A new era: New investment advice reporting requirement changes risk of liability for regulated institutions and branches in Germany | Practical Law

A new era: New investment advice reporting requirement changes risk of liability for regulated institutions and branches in Germany | Practical Law

This article is part of the PLC Global Finance November e-mail update for Germany.

A new era: New investment advice reporting requirement changes risk of liability for regulated institutions and branches in Germany

by Jochen Kindermann and Petra Brenner, Simmons & Simmons
Published on 15 Dec 2009Germany


Further to our update in August on the new Act aimed, among other things, at improving the enforceability of investor claims arising from misleading or incomplete investment advice, we set out below a little more detail on the contents of the Act and related liability issues arising in connection with it.
We reported in August (see Legal update, New reporting obligations in Germany likely to strengthen the position of German bank customers) on a new act (Gesetz zur Neuregelung der Rechtsverhältnisse bei Schuldverschreibungen aus Gesamtemissionen und zur verbesserten Durchsetzbarkeit von Ansprüchen von Anlegern aus Falschberatung (Act) which will significantly change the information obligations when providing investment advice to retail clients in Germany.
The Act comes into force on 1 January 2010 and among other things requires a detailed protocol (Anlageprotokoll) of the investment advice given to customers to be produced, combined with the obligation to hand over this protocol before entering into a business deal concerning a financial instrument with the customer.
The new protocol is likely to lead to a significantly higher number of court cases as the institution carries the burden of proof that the protocol is complete and correct.
As regards the timing of implementation, market participants should note that the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht) (BaFin) will probably indulge market participants; however, the German civil courts are likely not to be as lenient.
With the new reporting requirement the German legislator is introducing a new regime and ushering in a new era for investors. In this update, we would like to alert you to the impact of the new rules.

The Act

Contents of the Act in brief
The key element of the new Act is the new requirement for German banks, financial services providers and branches of foreign regulated institutions operating in Germany on the basis of the Directive 2004/39/EC on Markets in Financial Instruments (MiFID) passport to prepare a detailed written protocol of the investment advice they provide to their retail clients in terms of the definition of the MiFiD.
Details of what the protocol has to include are set out in a separate ordinance. This includes the reasons for and duration of the investment advice, information concerning the individual circumstances of the customer (which includes the information covered under the suitability test known from the MiFID) and information in relation to the recommended financial instrument. Furthermore, the report has to include information on the customer's investment strategy, the weighting of instruments the customer is aiming for and, finally, it has to set out the recommendation and details of the most relevant reasons for it.
The protocol must be signed by the person providing the advice and the institution must then provide the customer with the protocol prior to entering into any business transaction based on the advice.
To cope with the day-to-day practice of telephone based investment advice where it is usually not possible to provide the customer with the report prior to a transaction, a customer can waive its right to receive the report before the transaction is executed (although in this case the report has to be sent to the customer immediately after execution) and the customer must be granted a right to revoke any transaction based on the advice within a period of one week after receipt of the report provided the report is considered wrong or incomplete.
There have been various debates on how to deal with the uncertainty in relation to the one-week revocation period. Some firms have decided to avoid the one-week period by sending their protocol electronically or by fax immediately after giving the investment advice. An e-mail solution, however, gives rise to data protection issues if such a confidential report should be sent to a wrong address or be read by other internet users, in particular, if it is sent without encryption. In addition, it would be important for the institution to ensure that customers have received the report before entering into the deal with them. It can, however, become very difficult to provide sufficient evidence that a report has actually been received by the customer. A simple fax protocol would not provide sufficient evidence for the receipt of the protocol by the German customer following German court decisions.
In any event the new reporting obligation requires institutions to decide on a clear strategy and to make in-house preparations for the new reporting obligation to be able to start to deal with the new requirement as of end of December 2009.
Liability issues
In the new provisions the German legislator turns away from its view that the documentation of investment advice is purely for internal and supervisory purposes of the bank. Even the German High Court (Bundesgerichtshof) has accepted this view in the past (BGH Az. XI ZR 320/04; OLG Nürnberg 8 U 1857/05, WM 2007, 647) and neglected a right of the customer to receive copies of the investment advice given by the institutions. This usually led to customers, who carry the burden of proof in a civil court procedure, not being able to provide sufficient evidence and consequently losing their court trial.
The new Act not only requires the report to be handed over before the parties enter into the deal but also grants the customer an explicit right for a copy of the protocol to be provided. This obligation combined with the requirement that a bank bears the burden of proof for the correctness and completeness of the report leads to a significant increase in the risks borne by institutions in German civil court proceedings.
In this context it should also be emphasised that with the Act the current limitation period of three years starting with the day on which the parties enter into the deal will be prolonged. The new rule now states that the customer is able to raise any claims before a civil court within a period of three years starting from the day on which the client becomes aware of his claim, but no later than ten years following the day on which the claim came into existence. In practical terms, the result of this change means not only that customers can claim their rights for much longer, but also that institutions should consider retaining their records for a period of ten years (instead of the five-year period stated in the MiFID) to be able to defend their positions.
Cross-border implications
The new reporting obligation does not only apply to German banks or financial services providers. According to the German Securities Trading Act, the new rules would also apply to German branches of regulated institutions outside Germany.
It can also not be excluded that foreign regulated institutions which offer their financial instruments to retail customers on a cross-border basis without having a physical presence in Germany can be caught by the new requirement. This can be the case if a foreign regulated institution makes use of introducers based Germany.
Because of the purpose of the new Act to optimise the position of retail investors when claiming damages, the scope of the new provision is wider and consequently, it cannot be ignored by foreign entities by arguing they are only subject to home state regulation. However, the application on cross-border situations has to be determined on a case-by-case basis and depends on the way the entity actually approaches the market.