The Business Conditions and RD Statement are amongst the A/C Opening Documents executed by the plaintiff on 3 November 2000.   The defendant submitted that by these clauses, the plaintiff is estopped from arguing that he had relied on any advice or representation that the defendant or its staff might have made or that the defendant had or had assumed any duty of care in the plaintiff’s purchase of shares in the FS Fund.

164. However, the defendant’s closing submissions only referred to the terms in the RD Statement and not those in the Business Conditions. The terms in the Business Conditions (as referred to below) say that the defendant may provide the plaintiff with information, advice and recommendations in respect of dealings in securities.  These terms prima facie do not protect the defendant from its acts or omissions which are grossly negligent or from negligent loss of customer’s securities.  These terms therefore do not tally with the terms in the RD Statement.  If I should find that the defendant had been negligent in making the advice and recommendations to the plaintiff, these terms may not afford the defendant any protection.  Perhaps the defendant did not refer to these terms in the closing submissions for these reasons.

165. The relevant clauses in the two documents are :

“GENERAL BUSINESS CONDITIONS

…

5. CUSTODIAN AND INVESTMENT SERVICES

5.1 The Services

The (defendant) may from time to time provide the following services in respect of securities:

…

(b) information, advice and recommendations in respect of dealings in securities, either at the request of the Customer or on the initiative of (the defendant), provided always that (the defendant) shall not be under any obligation to provide advice on an on-going basis with regard to the management of the Customer’s investments in securities;

…

9. LIABILITIES

(a) Neither (the defendant), its associates, nor any of (their directors, officers etc) shall be liable to the Customer for any expenses, loss or damage suffered by or occasioned to the Customer by reason of (i) any action taken or omitted to be taken by any one or all of (the defendant), its associates, (their directors, officers etc) pursuant to these Conditions or in connection therewith other than as a result of the … or gross negligence of (the defendant), its associates, (their directors, officers etc); … (v) any loss, damage, destruction or mis-delivery of or to the Securities howsoever caused; unless the same shall result from the negligence of … (the defendant) or its associates or any of (their directors, officers etc) in which event the extent of the liability of (the defendant) shall be limited to the market value of such Securities at the date of discovery of the loss and in no circumstances shall (the defendant) be liable for any special, general or consequential damages, … (vii) any act or omission, or insolvency of, any person not associated with (the defendant) (including without limitation a third party nominee or Depositary); … and (x) … the error, failure, negligence, act or omission of any other person, system, institution or payment infrastructure.” (Italics supplied)

“RISK DISCLOSURE STATEMENT

Please Read This Carefully

The risk of loss in trading in foreign exchange, options, metals and other over-the-counter derivatives transactions can be substantial. The risk is significantly increased where the trading is conducted on a leveraged basis or where you may be borrowing in one currency to fund an investment in a second currency. You may incur substantial losses and/or gains.

(The defendant) does not assume any fiduciary or other responsibility to advise you about the merits or suitability of any transaction or even to give you all the information you may need in order to decide whether to enter into a transaction. Our employees do not have authority to give you advice about any transaction. You may not rely on any statement made by any employee or agent of (the defendant) as advice or as a recommendation. … You may not rely on (the defendant) in any regard to advise you on any transaction. You are responsible to independently satisfy yourself that you fully understand all the risks of the transactions that you enter into.

By signing below you acknowledge that you fully understand, accept and agree to the following:-

…

7. (The defendant) is acting as a Principal: You should note that (the defendant) deals with you at arms length as your counterparty. (The defendant) is not your adviser. (The defendant) is not your fiduciary, … You should not rely on any communication (written or oral) by or on behalf of (the defendant) as investment or trading advice or as a recommendation. You are responsible to make your own decisions. The decision to do a transaction is yours alone and shall not be deemed for any purposes to have been made by or at the recommendation of (the defendant).

ACKNOWLEDGEMENT

I/We have read and I/we understand this risk disclosure statement and found its contents acceptable. I/We will make my/our own independent decision to enter into any transaction and I/we will not rely on any communication of (the defendant) as investment advice or as a recommendation to enter into any transaction. I/We am/are capable of understanding and I/we will evaluate (either alone or with my/our own adviser) all of the terms, conditions and risks of any transaction that I/we enter into. I/We agree that (the defendant) will not be acting as my/our fiduciary or adviser.

I/We agree that this risk disclosure statement is not intended as a substitute for my/our actually becoming reliably and adequately informed as regards any specific transaction that I/we enter into. I/we accept responsibility for any transaction which I/we choose to enter into.” (Italics supplied)

166. Mr Jat submitted that the relationship between the plaintiff and the defendant was governed by the A/C Opening Documents which gave rise to the estoppel.  Mr Jat relied on JP Morgan Chase Bank v Springwell Navigation Corp [2010] 2 CLC 705 (CA) at §§170-171 and §§179-181 and DBS Bank (Hong Kong) Ltd v San-Hot HK Industrial Co Ltd & Anor [2013] 4 HKC1 at §§232 to 235.

167. The Springwell Navigation Corp case concerned investments by Springwell with the respondent bank.  Springwell was owned and controlled by a Greek shipping family.  It invested in emerging market securities including notes issued by the respondent bank that were linked to certain Russian bonds known as GKOs.  These notes were traded in US dollars, but the GKOs were traded in roubles. There was thus a possibility of currency loss on the notes at redemption.  To avoid such possibility, there was in the investment structure a forward currency contract for the conversion of the proceeds of the GKOs from roubles to US dollars at the redemption date.  Such investment is complicated.

168. In 1998, there was a Russian moratorium on foreign debt repayments and suspension of trading in Russian Federation issued bonds.  As a result, the GKOs did not perform and the notes linked to them defaulted.  Springwell suffered.  It sued the respondent bank for misrepresentation.  Gloster J. held that Springwellwas bound by its acknowledgment that the bank had made no representation or warranty to it because the acknowledgment was part of the terms of Springwell’s contract for purchase of the GKO linked notes.

169. The situation in Springwell was very much different from the situation in this case.  The reasoning in Springwell do not apply to this case where the plaintiff was advised to purchase shares in the low risk FS Fund that only produced moderate returns and was assessed by the defendant to be appropriate to the plaintiff’s risk profile and investment objectives.

170. Regarding the San-Hot case, the investments that San-Hot had engaged in with the defendant were contracts for purchase of listed shares and currencies that are commonly known as accumulators.  The details of how such contracts operate had been set forth by Deputy High Court Judge Pow, SC in §5 of the judgment.

171. Accumulator contracts are high risks investments and many people have suffered substantially from them.  DHCJ Pow held that the nature and scope of the services that the respondent bank provided to San-Hot were defined by terms that San-Hot had subscribed to.  Those terms are similar to the terms in the RD Statement.  Owing to the difference in the facts, the reasoning in San-Hot does not apply to this case as well.

172. I think it is important to firstly consider whether the RD Statement is applicable to the plaintiff’s purchase of shares in the FS fund. The first paragraph of the RD Statement cited above, which has not been referred to by the defendant, describes the types of transactions covered by the statement. This paragraph also refers to the increase of risk of the transactions by leverage (or margin) or borrowing in different currency.

173. The RD Statement also has specific provisions containing warnings on risks of “margin” or leveraged transactions (§3), risks on option trading (§4) and currency risks (§5). 

174. It is thus clear that this statement covers investment activities that are of high risks and not the FS Fund which is a low risk hedge fund.  Hence this statement did not apply to the plaintiff’s purchase of shares of the FS Fund or the MN Fund.  The defendant cannot rely on this statement to defend the plaintiff’s claim herein.  If need be, I would also invoke the contra proferentem rule of construction (§14-009 of Chitty on Contracts).

175. Despite my finding that the RD Statement did not apply to the plaintiff’s purchase of shares in the FS Fund, I would also consider the submissions by the plaintiff for completeness sake. 

176. Mr Mok, leading counsel for the plaintiff also referred to the 2nd paragraph on page one and §7 of the RD Statement and submitted that the 2nd paragraph properly construed does not contain any exclusion of liability for the defendant’s negligent information, advice and recommendations on any transaction or dealing by the plaintiff.  Mr Mok further relied on the contra proferentem rule and submitted that the terms of this paragraph do not mean that the defendant is excluded of all liabilities in particular liability for negligence.  I do not accept this submissions as the RD Statement does appear to make the defendant immune from liability for negligent advice and recommendation by providing that the plaintiff could not rely on the same.

177. Mr Mok further submitted that the two sentences in the 2nd paragraph of the RD Statement that “[o]ur employees do not have authority to give you advice about any transaction.  You may not rely on any statement made by any employee or agent of (the defendant) as advice or as a recommendation” are inconsistent with the sentence in §5.1(b) of the Business Conditions cited above. I agree.  I find that these two sentences are repugnant to the intention of the parties as expressed in clause §5.1(b) of the Business Conditions which clause applied to custodian and investment services provided by the defendant to the plaintiff and governed the relationship between the plaintiff and the defendant in respect of the plaintiff’s purchase of shares in the Fund or the MN Fund.  I therefore reject these two sentences from the 2nd paragraph of the RD Statement (§12-078 of Chitty on Contracts, 30^th edn).

178. Furthermore, in the light of the fact that Ms Yau was an Investment Adviser whose duty was to give advice to the plaintiff on investments, these two sentences in the 2nd paragraph of the RD Statement are contradictory to the reality.  It is thus artificial for the defendant to rely on them in defence of the plaintiff’s claim. 

179. I would however accept that these sentences may be appropriate for clients who engage in high risks investments of a highly speculative element like those stated in the first paragraph of the RD Statement referred to above.  The evidence does not suggest that Ms Yau or Ms Chau would give advice or recommendations to clients in relation to those high risks and speculative dealings.

CONTROL OF EXEMPTION CLAUSES ORDINANCE AND MISREPRESENTATION ORDINANCE

180. Mr Mok further relied on sections 7(2) and 8 of the Control of Exemption Clauses Ordinance; Cap 71 and section 4 of the Misrepresentation Ordinance and submitted that the terms of the RD Statement as relied on by the defendant are unreasonable and the defendant cannot rely on them.

181. I have already referred to the artificiality of the defendant’s reliance on the two sentences in the RD Statement above-mentioned and held that the RD Statement did not apply to the plaintiff’s purchase of shares of the Fund.  However, for the sake of completeness, I would also consider whether the terms of the RD Statement would be subject to the two ordinances and, if so, it will be for the defendant to satisfy the whether the terms can satisfy the reasonableness test in the Ordinances.

182. Mr Jat argued that the terms of the RD Statement that are relied on by the defendant are not exemption clauses and hence not covered by these two ordinances.

183. The RD Statement is a set of the defendant’s written standard terms of business used to contract with consumers like the plaintiff. Hence, Mr Jat referred to it as having created a contractual estoppel against the plaintiff.  The RD Statement seeks to provide contractually that the defendant’s employees have no authority to give advice about any transaction and the client may not rely on any statement made by the defendant’s employees as advice or recommendation. This is to avoid its liability for negligent advice and/or recommendation.  But the fact is that the defendant has employed a team of Investment Advisers whose duty is give advice and recommendation on investment to the clients.  Therefore, the RD Statement, which contains these contrary to facts statements, is just a set of clauses seeking to exempt the defendant from liability to the plaintiff for its negligent advice and recommendations.  They are subject to the two ordinances.

184. In coming to this conclusion, I am assisted by the following judicial observations which have been drawn to my attention by Mr Mok. The first observation is by Toulson J in IFE Fund v Goldman Sachs [2006] 2 CLC 1043 at §68:

“a party cannot by a carefully chosen form of wording circumvent the statutory controls on exclusion of liability for a representation which has on proper analysis been made.”

185. The second observation is by Christopher Clark J made in Raiffeisen Zentralbank v Royal Bank of Scotland [2011] 1 Lloyd’s Rep 123 at §314:

“In this respect the key question, as it seems to me, is whether the clause attempts to rewrite history or parts company with reality.”

186. On the question of reasonableness of the terms of the RD Statement, Mr Jat submitted that such terms are common in contracts between investors and banks.  The plaintiff is a very wealthy man, an experienced professional in financial market matters, a senior business executive, a sophisticated investor, and even a “financial adviser” to others.  He had relationships with multiple banks (the Bank of East Asia, the defendant, and Coutts Bank).  He freely entered into the relevant contractual terms knowing that they would govern his relationship with the defendant.

187. However, Mr Mok submitted that these terms cannot pass the test of reasonableness imposed by the two ordinances.  His grounds are that:

(1)    The unequal bargaining positions between the parties: the plaintiff was a private individual and the defendant a substantial entity with ample financial resources.

(2)    The provisions relied upon by the defendant were standard terms drafted by it, and not negotiated between the parties.

(3)    The defendant’s Investment Questionnaire on clients contemplated that clients might prefer to make investments with the defendant’s advice and the plaintiff was such a client.

(4)    Ms Yau was designated to provide financial advice/recommendations to the plaintiff.  She made the presentation and explanation of the fund to the plaintiff.

(5)    The very service sought by the plaintiff from the defendant was the provision of investment advice/recommendations.  This was among the principal obligations and services set out in the General Business Conditions 5.1(b).

(6)    The provisions are very wide and couched in vague wording.

188. I would also add that such terms, as Mr Jat submitted, are common in contracts between investors and banks so that the investors have little choice but to accept them.

189. Mr Mok also pointed to the A/C Opening Documents being dense and voluminous and the plaintiff’s attention had not been drawn to any particular clause.  But I have held that as a matter of fact the plaintiff had not been prejudiced by the way that he was asked to sign the documents or by their form or format as he from experience knew that these terms were to govern his relationship with the defendant.

190. Considering the competing submissions, I am in favour of Mr Mok’s reasoning.  The plaintiff may be an experienced investor having about 20 years experience in investing in equities.  But when it came to investing in funds, he could not tell which of the multitude of funds available from the defendant was suitable for him.  He also needed access to these funds which was not always available to an individual investor.  Hence, he needed the service of the defendant. The defendant also professed to be able to assist the plaintiff in satisfying his investment needs.  The defendant had a team of Investment Advisers whose duty and specialty was to provide advice and recommendations to clients on what investment decision to make.  But the terms in the RD Statement seek to exclude the defendant’s liability from the very service that the plaintiff needed and the defendant provided even if it was provided in a negligent way.  Nevertheless, the plaintiff had little choice in the matter.  Furthermore, the terms were in a standard form imposed on the plaintiff by the defendant.  He could not negotiate out of their severity or escape from them by going to another private bank as such terms were common in standard contracts of private banks. 

191. In the premises, I hold that the defendant has failed to prove that the terms in the RD Statement as relied on by the defendant have satisfied the requirement of reasonableness in section 3 of the Control of Exemption Clauses Ordinance.  The defendant therefore cannot rely on these provisions to exclude or restrict its liability to the plaintiff in relation to his purchase of shares in the FS Fund.

UNCONSCIONABLE CONTRACTS ORDINANCE

192. The plaintiff also relies on the Unconscionable Contracts Ordinance, Cap 458.  Under section 5 of this ordinance, if a contract or part of a contract for supply of services to a consumer should have been unconscionable in the circumstances relating to it at the time of its making, the court may refuse to enforce or alter the unconscionable part to avoid any unconscionable result. Since the plaintiff is relying on this ordinance, it is for him to prove that the contract for service he had with the defendant or part of the contract is unconscionable.

193. Section 6(1) and (3) of the Ordinance provide an inexhaustible list of matters that the court may have regard to in determining whether a contract or part of a contract is unconscionable:

“6. (1) In determining whether a contract or part of a contract was unconscionable in the circumstances relating to the contract at the time it was made, the court may have regard to (among other things)-

(a) the relative strengths of the bargaining positions of the consumer and the other party;

(b) whether, as a result of conduct engaged in by the other party, the consumer was required to comply with conditions that were not reasonably necessary for the protection of the legitimate interests of the other party;

(c) whether the consumer was able to understand any documents relating to the supply or possible supply of the goods or services;

(d) whether any undue influence or pressure was exerted on, or any unfair tactics were used against, the consumer or a person acting on behalf of the consumer by the other party or a person acting on behalf of the other party in relation to the supply or possible supply of the goods or services; and

(e) the amount for which, and the circumstances under which, the consumer could have acquired identical or equivalent goods or services from a person other than the other party.

…

(3) In considering the exercise of its powers under section 5 to grant relief in respect of a contract or part of a contract found to be unconscionable, the court may have regard to the conduct of the parties to the proceedings in relation to the performance of the contract since it was made.”

194. Mr Mok relied on the following factors in the opening submissions:

(1)   Relative bargaining strength of the parties: section 6(1)(a).

(2)   The actual ability of the plaintiff to understand the contractual terms: UCO section 6(1)(c).

(3)   Whether the impugned terms were printed in small print.

(4)   Whether the impugned terms had been drawn to the attention of, or explained to, the plaintiff.

(5)   Whether the plaintiff had been given a proper opportunity to read and comprehend the impugned terms.

(6)   Whether the impugned terms were reasonably necessary for the protection of the legitimate interest of the defendant.

(7)   Whether the plaintiff could have acquired identical services from other suppliers without similar terms.  The reasoning is that if other suppliers also insist on similar terms, the plaintiff in effect had no choice but to accept the terms: UCO section 6(1)(e).

(8)   The meaning and effect of the impugned terms, i.e. whether they would operate harshly against the plaintiff.

(9)   Any undue influence, or pressure, or unfair tactics that was used against the plaintiff: UCO section 6(1)(d).

(10)   Whether the plaintiff was easily persuaded by the defendant.

195. On the evidence, it is clear that factors 2, 3, 4, 5, 9 and 10 are not applicable as the plaintiff from experience was aware that he would be bound by the terms in the A/C Opening Documents.  I also accept Ms Chau’s evidence that a copy set of these documents should have been sent to the plaintiff as it was more likely than not that they would have been sent pursuant to the defendant’s standard practice.  If the plaintiff had not read them, that could be because of his awareness of what these standard terms were and hence chose not to spend time on them.  The defendant had also not employed any unfair tactic or that the plaintiff was easily persuaded by the defendant.  Even if the RD Statement was applicable to the plaintiff’s purchase of shares in the FS Fund, I do not think the remaining factors are sufficient to render the terms of the RD Statement that the defendant seek to rely on unconscionable.  I therefore hold that the plaintiff has failed to prove that the contract for service he had with the defendant or part thereof is unconscionable.  Hence, the plaintiff cannot rely on the Unconscionable Contracts Ordinance.

LIABILITY UNDER SECTION 108(1) OF THE SFO

196. The plaintiff’s next attack on the terms of the RD Statement is by relying on section 108(1) of the SFO.

197. By virtue of that section as quoted above, if the defendant should have made any representation, which was false when made and was made without reasonable care having been taken to ensure its accuracy, and such misrepresentations had induced the plaintiff to purchase an interest in a collective scheme (like the FS Fund), the defendant should be liable to pay damages to the plaintiff to cover the loss that the plaintiff had sustained by relying on the misrepresentation.

198. Mr Mok submitted in the opening submissions that the liability under section 108 has nothing to do with the assumption by the defendant of any liability to advise the plaintiff about the merits or suitability of any transaction.  Hence, the RD Statement has not excluded the defendant’s liability under section 108.  I agree.

DUTY OF CARE

199. The plaintiff has also made an alternative claim that the defendant had breached its duty of care to the plaintiff under the common law or as implied by the Supply of Services (Implied Terms) Ordinance, Cap 457. Section 5 of the Ordinance provides:

“5. In a contract for the supply of a service where the supplier is acting in the course of a business, there is an implied term that the supplier will carry out the service with reasonable care and skill.”

200. For the duty of care under common law, Mr Mok relied on a statement made by Mance J in the judgment of Bankers Trust International Plc v PT Dharmala Sakti Sejahtera [1995] 4 Bank LR 381 at 384:

“In short, a bank negotiating and contracting with another party owes in the first instance no duty to explain the nature or effect of the proposed arrangement to that other party. However, if the bank does give an explanation or tender advice, then it owes a duty to give that explanation or tender that advice fully, accurately and properly. How far that duty goes must once again depend on the precise nature of the circumstances and of the explanation or advice which is tendered. (emphasis added)”

201. Mr Mok further referred to NMFM Property v Citibank (No 10) (2002) 186 ALR 442 (Federal Court of Australia) where Lindgren J held at §§400-401:

“[400] While the advisers were not qualified financial planners, they knew that the investors were making important investment decisions. In most cases these decisions were made on the recommendation of the adviser alone. As I have said above, the presentation involved the adviser obtaining detailed financial information from an investor and showing how the package would work for him or her. In those circumstances, I think the advisers held themselves out as having sufficient understanding and experience to be able to advise the investor whether the package was suitable according to the particular investor’s circumstances.

[401]   In sum, although the presentation was in part a ‘sales pitch’, it went beyond that: it was in the nature of serious financial, taxation and investment planning and advice; the advisers intended the investors to receive and understand it in that way; and it was obvious that they were going to do so.”

202. Mr Mok submitted that the presentation of the FS Fund by Ms Yau to the plaintiff was not a mere “sales pitch”.  She made the representations and recommendations to him in the context of serious financial and investment decision-making. Mr Mok further referred to the judgment of Deputy High Court Judge Barma (as he then was) in Susan Field v Barber Asia Ltd, HCA 7119/2000 (17 June 2003) at §155:

“155.   The principle on which liability in tort in respect of advice given, whether by an investment adviser or some other professional, is now quite well established. In general, where a defendant assumes the responsibility of providing advice to a plaintiff, and knows or ought to know that the plaintiff is likely to rely on that advice, a duty of care is likely to arise. Pertinent factors to take into account will also include the relative skill and knowledge of the parties, the context in which the advice is given, whether the giver of the advice is doing so completely gratuitously or is getting a reward, whether in some direct or indirect form, and whether or not there are any express disclaimers of responsibility (which would negative any assumption of responsibility by a defendant).”

203. In the light of the above decisions and analysis, Mr Mok submitted that the defendant owed the plaintiff a duty of care in common law in giving him the advice and recommendations on his purchase of shares in the FS Fund.

204. Mr Jat disagreed.  He submitted that a bank does not generally have a duty to advise its clients (Ellingers Modern Banking Law, 5th ed 154-169).  But I think the argument here is whether the defendant had assumed a duty to advise the plaintiff and whether a duty of care has arisen.

205. I also refer to the statement by Lord Hoffmann in Customs and Excise Commissioner v Barclays Bank Plc quoted above.

206. Mr Jat referred to Springwell and submitted that the factors to consider on whether the defendant had assumed a duty of care are:

(1)   The contractual context;

(2)   What, if anything, did the bank say to the customers;

(3)   The actual role that the bank’s staff played;

(4)   The actual role that the bank’s department played;

(5)   The customer’s financial experience or sophistication;

(6)   The extent of the customer’s reliance on the bank; and

(7)   The regulatory background.

207. Mr Jat further relied on the A/C Opening Documents. However, I have already ruled against him on the RD Statement.  Regarding the Business Conditions, §5.1(b) provides that the defendant may provide advice and recommendations to the plaintiff on dealings in securities.  §9(a) also provides that the defendant may not be immune from liability for negligent advice and recommendations.

208. Mr Jat also tried to adopt Ms Yau’s ludicrous explanation that “introduction”, “advice” and “recommendation” all meant to her as “to introduce”, because her mental language for deliberation was Cantonese and they all meant “to introduce” in Cantonese.

209. This explanation is ludicrous as the three words all have clear equivalents in Cantonese.  “Introduction” has a different meaning from “advice” and “recommendation”.  I do not think Ms Chau, being a highly educated person, would take “introduction” to mean the same as “advice” and “recommendation” whether she was thinking in Cantonese or English. 

210. In any case, whether the defendant had a duty of care to the plaintiff is not a matter to be intended by Ms Yau subjectively.  I would again refer to the judgment of Lord Hoffmann in Customs and Excise Commissioners v Barclays Bank at §35:

“The answer does not depend upon what the defendant intended but, as in the case of contractual liability, upon what would reasonably be inferred from his conduct against the background of all the circumstances of the case.”

211. Mr Jat further submitted that the plaintiff could not have understood the defendant’s role was an adviser to him.  But this submission is contrary to the evidence of Ms Chau and Ms Yau and the defendant’s internal documentation including its Investment Questionnaire and call reports of meetings.

212. Mr Jat also submitted that the defendant was not the plaintiff’s main bank.  But I cannot see the relevance of that to the question of whether the defendant had a duty of care to the plaintiff.

213. Finally, Mr Jat referred to the plaintiff being an experienced investor and had declined to follow the suggestion of Ms Yau and Ms Chau on 28 July 2004.  But that highlights the fact that the plaintiff had followed the defendant’s advice on the other 16 investment decisions.

214. Regarding the duty under section 5 of the Supply of Services (Implied Terms) Ordinance, Mr Mok referred to §5.1(b) of the Business Conditions and submitted that giving investment advice on dealings in securities to clients was part of the defendant’s services to clients.  Hence, the defendant had to provide the service with reasonable care and skill.

215. It is clear that Ms Yau had recommended the FS Fund to the plaintiff in discharge of her role as an Investment Adviser of the defendant. She wished that the plaintiff would take it as a low risk fund that suited his investment needs.  She made the advice and recommendations in a commercial and contractual context and not gratuitously or on a friendly basis.  She also knew that the plaintiff would rely on her advice and recommendations in making his investment decision.

216. The plaintiff may be an experienced investor.  But he did not know the funds that were introduced to him.  He had to rely on the defendant’s advice.

217. Ms Yau wished that the plaintiff would accept and act on her advice to invest in the fund.  She thought that that would produce a “win” “win” situation as the plaintiff’s investment would be enhanced and the defendant would have more business.  In such circumstances, I find that the plaintiff has proved on a balance of probability that the defendant had a duty of care for him, both under the common law and the said ordinance, to act with reasonable care and skill.

ACTIONABLE MISREPRESENTATION OR BREACH OF DUTY OF CARE

218. I have held above that the defendant through Ms Yau and/or Ms Chau had made representations on the FS Fund to the plaintiff on which the plaintiff had relied in purchasing shares of the fund.  I have further held that the defendant cannot defend this claim by contractual estoppel by relying on the terms in the A/C Opening Documents.  I have also held that the terms in the A/C Opening Documents that purport to make the defendant immune from the plaintiff’s claim are exemption clauses that cannot satisfy the requirement of reasonableness in the Control of Exemption Clauses Ordinance and Misrepresentation Ordinance. But they are not unconscionable within the meaning of the Unconscionable Contracts Ordinance.  I have also held that the defendant would be liable to the plaintiff under section 108(1) of the SFO if the plaintiff should have suffered loss by purchasing shares in the FS Fund as a result of relying on the defendant’s misrepresentations on the fund.  Finally, I have held that the defendant had assumed a duty of care both under the common law and the Supply of Services (Implied Terms) Ordinance when giving advice and recommendations on the fund to the plaintiff.

WAS THE DEFENDANT NEGLIGENT IN MAKING THE MISREPRESENTATIONS TO THE PLAINTIFF OR IN DISCHARGE OF THE DUTY OF CARTE

219. The question on whether the defendant should be liable to the plaintiff for the misrepresentations on the FS Fund that it had made through Ms Yau to the plaintiff depends on whether it had done the initial and on-going due diligence on the fund with reasonable care and skill so that it had reasonable grounds to believe and did believe up to the revelation of Mr Madoff’s fraud that the misrepresentations were true. 

220. The defendant has called Mr Friedman to testify what the defendant had done in terms of such due diligence.  Each side has also called an expert witness to opine on whether the defendant has discharged these tasks with reasonable care and skill.  I set forth the evidence of Mr Friedman below.  Regarding the experts, they both have immense experience in working for banks and financial institutions.  I accept their expertise.  I will however deal with the experts’ evidence as part of the analysis and discussion on how well the defendant had fared on this issue.

Evidence of Robert Friedman

221. Mr Friedman was the former Managing Director and Head of a group within the defendant.  The group was known as Global Investment Group (“GIG”).  It had other names at different times.  It was responsible for reviewing on initial and on-going basis the investment products that the defendant had made available for investment by its private banking clients. 

222. As Head of GIG, Mr Friedman was also the Chairman of the Client Investment Committee (“CIC”), a sub-committee of the Risk Management Committee of the defendant’s Board of Directors.  The CIC was responsible for approving new investment products and overseeing their on-going due diligence. 

223. Mr Friedman was also a member of the Product Approval Committee (“PAC”).  That committee was headed by the President of the defendant.

224. Mr Friedman was familiar with the defendant’s due diligence and approval of the investment products of FGG including the FS Fund.

225. Mr Friedman retired in February 2009.

226. The FS Fund was offered by FGG.  FGG had, in accordance with the stated investment policy, established a discretionary account for the FS Fund at BLMIS and had invested at least 95% of the fund’s assets with BLMIS.  It was a well known fund.  In around 2001, the defendant’s private banking clients requested to invest in it, but FGG said that it had no available capacity.  Sometime during the 2nd half of 2002, FGG agreed to provide the defendant with limited capacity of the fund.  GIG then conducted due diligence on the fund by reviewing and evaluating its documents, analysing its performance, meeting with the people from FGG, researching into and assessing on Mr Madoff and BLMIS.

227. GIG in its initial due diligence had reviewed the following documents:

(a)   the Due Diligence Questionnaire dated 17 September 2002 provided by FGG (the “DD Questionnaire”);

(b)   the FS Fund’s directors report and audited financial statements for the year ended 31 December 2001 (“the 2001 Financial Statements”); and

(c)   the FS Fund’s Confidential Private Placement Memorandum dated October 1, 2002 (“the 2002 Placement Memorandum”)

(together called “the Initial Due Diligence Documents”).

228. The DD Questionnaire provided information about the FS Fund and its manager, FGG, including their history, management, strategy and track record.  It stated that the fund was established in 1990 and had US$3.9 billion in assets as of 2002.  The fund employed a “split/strike conversion” strategy and had achieved consistent returns since its inception. The questionnaire also stated that FGG had been in the hedge funds industry since 1983 and, as at 2002, managed more than US$5 billion for over 5,000 investors worldwide. 

229. GIG evaluated the auditing and administration services provided to FGG by third parties.  The DD Questionnaire revealed that PwC audited the FS Fund’s financial statements, Citco Fund Services (Europe) BV (“Citco”) was the fund’s administrator.  Citco Bank Nederland NV (“Citco Bank”) was the fund’s custodian.  Mr Friedman knew from experience that PwC and Citco were large and reputable accounting firm and hedge fund services organisation respectively.

230. GIG’s review of the 2001 Financial Statements did not reveal anything of concern.  GIG relied on an Auditor’s Report by PwC contained in the statements which stated that, in PwC’s opinion, the statements gave a true and fair view of the financial position of the FS Fund as of 31 December 2001 and of the results of its operations and cash flows for that year in accordance with international accounting standards.

231. Regarding the fund’s performance, GIG analyzed the fund’s returns by comparing them against various benchmarks, including the S&P 100, deposit rates and other hedge funds.  It concluded that the fund produced good, but not spectacular annualised returns.

232. GIG staff also interviewed FGG personnel by telephone and in person.  One meeting took place on 18 December 2002 at FGG’s offices (“the December 2002 meeting”).  It was memorialized in a call report.

233. The call report noted that the meeting had addressed, amongst other things, the fund’s investment strategy, administration and control.

234. Financial institutions that invested in the fund were not allowed to visit Mr Madoff for due diligence purposes.  However, large private clients who invested directly with BLMIS were sometimes given access to Mr Madoff.  Mr Friedman knew of a client who had visited Mr Madoff in December 2002.

235. The information GIG obtained in the December 2002 meeting was consistent with and reinforced the information contained in the Initial Due Diligence Documents.

236. GIG did request through FGG a meeting with Mr Madoff as part of the initial due diligence.  However, the request was turned down as Mr Madoff generally would not meet with investors in one of the feeder funds.  Mr Friedman was not surprised by the refusal. He said in his experience, managers of hedge funds who employed proprietary trading models were often quite secretive (to prevent others from copying their strategy).

237. For the research and due diligence on Mr Madoff and BLMIS, GIG relied on the due diligence that FGG purported to perform on them, the then prevailing market information and also GIG’s own research and knowledge of the industry.

238. FGG kept an intense due diligence process on the FS Fund and had complete transparency with BLMIS regarding the fund.

239. BLMIS was founded in 1959 and was regulated by the SEC.  It handled 15% of the volume of listed stocks in the United States.  It had never had any issue with the regulators since inception.

240. The trades of the FS Fund were executed through a brokerage account that FGG opened with Mr Madoff some 13 years prior to the December 2002 meeting.  FGG stated in the DD Questionnaire that in relation to its operational risk, it monitored the daily trades carried out by BLMIS in the fund’s account opened at BLMIS and received copies of the trading tickets.  It saw all the trades on a daily basis.  It also retained an ex-option trader as an independent consultant to check every month the execution prices of each trade.  It had full transparency on a daily basis to the holdings level data in the portfolio.  It could verify adherence to the trading style and ensure that “puts” are in place to protect the portfolio’s downside.  Its accounting and control function monitored all cash flows related to the fund.  It had never had any issue with Mr Madoff since they started the relationship.

241. One issue that could arise with BLMIS was that there was no third party broker for execution.  Hence, FGG employed the ex-options trader to check execution prices.

242. Citco was the administrator of the FS Fund.  Citco received the same information as FGG received from Mr Madoff.  Citco reconciled with the prime broker and produced an independently calculated monthly net asset value.  

243. These statements in the Due Diligence Questionnaire were consistent with what GIG learned in the December 2002 meeting with FGG personnel. Mr Friedman was not aware of anyone who had doubted the truthfulness of these statements.

244. FGG had an excellent reputation in the hedge funds industry.  GIG relied on FGG’s due diligence on Mr Madoff and BLMIS.  It was common practice to rely on third parties for due diligence, in whole or part.

245. GIG, after reviewing the available market information, did not consider that there was any issues with Mr Madoff or BLMIS for the following reasons:

(a)    First, Mr Madoff had an excellent reputation.  He had been a key figure in the growth of the NASDAQ stock market and a prominent figure in the securities industry.  A press release by the SEC in December 2008 noted that he had served as vice chairman of NASD (the predecessor institution to the FINRA), a member of its board of governors, and chairman of its New York region.  He was also a member of NASDAQ Stock Market’s board of governors and its executive committee and served as chairman of its trading committee.

(b)    Second, BLMIS, as a regulated broker-dealer, was subject to regular on-site examinations by the NASD (and later FINRA).  Mr Friedman believed that GIG was aware that the SEC had investigated Mr Madoff’s operations in 1992 and found nothing amiss.

(c)     Third, GIG was also aware that a division of Tremont Capital Group (“Tremont”) had significant investments with BLMIS through its own feeder fund.  Tremont had a good reputation in the industry and was known for its rigorous due diligence processes.  The defendant’s affiliate American Express Financial Advisors (now Ameriprise) had hired Tremont to conduct due diligence of hedge funds and got help from Tremont to develop the defendant’s fund-of-fund business throughout 2001-2003.  During that time that GIG worked with Tremont on other investments, GIG had high regard of Tremont’s operations and personnel.

(d)    Fourth, and finally, GIG took comfort in the involvement of reputable independent third-parties at all levels of investments with Mr Madoff. In addition to the oversight provided by FGG, the FS Fund was audited yearly by PwC, and received administrative and custodial services from Citco.  PwC would have verified the assets of the fund and Citco Bank would have verified that BLMIS was maintaining the fund’s assets as a proper sub-custodian.

246. Regarding Mr Madoff’s use of the brokerage arm of BLMIS to execute trades on behalf of the FS Fund, it was not uncommon for an investment manager to also provide custodial and trade execution services, either directly or through an affiliate, especially when the investment manager was itself a broker-dealer like BLMIS, which was a large, reputable, registered and regulated broker-dealer. (BLMIS was at all times a broker-dealer registered with the SEC as well as the industry’s regulatory bodies, i.e., NASD (later renamed FINRA), and the New York Stock Exchange).  GIG thus did not find it unusual that the FS Fund would maintain a managed brokerage account with BLMIS or that BLMIS would provide sub-custodial and trade-execution services for this account.  Furthermore, FGG also had an experienced option trader, Mr Amit Vijayvergiya (“Mr Amit”) to independently confirm execution prices and positions on a monthly basis.  FGG’s independent third-party administrator, Citco, received the same trade and portfolio information from Mr Madoff as FGG and did not find any issues.

247. GIG in the initial due diligence review also uncovered two news articles questioning Mr Madoff’s underlying strategy and returns:

(a)    “Mr Madoff Tops Charts; Skeptics Ask How”, MarHedge, May 2001 (“MarHedge Article”); and

(b)    “Don’t Ask, Don’t Tell”, Barron’s Online, May 7, 2001 (“Barron’s Article”).

248. GIG did not find the articles troubling at the time. They questioned how BLMIS had produced the returns, noting that others had been unable to replicate the success of the “split/strike conversion strategy”. However, there was no suggestion that BLMIS was engaged in any fraud.  Neither article questioned the legitimacy of Mr Madoff’s returns.  In addition, the articles indicated that Tremont also had a feeder fund with Mr Madoff.

249. GIG never suspected that the FS Fund’s returns were fraudulent, but was of the view that the returns seemed reasonable and plausible. For example, the MarHedge Article stated that “among 423 funds reporting returns over the last five years … [the FS Fund] would be ranked at 240 on an absolute return basis and come in number 10 if measured by risk-adjusted return as defined by its Sharpe ratio”.  Even compared to a smaller 41-fund database over a shorter period to time, the fund was only the third-best standard deviation in returns.  Thus, whilst the returns of the fund were solid, and in some respects excellent, they were not so outstanding that it was perceived to be an outlier at any time.

250. The MarHedge Article also raised questions about the fees and structure of the FS Fund.  FGG earned the management and performance fees while Mr Madoff earned only brokerage commissions.  GIG, however, did not consider this to be indicative of fraud.  The article made it clear that the brokerage commissions were very lucrative, and GIG was told that they amounted to 1.5% of net assets that Mr Madoff managed — a figure in line with the management fees charged by many hedge funds.  Moreover, Mr Madoff was a successful industry professional in addition to managing money for his brokerage clients.  He served on various boards and advisory committees.  It seemed reasonable to GIG that he truly did not want to be bothered with the collateral issues associated with the marketing of a hedge fund, which would be both costly and time consuming, and therefore outsourced those functions to entities like FGG.

251. For the above reasons, GIG was comfortable with the FS Fund as an investment product.

252. The FS Fund was then launched as part of a Concentrated Elite Fund of the defendant in 2003.

253. FGG later notified the defendant of the availability of another US$50 million capacity of the fund.  GIG then requested approval from the CIC to offer it directly to the defendant’s clients.  CIC Memorandum dated 23 September 2003 was produced which outlined the annual returns of the fund and its assets.  The defendant then at a CIC meeting on 30 October 2003 allowed its clients to invest in the fund directly.

254. Regarding ongoing monitoring, GIG, from the approval of the FS Fund in 2003 until 2008, had conducted ongoing due diligence on the fund in accordance with its formal due diligence policies.  GIG constantly:

(a)    monitored the fund’s performance and analysed its risks and returns;

(b)    maintained regular contact and communication with FGG; and

(c)     provided written reports to the CIC on a quarterly basis.

255. GIG monitored the performance of the FS Fund on a weekly and monthly basis.  It received from FGG data relating to the fund’s performance and risk.  It also created and/or reviewed and analysed on a regular basis:

(a)   weekly and monthly NAV reports, which showed weekly and monthly NAV figures and monthly and annual percentage returns;

(b)   monthly fact sheets, which showed monthly returns for the fund over a 15-year period; a comparison of returns and volatility against various benchmarks; and other performance metrics;

(c)   monthly analyses of the Concentrated Elite Fund, which included details of the market conditions and performance of the fund;

(d)   monthly reports from independent RiskMetrics Group analysing the fund’s holdings by exposure, sensitivities, stress and Value at Risk (“VaR”) across four different cross-sections, namely, the type of security, currency, credit rating and industry sector.  VaR is a widely used statistical measure of the risk of loss on a portfolio.

(e)   monthly risk reviews from FGG highlighting the fund’s performance and recent returns and depicting its volatility and VaR in charts and graphs;

(f)    monthly strategy reviews from FGG discussing the performance and investment positions of the fund;

(g)   semi-annual updates from FGG explaining how the strategy was implemented over that period;

(h)   annual audited financial statements of the fund;

(i)    FGG presentations; and

(j)    updated DD Questionnaires from time to time.

256. Mr Friedman also produced samples of the above-mentioned documents.

257. The defendant also generated its own standardised reports on the performance of the fund in relation to numerous measures (known as “PerTrac” reports), including monthly correlation analysis of the fund against indices such as the NASDAQ Composite US dollar Index.

258. GIG’s ongoing review of the performance and risk analysis of the fund did not reveal anything of concern.  The returns were consistent with what was expected of such a fund in the light of the market conditions and when compared with similar funds and the relevant market indices.

259. GIG also monitored the operations and risk of the fund through contact and communication between its personnel and FGG employees (including Mr Amit, FGG’s risk management officer).

260. Around a year after the defendant had offered the fund to its clients on a direct basis, Mr Sam Perruchoud of the defendant attended a meeting on 17 December 2004 with Philip Toub and Mr Amit of FGG to conduct follow-up due diligence.  The meeting was recorded in a Due Diligence Call Report.

261. The purpose of the meeting was to assess any change in the risk oversight performed by FGG on BLMIS and Mr Madoff.  Mr Perruchoud used a standard due diligence questionnaire to review the performance and implementation of the strategy of the fund, the assets, the portfolio held and any change in risk management.  The meeting also discussed the monitoring that FGG said it had conducted on the fund as well as Mr Madoff’s relations with regulators (including the SEC). FGG again assured the defendant that Mr Madoff had good relations with regulators and that no problem had arisen or was expected.  Mr Perruchoud also noted that the fund’s performance was lower than its past performance, and explained that this was due to the increased time required to implement the split/strike strategy and the volume of assets involved.

262. Mr Friedman read the call report shortly after its preparation and thought that nothing was out of the ordinary and that the fund’s lower performance was consistent with his understanding of how the strategy, worked, and GIG had no reason to doubt FGG’s explanation in that regard.

263. In August 2007, there was turbulence in the market with the start of the credit crisis.  On 2 August 2007, GIG participated in a conference call with Mr Amit and was informed that the fund was wholly invested in US Treasury bills.

264. In September 2008, in response to client concerns over the turmoil in the credit default swap (“CDS”) market, GIG asked FGG: (1) whether the over-the-counter (“OTC”) options in the split/strike conversion strategy were being properly valued given the turmoil in CDS markets and whether the fund had counterparty risk in its options trading; (2) what positions were held by the fund at that time; and (3) whether the fund was comfortable with its arrangement with BLMIS given the stress on broker-dealers like BLMIS at that time. 

265. FGG responded that the split/strike conversion strategy was not implemented, so the assets of the fund were in short-dated US Treasury bills. FGG also assured GIG that it had assessed the creditworthiness of each counterparty and the fund’s options trading was sufficiently diversified.  FGG further said that it believed BLMIS continued to operate as a viable going concern.  As an added precaution, FGG established dedicated accounts at BLMIS which contained the assets of the fund’s split/strike conversion strategy (the majority of which was cash).  The accounts were segregated from other accounts at BLMIS and could not be borrowed against nor lent out.  They were thus protected from unforeseen financial difficulties including the CDS crisis.

266. As part of their ongoing monitoring of the fund, GIG personnel often had scheduled calls or meetings with FGG for general status updates in preparation for quarterly CIC meetings, including in 2006 which was long before the onset of the credit crisis in August 2007. 

267. Despite Mr Madoff had rarely met with investors, the defendant continued to request meetings with him once every six months.  In April 2008, he agreed to meet the representatives of the defendant.  Arrangements were then made for three members of GIG including Mr Friedman to meet him.  In preparation for the meeting, a GIG employee Mr Haindl had called Mr Amit and two other employees of FGG and considered what issues to raise with Mr Madoff.  GIG also reviewed the fund’s most recent risk report and its latest DD Questionnaire and drafted a list of questions to be raised with Mr Madoff, predominantly related to the fund’s strategy, risk, and oversight.

268. The meeting was on 15 April 2008.  It took placed after the markets had closed and lasted for more than one and a half hours.  The trading floors were no longer occupied at that time.  The three main topics discussed were the split/strike conversion strategy, Mr Madoff’s market timing, and BLMIS’s order flow.

269. After the meeting, GIG conducted follow-up analysis with Mr Amit.  GIG asked for a description of the implementation of the split/strike conversion strategy over the prior two years and an explanation for the difference in overall annual results for the years 2006 and 2007.  Mr Amit provided a detailed account of the fund’s activity in 2006 and 2007, noting that the market was favourable for the strategy in 2006 as compared to 2007.  Mr Amit further explained that Mr Madoff was often not able to fully implement the strategy because of market conditions, especially in the unpredictable markets of 2007.

270. GIG did not suspect anything was amiss before the meeting with Mr Madoff.  Nothing about the meeting or the follow-up with Mr Amit aroused any suspicions either.

271. Mr Friedman is a straight forward witness.  His evidence is reasonable.  He also answered questions directly and frankly.  He is a truthful witness.  I accept his evidence.

The plaintiff’s arguments

272. Mr Mok devoted the whole of his closing submissions on this issue.  He summarized his essential complaints in §15 of the closing submissions as follows:

“15. It is the plaintiff’s case that:

(1) the defendant was aware that BLMIS was the investment manager for the fund, the executing broker that traded as principal against the fund and the sub-custodian of the fund.

(2) the defendant was aware that Mr Madoff was pulling the strings at FSL and was behind the strategy.

(3) the defendant was aware that financial institutions which invested through feeder funds with BLMIS were not allowed to have access to Mr Madoff for the purpose of due diligence.

(4) the defendant itself had requested to meet Mr Madoff on numerous occasions so that they could conduct due diligence.

(5) the defendant was aware that the fund’s strategy was purportedly implemented by Mr Madoff, which was supposed to be responsible for the profitability of the fund. Yet the performance fees went to FGG and in contrast BLMIS would only get brokerage fees.

(6) the defendant was aware that there were people in the industry who were raising serious questions on the consistently low volatility returns of the fund, meaning no down year in the whole history of the fund and only a handful of insignificant losses in a few months, and that these concerns were repeated or reported in reputable publications such as MarHedge and Barron’s.

(7) the defendant’s own policy was that fraud and theft risk should be assessed individually as a risk category. Even though the 2000 policy document [E20/5121] appears to have been superseded, the fraud/theft risk as a category of risk had not been eliminated. Indeed it would be strange in the extreme if it had.

(8) the defendant was aware that the fund was a single manager fund and therefore the risks associated with the integrity of the manager were particularly crucial.

(9)    the defendant when approving the fund to be included in the concentrated fund of funds, expressly stated that they would conduct due diligence to reduce such risks.”

273. Mr Mok then submitted that despite the above, the defendant did nothing to address these risks.  It just relied on (1) the representations of FGG, (2) the fact that Citco Bank was the custodian and (3) PoW being the auditors of the fund’s accounts.  Furthermore, the defendant’s reliance on the representations by FGG or Citco/Citco Bank did not constitute due diligence as the information relied upon by them in making the representations ultimately came from BLMIS.

The crux of the matter

274. Mr Mok then submitted on the defendant’s alleged deficiencies under no less than thirty sub-headings.  He made a lot of criticisms against the defendant for not taking a thorough examination of the operation of BLMIS.  He also criticized the defendant for not taking any step to ensure or find out if there were independent checks to ensure that BLMIS was properly run with internal controls and segregation of duties to prevent fraud and theft. 

275. I agree that the defendant’s due diligence on the fund should have covered many aspects to find out if the fund was good enough to be marketed to its own clients.  However, this case is not on the adequacy of due diligence on the fund in general.  Furthermore, the plaintiff’s loss was not caused by the problematic operation or lack of internal control or segregation of duties in BLMIS.  The plaintiff suffered loss because the fund was not genuine but a fraudulent Ponzi scheme.

276. The question is therefore a narrow one of whether the defendant was negligent in not discovering the Ponzi scheme.  The standard to apply should be the industry standard prevailing at the material time which was before Mr Madoff’s fraud was revealed.  It is not a question of whether the defendant had done enough due diligence to ensure that BLMIS was operated properly as a broker-dealer or that there was no risk of fraud or theft by some member of staff within BLMIS.

277. Mr Mok has repeated his criticisms under the many sub-headings.  I have reorganize them and dealt with them under slightly different sub-headings as per below.

The defendant’s due diligence team

278. Mr Mok submitted that Mr Friedman did not know much about the due diligence done by the defendant on the fund as he was merely reading e-mails sent or copied to him whilst the due diligence was done by the team led by Mr Perruchoud in Switzerland.  He also criticised the defendant’s due diligence team for not having people trained to perform due diligence and not appeared to have due diligence experience. 

279. I do not agree with Mr Mok on this.  Though Mr Friedman is the only witness testifying on the due diligence conducted by the defendant, the defendant has produced a lot of documentary evidence on the due diligence that it had conducted on the fund.  I should not just consider what Mr Friedman had read, but what exactly the defendant had done.  For that purpose, I should look at all the evidence on due diligence.

280. Regarding the plaintiff’s argument that the defendant’s due diligence team as led by Mr Perruchoud did not appear to have sufficient training or qualification to conduct due diligence, I agree that that may affect the quality of the defendant’s due diligence on the fund, but again the question should be what and how the due diligence was done rather than the training or qualification of those who did it.

The defendant was under pressure to sell the fund

281. Mr Mok said that Mr Friedman was under pressure to approve the fund as it was selling like hot cakes and clients of the defendant wanted to buy it.  But the evidence rather appeared to show that Mr Friedman was only prepared to approve the distribution of the fund after a satisfactory due diligence was performed and due approval given to the fund. 

Due diligence mainly on the profitability of the fund

282. Mr Mok then submitted that the defendant had attributed almost all the time for due diligence on measurement of the financial performance of the fund and not whether there was a risk of fraud or theft.  He further said that Mr Friedman had even denied that there was a policy in the defendant to individually assess fraud and theft as a risk category.

283. I agree that the defendant had spent a lot of time to measure the financial performance of the fund.  That is one of the main considerations on whether the fund should be marketed to its clients.  However, the question remains whether the defendant was negligent in not discovering the fact that the fund was merely a Ponzi scheme. 

Reliance on the financial statements audited by PoW

284. Regarding the financial statements audited by PoW, Mr Mok submitted that the defendant did not know how the audit was conducted and on what information it was based.  The audited statements just showed a snapshot of the fund at the year-end and did not assist the defendant in assessing whether there were checks and balances to prevent unlawful activities from happening after the snapshot.

285. However, I do not think this point is factually correct. Mr Friedman did repeatedly say that he was aware how auditors work and explained how they worked (day 5, p 35 line 8 – p 36 line 22, p 105 lines 3-13, p 126 line 7 – p 128 line 22 and day 6, p 103 line 24 – p 104 line 7).

286. Mr Friedman also rightly explained that though financial statements do not deal with forward-looking information generally, they always show how things are on a particular date and summarize what happened over the year. They would also say where are the assets which they have tested (day 6, p 104 lines 8-24).

287. Furthermore, PoW also stated at the beginning of the audited financial statements of the fund of how they had conducted their audit and their opinion on the financial statements: 

“Scope

We conducted our audit in accordance with international standards on auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

Opinion

In our opinion the financial statements give a true and fair view of the financial position of the [fund] as of December 31, 2001 and of the results of its operations and its cash flows for the year then ended in accordance with international accounting standards.” 

[B2/34 – 1/416 and E8/237/2220]

288. In the premises, I hold that the defendant was entitled to rely on the financial statements audited by PoW in its initial and on-going due diligence on the fund.

No due diligence on why there was low volatility and good returns

289. Mr Mok then criticized the defendant that it had not in the due diligence considered why the fund was consistently of low volatility and had been able to produce good returns.

290. Mr Jat in response pointed out that this is not a fair or correct view of the evidence.  Mr Friedman’s evidence in fact showed that there was an article in the press that did an analysis of a generalized options strategy of the kind employed by the fund.  It concluded that such strategy could add value to an investment.  The defendant had also been assured by FGG that the trades done by the fund, which had all been passed to FGG, showed that the fund was operating purely on the split/strike strategy and the trades could account for all the returns.  In 2004, FGG also showed Mr Perruchoud a series of trades for a month and showed how the returns were calculated.  Mr Amit had also showed Mr Haindl in a meeting all the trades and how the strategy worked (day 5, p 137 line 13 – p 140 line 14) (though we now know that all the trades were falsified by Mr Madoff).

291. Mr Friedman further said that there were certain managers in the industry who had performed extraordinarily well for an extraordinarily lone period.  These managers attracted investment money and most of them turned out to be honest (day 5, p 44 line 22 – p 46 line 19).

292. I therefore accept that the defendant has properly considered why the fund was of low vitality and had produced good results for the above reasons in particular that the defendant had considered the actual trades of the fund though the trade tickets were in fact fake ones.

Internal controls of BLMIS

293. On due diligence of the internal controls of BLMIS, Mr Jat also pointed out that there was never any issue that BLMIS did not have internal controls.  Mr Friedman has given evidence of normal segregation of duties within BLMIS.  The asset management team sat one floor above the trading floor (day 6, p 114 lines 4-19).  Segregation of duties was also a matter regulated by SEC (Porten’s report at C2/36/1065/§57).

294. Both experts also said that the Ponzi scheme could have been operated because of the collusion or conspiracy of Mr Madoff, his brother and a number of other persons within BLMIS and not because of the lack of internal controls in BLMIS (day 6, p 107 lines 1-11 and day 7, p 100 line 14 to p 101 line 16). 

No yearly on-site visit of Mr Madoff/BLMIS

295. Mr Mok also submitted that despite the defendant’s acceptance that FGG was only the “official manager” and BLMIS the actual manager of the fund, it did not conduct the essential yearly on-site visit of BLMIS, because Mr Madoff would not give them access.  It had to live with this if it wanted to sell the fund.  Mr Madoff maintained extreme secrecy to his operation and the defendant thus accepted such secrecy. 

296. However, I note the fact that FGG was getting all the trade tickets and Citco also received the same trading information from BLMIS. Hence, there was no secrecy but an apparent transparency of the trades (though we now know that they are fictitious) to FGG and Citco.  If Mr Madoff had kept his (supposed) operation in secret, that at least did not appear to extend to the (supposed) full and complete trading information it had given to FGG and Citco.  Mr Madoff had fooled FGG and Citco into believing that the trading activities were genuine.  There is however nothing to suggest that they knew or had reason to suspect at the time that these activities were not genuine.  There was also no reason for the defendant to doubt the verification of the trades by them.

297. Regarding site visit of BLMIS, the evidence does say that large private clients who invested directly with BLMIS and not in one of its feeder funds were sometimes given access to Mr Madoff.

298. Furthermore, Mr Madoff did agree to meet with the defendant on 15 April 2008.  The defendant had made preparation for the meeting by communicating with FGG and considered what issues to raise with Mr Madoff.  Mr Friedman was one of the three staff members of the defendant who went to the meeting. They discussed with Mr Madoff on the split/strike strategy, Mr Madoff’s market timing and BLMIS’s order flow.  The defendant’s GIG did not suspect anything was amiss before the meeting.  Nothing in the follow up of the meeting aroused any suspicion either.  There is also nothing to suggest that the lack of any on-site visit to Mr Madoff/BLMIS prior to 15 April 2008 had contributed to the defendant’s failure to discover Mr Madoff’s fraud.

FGG and Citco received the same trade information from BLMIS

299. Mr Mok also said that Citco received the same information as FGG which also came from Mr Madoff/BLMIS.  He thus submitted that Citco’s involvement did not provide additional safeguard as it had no independent source of information or means to verify the information.  He then criticized the defendant for deferring entirely to Citco and did not undertake independent checks into BLMIS. 

300. However, I am of the view that this criticism is based on misinterpretation of the evidence.  Citco was the independent third party administrator of the fund.  It was not the custodian.  It received from BLMIS the same trade and portfolio information as FGG.  Based on such information (which we now know were fictitious), it carried out reconciliation with the prime broker and calculated the monthly net asset value.  Its task was not to detect whether the trade and portfolio information was fictitious.  It is therefore incorrect to say that the defendant should conduct independent checks on BLMIS because Citco did not do so.  Furthermore, there is no suggestion that Citco had failed in its verification or that such failure had led to the plaintiff’s loss.  The evidence suggests that the fictitious trade information had fooled Mr Amit of FGG and Citco who did not find any problem with it.

301. Mr Mok later submitted under the heading of “Citco” that the defendant accepted at face value that the transactions were genuine simply because they were provided by BLMIS, a reputable broker but without verification by Citco.  However, I reiterate again that it was not the task of Citco to verify whether the trade information was fictitious.  This criticism is not based on proper grounds.

Mr Amit

302. Mr Mok submitted that there was limited value in Mr Amit’s verification of trade prices as that could not verify if the trades were real.  I agree with this, because the purpose of Mr Amit’s verification was not to test whether the trades were real or fictitious but whether the trade prices were in line with the market.  Hence, this criticism of the verification is misplaced as it is based on a misinterpretation of the evidence.

303. Mr Mok also raised in closing submissions that there was no due diligence on Mr Amit.  But, as Mr Jat rightly responded, the plaintiff had never raised this issue at the trial and there was no dispute on what Mr Amit had done.  The plaintiff therefore cannot raise this issue in the closing submissions.

Due diligence on Citco Bank’s custodianship and self-custody by BLMIS

304. Mr Mok criticized the defendant under “self-custody” for not considering the custodian agreement between FGG and Citco Bank and just took comfort in its knowledge of what a standard custodian agreement should be. Mr Mok regarded it nonsensical for the defendant to have assumed that Citco Bank’s agreement was a standard one.  

305. I am however of the view that Mr Mok’s criticisms overlooked the fact that the plaintiff’s loss was not occasioned by any problem in the terms of Citco Bank’s custodian agreement.  I see no reason why the Ponzi scheme could have been discovered if the defendant should have asked for a copy of this agreement and studied it.

306. Mr Mok also submitted that the defendant did not know what supervision Citco Bank had to exercise over the assets of the fund that were kept by BLMIS.  Hence, he submitted that the defendant had failed to conduct due diligence on FSL or the fund before or after August 2005 when the fund was recommended to the plaintiff.

307. I would refer to the evidence of Mr Friedman that Citco Bank as the custodian of the fund’s assets had the duty to supervise BLMIS, the sub-custodian to ensure that the assets held by the custodian were there (day 5, p 37 lines 9-20). 

308. Citco Bank had also acknowledged in the 2004 edition of the Placement Memorandum that:

“Sub-custodians may be appointed by Citco (Bank) provided that Citco (Bank) shall exercise reasonable skill, care and diligence in the selection of a suitable sub-custodian and shall be responsible to the (fund) for the duration of the sub-custody agreement for satisfying itself as to the ongoing suitability of the sub-custodians to provide custodial services to the (fund). Citco (Bank) will also maintain an appropriate level of supervision over the sub-custodians and will make appropriate inquiries periodically to confirm that the obligations of the sub-custodians continue to be competently discharged.” (E(8)/237/2173)

309. In the light of the obligations as acknowledged by Citco Bank, this submission of the plaintiff has no merit. 

Due diligence on BLMIS as the investment manager, execution broker and custodian

310. Mr Mok said the defendant knew that Mr Madoff/BLMIS was the investment manager, execution broker and custodian.  When hedge fund managers traded through affiliated brokers, fraud was possible.  The defendant recognized this as a risk of fraud, but did nothing about it.   

311. Mr Mok also referred to BLMIS’s position as the sub-custodian of 95% of the fund’s assets.  He submitted that this had compounded the risk of theft.  However, I have already dealt with above the supervision by Citco Bank on BLMIS as the sub-custodian.

312. Regarding the arrangement of fund managers trading through affiliated brokers, Mr Friedman’s evidence showed that such was not rare or unacceptable in the industry.  Even after Mr Madoff’s fraud was exposed, about 20% of the hedge funds still had such arrangements.  In such situations, the defendant relied heavily on the auditors and custodians (day 5, P 110 line 9 – p 111 line 20).

313. I also note that the SEC was aware of such arrangement, but for practical reasons did not amend the rules to require the use of independent custodians (C(6)/105/2059 middle column).

314. Regarding the submission that the defendant recognized this as a risk of a Ponzi fraud, Mr Jat responded that this was not a correct characterization of the evidence.  I agree with Mr Jat that the risk recognized by the defendant was the mis-prizing of the stock trades or option trades undertaken by BLMIS in the capacities of fund manager and executing broker but not a risk of Ponzi fraud. Mr Mok was aware of this when he cross-examined Mr Friedman on this issue.  Mr Friedman made this stance clear when he referred to FGG’s employment of the ex-option trader Mr Amit to check the execution prices to allay the mis-prizing concern (day 5, p 150 line 7 – p 151 line 19). 

315. Furthermore, the trades and assets information of the fund from BLMIS were also supposed to have been verified independently by the auditors PoW and the custodian Citco Bank.  Furthermore, there was supervision of BLMIS by FINRA and SEC.  Both expert witnesses also agreed that custody was a matter that SEC would supervise (Porten’s report at C2/36/1065/§57, footnote 98 and day 7, p 104 line 14 – p 105 line 25).  I will also consider this supervision below.

316. In the premises, I find that before the revelation of Mr Madoff’s fraud, the industry regarded it acceptable for fund managers to trade through affiliated brokers.  The SEC still accepted such arrangement after the fraud was revealed.  I also find that the defendant was entitled to rely on the work of the auditors and custodian to minimize the risk of fraud.

Supervision of BLMIS by FINRA and SEC

317. Mr Mok also attacked the defendant for having relied on the supervision of BLMIS by FINRA and SEC, the regulators and authorities on the custody of assets kept by BLMIS.  The position of the defendant on this matter has been summarized by the question and answer between the court and Mr Porten, the defendant’s expert witness:

“Court: Mr Porten, let me try and see whether I understand you correctly. Since custody of assets in such an important and obvious issue, if a broker/dealer is regulated by some public bodies or government bodies, I think commonsense dictates that you can assume that custody is the thing, or one of the important things, that they would have supervised and scrutinized. So once you know that that broker/dealer is a regulated broker/dealer, then you can rest assured that custody should not be a problem. You don’t even need to ask. You can safely assume that to be the case, because this is such an important thing and such an obvious thing that any regulatory body should consider, should scrutinize. Is that the gist or effect of what you are telling me on this?

Porten.  Precisely, …”

318. Mr Mok criticised the defendant that it did not know what part of BLMIS’s broker-dealer business or how its business operation was supervised by FINRA, but just assumed that FINRA would exercise some oversight that BLMIS as a broker-dealer would not abscond with the client’s funds.  He further submitted that as far as it was necessary to assess fraud or theft risk or what action to take to minimize such risk, the defendant had no basis to rely on the action of FINRA or SEC as sufficient due diligence for itself.  He also submitted that the defendant only learnt afterwards of the limitation in SEC’s jurisdiction in that SEC would not look at the matter of custody to see whether or not the custody risk had been properly assessed by relevant internal controls.

319. Mr Jat however pointed out that this submission embodied a fallacy.  The SEC indeed had no requirement for the broker-dealers to obtain an “Internal Control Report” on internal control risks that could arise in situations of “related person” or “affiliated” custody arrangement.  Such situations were those where broker-dealers and investment advisers also served as qualified custodians. The SEC later introduced a requirement to address to such custodial risks.  Dealer-brokers and investment advisers then have the obligation to obtain from the related or affiliated person “an annual internal control report” containing an opinion from an independent public accountant with regard to the related person’s custody controls.  The SEC described this new requirement as an “important additional safeguard for client assets maintained with the adviser or a related person”.  The introduction of the new measure should not be taken to mean that before the measure was introduced, the SEC had no jurisdiction to see if the risk concerning custody had been properly assessed (C(6)/105/2509 - in particular the 3rd column - to 2510). 

320. I also repeat my reference to the evidence of the experts that the SEC had supervised broker-dealers on custody of client’s assets (C2/36/1065/§57 and day 7, p 104 line 14 – p 105 line 25). 

321. In the premises, I find that there was nothing wrong for the defendant to have relied on the supervision by FINRA and SEC on BLMIS including the matter of custody of client’s assets.

Due diligence and professional work by third parties

322. Mr Mok then referred to the defendant’s reliance on the due diligence of the internal controls of BLMIS by third parties.  He submitted that such attitude was plainly unsatisfactory as internal controls had many different facets and the defendant could not rely on third party representations as being reflective of the full picture.  He further submitted that the 3rd parties all relied on BLMIS as the source of information.  There was also no real independent verification of the information from BLMIS as PoW and Citco (Bank) merely took the information from BLMIS and then gave it a clean bill of health without verifying the information with an independent source.

323. Mr Mok further referred to a dialogue between him and the defendant’s expert Mr Porten and submitted that the defendant had blindly relied on the representations of third parties and did not seek to understand even by a simple enquiry on what exactly a third party like Citco Bank had done to supervise the existence of the fund.  The dialogue is:

“Q.  So in effect, what you’re saying is that the bank really didn’t need to do anything, if Citco said in one sentence, “I will exercise supervision”; the bank is happy.  If FGG says, “I have obtained information from Madoff”, the bank is happy.  And Citco says, “I’ve obtained information from Fairfield who in turn got information from Madoff”, the bank is happy. That is the standard of due diligence which the bank exercised.  Is that what you’re telling his Lordship? that’s due diligence?

A. The standard of due diligence states you can accept representations made by third parties if you’re comfortable that they are competent to do what they’ve represented they do.  Investors receive annual reports of a company. They receive annual reports of a fund.  Representations are made in those reports.  Investors rely on them all the time.  They couldn’t begin to do their job if they had to replicate and verify that the third parties, be they the custodians or the auditors, know how to do their job.  You accept that on its face.

Q. Mr Porten --

A. And that’s adequate due diligence, that’s appropriate due diligence.

Q.    Mr Porten, I’m not suggesting that the bank should replicate what was done by Citco.  All I’m asking is whether or not it would be part of the due diligence to understand what exactly did Citco do by way of exercising their supervision or by way of making inquiry on the periodic basis, and in particular whether or not they did or they did not check with an independent third party as to the existence or otherwise of the assets of the fund.  It was a simple question, a simple line of inquiry. Do you agree?

A. And my answer is “no”, for the reasons I’ve cited before.  And in my experience, I don’t recall a single incident where a client wanted to know exactly how the custodian was doing its job.  It accepted the representation of the custodian.” (day 8, p 88 line 25 – p 90 line12)

324. These submissions in effect asserted that PoW and Citco Bank did not do what they had professed to do and were supposed to have done.

325. PoW has stated in the financial statements of the fund that they planned and performed the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The audit also included examination on a test basis of evidence supporting the amounts and disclosures in the financial statements.  If PoW was to achieve that, it could not have just relied on information from BLMIS which would be self-serving. 

326. Regarding Citco Bank, I have referred to above what it had acknowledged in the Placement Memorandum that it would do in supervising BLMIS.  Mr Friedman has also said that it should have supervised BLMIS and to ensure that the assets held by it as the sub-custodian were there.  But Mr Friedman has also said that Citco Bank, as the primary custodian, had probably failed to do the testing and check at the independent source like going to the DTC to check the records.

327. I cannot tell whether PoW and Citco Bank had merely accepted the information from BLMIS without verifying it with an independent source. But if both of them had failed to do what they had professed to, there is no evidence to suggest that the defendant was aware of their failures.  In any case, there is no reason to suppose that the defendant would have been aware or expected of their infractions, if any.  The defendant should have been entitled to assume that both of them, being professionals, would have carried out their duties properly and to have verified the information from BLMIS with an independent source.

328. Mr Jat also submitted in his closing submissions that auditors were given full co-operation by their clients, otherwise their accounts might be qualified.  For custodians, they had access to the ultimate sources of information like the relevant account with the DTC (Depository Trust Company in New York) where the securities were deposited.  However, an investor did not have these capabilities.  The investor had to rely on confirmations from the auditors and professional custodians.

329. Mr Porten also gave evidence that a professional could rely on the research and due diligence of a fellow professional.  He referred to the 1999 edition of the Standards of Practice of Chartered Financial Analysts (CFAs).  Standard IV (A.1) requires the CFA to have a reasonable and adequate basis, supported by appropriate research and investigation, for his investment recommendations or investment actions.  The Standards Handbook provides that the nature of the due diligence and the thoroughness of the research and investigation required by the standard will be dictated by the relationship of the CFA and the client and other circumstances of the case.  The handbook further provides that a CFA can comply with this standard if he makes the recommendation or action on the basis of the research of his firm or that of another party who exercised diligence and thoroughness in arriving at a decision (C(6)/2200). 

330. Mr Jat also referred to Seymour v Ockwell [2005] PNLR 758 at 791 where HH Judge Havelock-Allan, QC referred to Rule 28.3 of the Financial Intermediaries and Brokers Regulatory Association (FIMBRA) of the United Kingdom. Though the recognition of FIMBRA was revoked by the Securities and Investments Board Ltd in June 1994, these rules were adopted in Ch 12 of the Rulebook of the Personal Investment Authority.  Rule F 28.3(1) and (2) of the rulebook provide:

“F28.3 Good Communication

1. You must ensure that anything you say or write to another person in the course of your business, and any document you give or send him, is clear, fair and not misleading.

2. Where you give or send to a client

a. a projection relating to a packaged product, or

b. product particulars

which have been produced by another authorised person, you are entitled to assume that the requirements of (1) above have been met.”

331. Mr Jat also referred to the Corporate Finance Adviser Code of Conduct issued by the SFC of HK in April 2003.  §5.5 of the code deals with reliance by the corporate finance adviser on the work of independent experts or other professionals.  It provides that the adviser should undertake reasonableness checks to assess the relevant experience and expertise of the experts or other professionals to satisfy itself that reliance can be placed on their work.  In addition, the adviser should review and discuss with its clients the qualifications, bases and assumptions adopted by the experts or other professionals and satisfy itself that the qualifications, bases and assumptions have been made with due care and objectivity and on a reasonable basis.  But this latter requirement does not apply to the work performed by accountants in respect of the audit of results and accountants’ reports derived therefrom (item 13 of the defendant’s reference items).

332. The SFC has also published in October 2013, a Code of Conduct for Persons Licensed by or Registered with the SFC.  §17.7 deals with the due diligence to be undertaken by a sponsor of listing on expert reports.  Note 1 to this rule however provides a qualified exemption on the audited account of a reporting accountant.  It provides:

“Note 1: As a reporting accountant performs audit procedures on information received from a listing applicant under applicable professional standards, a sponsor is not expected to carry out any further due diligence on this information. Nevertheless if a sponsor is aware of any matters which raise concerns relating to the information underlying the accountant’s report, the sponsor should conduct further enquiries necessary to satisfy itself that these concerns are addressed; these enquiries may involve obtaining relevant supporting information and documents.”

333. In the light of the rules in the different codes or standards of practice, Mr Jat submitted that the defendant was entitled, in doing due diligence on the well established and professionally run FS Fund, to rely on 12 years of accounts audited by PoW and the representations of Citco Bank, the custodian on the existence of the assets of the fund. 

334. I agree with Mr Jat.  I am of the view that if the auditors and custodian are supposed to work according to professionally acknowledged standards or code of conduct or declared principles which are acceptable, then unless there are matters that raise concerns about their reports or the information underlying their reports, the financial adviser can safely rely on the reports without making any further enquiry on them or to replicate their work.  Since there is no suggestion that there was anything in the financial statements audited by PoW or the representations of Citco Bank that had raised any concern, I therefore hold that the defendant was entitled to rely on these audited financial statements and representations in conducting the initial and ongoing due diligence on the fund and without any further enquiry on PoW or Citco Bank.

Due diligence by simple enquiry on third parties

335. Mr Mok in cross-examining Mr Porten also suggested that it should be part of the defendant’s due diligence to make a simple line of enquiry to Citco Bank on a periodic basis on whether they had check with an independent third party as to the existence of the assets of the fund.  He repeated this in the closing submissions.  I think such enquiry is on the basic checking that Citco Bank should have always done.  I cannot see why the defendant should have periodically enquired Citco Bank on this. 

336. Furthermore, the concern aroused by this case is whether the fund was just a Ponzi scheme with no asset in existence.  Hence, the plaintiff considered the above simple enquiry on the existence of the assets of the fund necessary.  But different case would raise different concerns and, hence, the need for simple enquiries of a different nature.  On the whole, I do not see the justification for requiring the independent professionals to answer such basic enquiries.

Due diligence specifically on “fraud/theft/error risk”

337. Mr Jat also addressed to the plaintiff’s argument that the defendant should conduct due diligence specifically on “fraud/theft/error risk” as the defendant’s Product Development Policy had referred to such risk. Mr Jat submitted that the risk that the defendant referred to appeared to be the risk of fraud of some members of staff of the manager and not a Ponzi scheme fraud. I agree with Mr Jat.  I also agree with Mr Jat that the best way to detect a Ponzi scheme is to look at the auditors, the audited accounts, the track record of the fund and the people involved in the running of the fund.

338. Mr Mok also submitted that Mr. Friedman had denied in oral evidence that the defendant had a policy to individually assess fraud and theft risk as a risk category.  However, that denial appeared to have been directed to Mr Mok’s question of whether the defendant was aware that somebody had alleged that the fund was a fraud.  Unfortunately the question was rolled up with two matters and I failed to stop it and had it clarified before Mr Friedman was asked to answer it.  I do not accept that Mr Friedman’s denial had the effect contended by Mr Mok. I think the fair way to regard this piece of evidence is to hold that Mr Friedman did not give a clear answer to the question of whether the defendant had such a policy (day 6, p. 99 line 21 to p. 100 line 22).

Assets of the fund in Treasury bills

339. Mr Mok in cross-examining Mr Porten did mention that the financial statements of the fund show that on 31 December, all assets were in Treasury bills.  He also raised this in the closing submissions.  But this issue was never pleaded or mentioned as an issue in the opening submissions.  He only mentioned it in his oral opening as part of the factual background rather than as an issued relied on by the plaintiff.  I do not think the plaintiff can rely on it in support of his case now (day 1, p 141 line 8 - p142 line 25).

Faith in reputable brokers

340. Mr Mok then referred to the evidence of Mr Porten that there was no way of knowing that Mr Madoff was perpetrating a fraud and there was no reason to suspect that the transactions did not take place or that Mr Madoff was a fraudster.  Mr Porten also said that he never had any problem in dealing with brokers of known reputations.  Mr Mok thus submitted that Mr Porten sounded as though one can displace any sort of due diligence whenever the broker is a reputable one. He then submitted that it was bizarre for the defendant to merely rely on the statements from Mr Madoff plus some sort of oversight by FINRA and SEC and then marketed US$600 million of the fund to its clients.  It was also bizarre to accept the face value of the word of a broker-dealer that a certain transaction had taken place.

341. I agree with Mr Mok that the evidence of Mr Porten at times gave the impression that he would accept the monthly statement of a reputable dealer-broker without more as reliable information of what is stated therein.  However, that is not the defendant’s attitude.  The defendant certainly did not just take the representations of Mr Madoff without more as sufficient due diligence. 

Unreasonable fees for FGG

342. Mr Mok then referred to the fact that FGG was getting all the management and performance fees but BLMIS was (supposedly) getting the brokerage commission of the transactions only.  Mr Friedman accepted that it was unusual for BLMIS, the investment manager not to get any of the incentive fees.  There were also people in the market who were questioning how Mr Madoff had earned his fees. Mr Mok thus submitted that the defendant should find out the underlying motive of Mr Madoff in accepting such an apparently disadvantageous fee structure.  He further submitted that the defendant was naïve in accepting the representations of FGG at face value as to the nature or extent of its due diligence on BLMIS, just because the defendant regarded FGG as being honest and its representations correct.  Mr Mok submitted that the defendant used its blind faith in FGG for due diligence.

343. I disagree with this submission.  There was never any issue on the integrity of FGG.  There was every reason for the defendant to have accepted the representations of FGG which had good reputation in the industry as the representations did not appear to be problematic.  Furthermore, the reputation of FGG was only one matter that the defendant had paid regard.  The defendant in its due diligence had considered other issues as well.

Auditors of BLMIS

344. Mr Mok also submitted that the defendant had failed to do due diligence on the auditors of BLMIS notwithstanding the key role of BLMIS in running the fund.  The auditors were a firm of three persons comprising Mr Madoff’s brother-in-law, a semi-retired person and a secretary.

345. I agree with the defendant.  The auditors of the fund were important but not the auditors of BLMIS.  The audited financial statement of the fund tells how the fund has been performing in the year under audit and its situation as at the last day under review.  The audited financial statement of BLMIS only talks about the business of BLMIS.

The red flags

346. The plaintiff’s expert Mr Wisener identified 16 red flags in his report, but accepted that the 12 of them did not relate to the question of whether the defendant would be alerted to the possibility that the fund was a Ponzi scheme.  He only maintained four of them as relevant.  He said the red flags were a compilation of concerns that would have arisen had sufficient due diligence been done.  Some of them were enough to make fraud a consideration.  The four red flags are:

(1)    Red Flag 1: Conflict as executing broker same as clearing broker.

(2)    Red Flat 3:  Key man risk with Mr Madoff.

(3)    Red Flag 15: Severe lack of transparency (secrecy).

(4)    Red Flat 12:  No management fee for BLMIS but just commissions.

347. The first red flag was that BLMIS acted as both the executing broker and clearing broker which would allow price and trade manipulation. I have already dealt with this issue above when I considered the triple roles of BLMIS and the supervision of BLMIS by PoW, Citco, Citco Bank, FINRA and SEC.  In the light of my discussions above, this issue was satisfactorily resolved.

348. Under the 2nd red flag of key man risk, Mr Wisener opined that Mr Madoff had concentrated control over the entire trading activity. Such concentrated control exposed the fund to manipulation by Mr Madoff and the risk that the fund might not sustain if something should happen to him because he had made himself valuable and irreplaceable.

349. However, this red flag was caused by the popularity of Mr Madoff.  It showed the need for a proper succession arrangement for the key man and not that the fund could be a Ponzi scheme.  I do not see the relevance of this red flag.

350. Regarding the 3rd red flag of secrecy, Mr Wisener opined that Mr Madoff conducted his business with a level of secrecy much greater than what was expected in the hedge fund business.  The defendant could not visit him during the initial due diligence and was only able to meet him on 15 April 2008 after trading hours.  Mr Wisener said that such secrecy allowed the possibility of manipulation without accountability.

351. However, the evidence is that Mr Madoff only declined visits by investors of his feeder funds.  They were not his direct clients but clients of his clients.  He was willing to meet the managers of the funds and those who invested directly with BLMIS.  The managers of funds are usually sophisticated investors. Mr Madoff was also willing to be interviewed by journalists.  He was also transparent with FGG and Citco on his supposed trading activities.  I have referred to his providing trade tickets to FGG and the same trade information to Citco so that they were fully aware of the strategy that he was supposedly employing.  FGG also had Mr Amit to verify the trade information against market information.

352. Regarding the site visit on 15 April 2008, nothing untoward was discovered.  I also cannot see what difference it would have made had the visit been made during trading hours.

353. If Mr Madoff was keeping his operations under secrecy, the secrecy did not apply to FGG and Citco with whom his operation was supposedly transparent.  I therefore do not agree that this is a red flag.

354. Under the last red flag, Mr Wisener said that Mr Madoff performed the full services of a manager, but was not getting any of the management and performance fees as would be expected in the industry.  Mr Madoff was only getting the brokerage commissions.  He was forfeiting millions of dollars of fees to FGG.  This arrangement allowed BLMIS not to be registered with the regulatory bodies as an advisor and avoided regulatory scrutiny.  Mr Wisener opined that this would allow manipulation and fraud.

355. Mr Jat however pointed out that hedge funds were not required to be registered and regulated until about 2005 (day 6, p 10, lines 20-24).  Furthermore, BLMIS was a registered broker.  Its execution and clearing activities, including custodianship of assets, were already subject to regulatory scrutiny.  BLMIS was also registered as an adviser in 2006.  Hence, the avoidance of regulatory scrutiny alleged by Mr Wisener did not apply from then on.  Mr Jat also pointed out that when BLMIS waived the fees in favour of FGG, it yielded to the supervision by FGG, which had a strong incentive to supervise and scrutinize its trading activities.

356. Mr Madoff had also explained to journalists why he was not taking the fees and no journalists regarded it as untoward.

357. Mr Friedman also gave evidence that brokerage commission could be more substantial than management and performance fees (day 6, p 11, lines 3-14 and p 99, lines 12-20). 

358. This red flag, if relevant and could have been suggestive of something extraordinary, was explained away by the information, regulatory scrutiny and explanation available to the defendant as above-mentioned.  It also could not have suggested to the defendant that the fund would be a Ponzi fraud.

The defendant’s submissions on its initial due diligence

359. Mr Jat submitted that GIG of the defendant had conducted proper initial and on-going due diligence on the fund.  It was then approved by PAC and CIC before it was made available for purchase by the defendant’s clients.

360. In conducting the due diligence, the defendant had considered twelve years of unqualified financial statements of the fund audited by PoW.  The defendant regarded the statements as reliable information on the fund’s performance and asset position over the years.  The defendant also relied on the fact that Citco Bank was the independent custodian. 

361. In the initial due diligence process, GIG had considered the 20-page DD Questionnaire provided by FGG, the fund’s directors’ reports, its audited financial statements and the Placement Memorandum.  GIG also interviewed the staff of FGG on the fund.  FGG, which owned the fund through its subsidiary FSL, had been in the hedge fund industry since 1983.  It was a prominent firm with offices in New York, Greenwich, London and Bermuda and representative offices in various other places.

362. Cito and Citco Bank provided administrative and custodial services respectively to the fund.  The Citco Group was the largest provider of such services in the world.

363. Mr Jat further submitted that in relation to the risk of the fund being a fraud, the defendant’s review of the financial statements audited by PoW and the fact that Citco Bank was the custodian were sufficient for due diligence purpose.  The defendant was aware of how auditors audit a fund as it had in-house funds that had to be audited.  The auditors had to go to the ultimate source to verify the existence of the assets and to test the transactions also at the source.  The defendant was entitled to rely on these professionals and did not have to go further.

364. Mr Jat also referred to the statements made by PoW in the audited financial statements and Citco Bank’s acknowledgment in the Placement Memorandum of its obligations towards its sub-custodian.  I have already referred to these statements and acknowledgment above.

365. Mr Jat also referred to Mr Wisener’s evidence that Citco had a “Statement of Auditing Standards (SAS) 70” certification which signified good internal controls.

366. Mr Jat also made the following points:

(1)   FGG was receiving (the supposed) trade tickets and all (supposed) trade documentation from BLMIS on a daily basis.

(2)   BLMIS, being a registered broker, was all along regulated by the SEC and FINRA and subject to inspections and examinations.  It executed transaction and held assets for the fund, viz, its sub-custodianship, in its capacity as a broker. The regulators should have detected its fraud (day 5, T123:25 – 124:19).

(3)   Mr Madoff had a sterling reputation.

(4)   The fund had been operating for 12 years.  All redemptions were satisfied.  No Ponzi scheme before had lasted that long.  Mr Friedman also recalled that Ponzi frauds had never gone beyond a small scale and a short time (day 6, T107:19 – 108:9).

(5)   The performance of the fund was consistent with its stated approach and the capabilities of Mr Madoff/BLMIS.

(6)   FGG stated that it had conducted intense due diligence on Mr Madoff/BLMIS.  The fund was a significant part of FGG’s business.  FGG had a strong incentive to ensure that it was a proper fund that was being run properly (day 5, T142:24 – 144:19, 157:17-25).

(7)   Other entities, e.g., the Tremont Group, which was well known for conducting rigorous due diligence, had also established feeder funds to invest with BLMIS/Madoff (day 5, T14:17-22).

367. For the above reasons, Mr Jat submitted that at the material time, the initial due diligence by the defendant with regard to the risk of fraud was more than reasonably sufficient. 

368. Regarding the two articles

(a)  Mr Madoff Tops Charts; Skeptics Ask How”, MarHedge, May 2001 (“MarHedge Article”); and

(b)    “Don’t Ask, Don’t Tell”, Barron’s Online, May 7, 2001 (“Barron’s Article”).

I agree with Mr Friedman that they only questioned how BLMIS could have produced the returns whilst others were unable to replicate the same success with the “split/strike conversion strategy”.  There was, however, no suggestion that the fund was a fraud.  As against these two articles, there was the (supposed) transparency of trade given by BLMIS to FGG and Citco.

369. Regarding the confidential compliant by Mr Harry Markopolos to the SEC in 2005 which he published after Mr Madoff’s fraud was revealed, the SEC had looked into the matter but found no evidence of fraud [D1/16/ 246].  It was thus unreasonable to say that the defendant should have detected the fraud in its initial due diligence.

370. I have held above that if the auditors and custodian are supposed to work according to professionally acknowledged standards, code of conduct or declared principles which are acceptable, then unless there are concerns about their reports or the underlying information, the financial adviser can safely rely on the reports without making any further enquiry on the auditors or custodian or to replicate their work.  I agree that the defendant could have relied on the work of PoW, Citco, Citco Bank, FINRA and SEC in conducting its due diligence.

371. In the premises, I agree with Mr Jat that the defendant had conducted the initial due diligence on the fund with reasonable care and skill. I find that the defendant has proved on a balance of probability that it had reasonable grounds to believe and did believe up to the time when the plaintiff subscribed for shares in the FS fund that the representations made by Ms Chau and/or Ms Yau on the fund to the plaintiff at the meeting on 17 August 2004 were true.  I hold that the defendant was not negligent in failing to discover in the initial due diligence that the fund was in fact a fraud.  I also hold that the defendant has proved on a balance of probability under s. 108 of the SFO that when Ms Chau and/or Ms Yau made the representations on the fund to the plaintiff at the meeting on 17 August 2004, it had taken reasonable care to ensure the accuracy of the representations.  I further hold that the plaintiff has failed to prove on a balance of probability that the defendant had breached the duty of care both under the common law and the Supply of Services (Implied Terms) Ordinance in failing to discover the fund was a Ponzi scheme in the initial due diligence. 

The defendant’s on-going due diligence on the fund

372. Mr Friedman’s evidence shows that after the fund was approved to be sold by the defendant in 2003, GIG continued to monitor the fund on weekly and monthly basis.  Its staff often phoned the staff of FGG before the quarterly review of the fund by CIC.  Its staff also paid annual visits to FGG.

373. In the annual visit conducted on 17 December 2004, Mr Perruchoud actually went through the trade tickets for a month to consider the trade activities in detail and to ensure that FGG was monitoring BLMIS.

374. In 2008, when the financial crisis unfolded, GIG made a number of queries with FGG to ascertain the fund’s position.

375. Three members of staff of GIG also had a meeting with Mr Madoff on 15 April 2008.  I have already discussed this meeting above.

376. Obviously, the defendant continued to review the yearly financial statements audited by PoW.  The fund also continued to operate with redemptions and purchases from time to time.

377. The defendant’s initial due diligence work also continued to be relevant.

378. In the premises, I am of the view that with respect to the risk of fraud, the defendant had conducted the on-going due diligence with care and skill.  I find that the defendant has proved on a balance of probability that it had reasonable grounds to believe and did believe up to the time when Mr Madoff revealed his fraud at the end of 2008 that the representations made by Ms Chau and/or Ms Yau on the fund to the plaintiff in the subsequent review meetings were true.  I further hold that the defendant was not negligent in failing to discover in the on-going due diligence that the fund was in fact a Ponzi scheme.  I also hold that the defendant has proved on a balance of probability under s. 108 of the SFO that when Ms Chau and/or Ms Yau made the representations on the fund to the plaintiff at the subsequent review meetings, it had taken reasonable care to ensure the accuracy of the representations.  I further hold that the plaintiff has failed to prove on a balance of probability that the defendant had breached the duty of care both under the common law and the Supply of Services (Implied Terms) Ordinance in failing to discover the fund was a Ponzi scheme in the on-going due diligence.

Mr Mad off’s connection to the fund not revealed

379. Regarding the allegation that Ms Chau and Ms Yau had not told the plaintiff about Mr Madoff’s connection with the fund, I do not think this would have affected the plaintiff’s decision to invest in the fund. It is the plaintiff’s case that he had followed Ms Yau’s advice in investing in the fund.  Even if Ms Chau or Ms Yau should have told him at the meeting on 17 August 2005 or one of the subsequent meetings that Mr Madoff was running the fund, Ms Yau’s view of the fund and hence her recommendation of it to the plaintiff would have been the same, because Mr Madoff had an excellent reputation at that time and it was his name that attracted the investors’ funds.

Investigations, reports or news articles connected to Mr Madoff

380. Mr Mok also submitted at the end of the closing submissions that the defendant had not advised the plaintiff of any investigations, reports or news articles connected to Mr Madoff before the fraud was revealed.  Ms Chau and Ms Yau had admitted that they were not aware of these matters.  But in the eyes of GIG, these matters, in the context of due diligence as a whole, were not of concern because the investigations gave Mr Madoff/BLMIS a clean bill of health.  Mr Madoff in fact used the investigation results to market his business.  Hence, even if these matters were known to Ms Chau and/or Ms Yau, they would either have disregarded them as matters of no concern or revealed them to the plaintiff with a recommendation that they were not matters of concern as Mr Madoff came out of the investigations alright.  The plaintiff would of course have accepted such recommendation as he said he would have followed the defendant’s recommendations.  I therefore hold that the non-disclosure of Mr Madoff’s connection with the fund or the investigations, reports and news articles on Mr Madoff is neither here nor there.  Their disclosure would not have prevented the plaintiff from subscribing the shares in the fund.

The 19 redemptions of the FS Fund totalling about US$9 million in July and August 2007

381. The plaintiff said that if the redemptions had been disclosed to him in July or August 2007, he would have redeemed his shares in the FS Fund and put his money back in monthly fixed deposit as he was a prudent investor.  These redemptions constituted around 3% of the US$600 million invested by the defendant’s clients through the defendant.  They were triggered by the failure of the Bear Stearns High Grade Structured Credit Fund which involved with US sub-prime related securities and borrowing with leverage.  That was a high risk investment and different from the FS Fund.  If the plaintiff should have asked to redeem his shares in July or August 2007 because of these redemptions, it is clear that he would have been given the same bullish advice by Ms Yau and he would have kept the shares in the FS Fund.  I do not think the defendant should be liable for this claim by reason of the non-disclosure of these 19 redemptions to the plaintiff. 

Appropriate level of due diligence?

382. Mr Mok in §§55 and 56 of the opening submissions suggested that because the plaintiff had certain investor characteristics, the defendant should have adopted an appropriate level of due diligence on the fund for the plaintiff.  I disagree with this submission.  When it comes to the risk of the fund being a Ponzi scheme, there cannot be different standards or levels of due diligence for investors of different characteristics.

JUDGMENT

383. I have held that the plaintiff has failed to prove that the defendant had conducted the initial and on-going due diligence on the fund negligently which caused its failure to discover the Ponzi scheme.  I have also held that the defendant had conducted the due diligence with reasonable care and skill.  I therefore dismiss the plaintiff’s action.

COSTS

384. The plaintiff has succeeded on the issue of representations. The defendant should pay the plaintiff costs on this issue.  The defendant has succeeded on the issue of negligence.  The plaintiff should pay the defendant costs on this issue.  I consider that the costs incurred on the issue of representations are less than the costs for the issue of due diligence.  Instead of requiring each party to go for a taxation of costs, I would make a costs order nisi that the plaintiff do pay the defendant 50% of the costs of the action to be taxed with certificate for two counsel.