A review of client categorisation in Linear Investments v Financial Ombudsman Service [2025] EWCA Civ 1369
Summary
In Linear v FOS the Court of Appeal upheld the Financial Ombudsman’s finding that Linear had wrongly permitted its client (C), who was not a professional investor and who did not meet the qualitative and quantitative criteria to become an elective professional client, to invest in a trading strategy designed for professional investors. The Court also upheld the Ombudsman’s decision to compensate C by reference to the FTSE private investors income total return index, rather than to a higher risk professional index.
The Court did however uphold Linear’s appeal that C’s award should be reduced to reflect C’s misrepresentations about his trading experience made in his account opening form.
Rule 3.3.5R and the proper assessment of elective professional clients
A firm must carry out an assessment of a client wishing to be treated as an elective professional client. That assessment has two elements:
A qualitative assessment of the knowledge, expertise and experience of the client, such that the firm has a reasonable assurance that the client has the necessary experience, expertise, experience and knowledge to make their own investment decisions and understand the risks involved (COBS 3.5.3R(1).
A quantitative assessment that requires two of following three criteria be satisfied (COBS 3.5.3R(2)):
the client has carried out transactions of significant size, in the relevant market, at an average frequency of 10 per quarter over the previous four quarters (Transaction Frequency Test);
the client’s portfolio exceeds Euro 500,000 (Portfolio Test); and
the client has worked as a professional in the financial sector with knowledge of the relevant transactions and service, for at least a year (Experience Test).
Rule 3.5.3.R also imposes a number of procedural requirements, including that the client must apply in writing to be treated as a professional client and that warnings about the loss of legal and other rights are given by the firm.
Facts
L operated a quantitative trading strategy in derivatives that included contracts for difference (CFDs). That strategy was only open to professional clients. C, a professor of robotics at the LSE , wanted in on the strategy and applied to be treated as an elective professional client. In his application C stated - amongst other things - that he had:
been employed at a university for 12 years;
experience in trading CFDs with an average transaction size of 20+ lots per transaction; and
invested in blue chip stocks for about 15 years;
worked for a year in the financial sector; and
had an investment portfolio of around £800,000.
C’s answers to the Transaction Frequency and Experience Test were cursory, amounting to little more than ‘tick box answers’, not supported by evidence and misleading. In particular, there was no evidence that C had traded CFD’s or worked as a professional in the financial sector.
Relying solely on the answers given in account opening form Linear opened an account for C.C invested £100,000. About half of C’s investment was lost.
C initially tried to complain to Linear but as an elective professional client Linear claimed he had no such right.
The Ombudsman’s decision
The Ombudsman ordered L to compensate C in full for the losses he had sustained on his investment, calculated by reference to a standard FTSE index suitable for retail investors, plus 8% interest, for the following reasons:
C’s answers to the tick box questions on the account opening alone did not give enough information to Linear a reasonable assurance that C was able to make his own investment decisions and understood the risks involved.
The information that C did include on the account opening form put Linear on notice that it needed further evidence from C as to his trading experience.
If Linear had sought further information to support the tick box answers it was unlikely C would have been able to provide it and consequently he would not have satisfied the qualitative test.
As a result of those failings C effectively self-certified as an elective professional client.
In addition the Ombudsman also found that Linear had mismanaged C’s investment and had not managed his investment consistent with a medium risk mandate and failed to provide C with clear and fair information about the fees and performance of the product.
The Ombudsman considered the impact of C’s misleading answers in the account opening form on the question of contributory negligence and found that this issue only arose in respect of the classification of C as an elective professional and did not affect his findings as to Linear’s mismanagement and failure to provide information which entitled C to full redress irrespective of the issue of categorisation. The Ombudsman added that there was no obligation to apply the principles of contributory negligence to his decision but only take them into account in coming to his decision.
Linear’s Appeal
Linear appealed the Ombudsman’s decision on 3 grounds:
Ground 1
Rule 3.5.3.R imposed a procedural obligation on Linear to conduct an adequate assessment (Adequate Assessment). It did not impose an obligation on Linear to get C’s classification right (Objective Assessment). Linear carried out an Adequate Assessment by obtaining the information required by 3.5.3(2) as provided by C in the account opening form. Furthermore, C’s answers in the account opening form were more than self-certification but binding representations that had contractual significance.
Ground 2
As C had applied to invest in a higher risk professional strategy, compensation should not have been assessed by reference to a “vanilla” financial index, but by a comparable professional index or strategy.
Ground 3
C’s award should have been reduced by reason of the misrepresentations he had made in the account opening form, which caused Linear to enter into a relationship with him in the first place.
The Court of Appeal’s decision
The Court reiterated that the Ombudsman’s decisions, whilst based in law take into account other matters such as rules, guidance, standards and “good industry practice”. However, those decisions are amendable to judicial review on conventional grounds.
Ground 1
The Court decided that account opening form completed by C did not form part of the contract and that representations made by C in it were not, as a consequence, terms of the agreement between Linear and C.
The Court considered that estoppel by representation might be a more suitable basis to consider the answers given by C in the account opening form. On the basis of this analysis, Linear had to demonstrate that reliance on the representations was reasonable. However, in this case the fact that C completed a few general tick boxes and nothing more and, was not enough for Linear to reasonably rely upon. Indeed, there were matters that should have put Linear on inquiry, such as C’s tick box confirmation that he had traded in CFD’s, whilst in another part of the form he had stated that his experience of investing was in blue-chip stocks.
The Court pointed out that the obligation to make a careful assessment of the representations made by a client is all the more relevant where the representee is a regulated entity. This approach is consistent with cases such as Wilson v MF Global UK [2011] EWHC 138 (QB). In essence the starting point for an assessment are the client’s representations. However, the firm will not be able to rely on those representations if there are reasons to make further inquiries.
The Court did not need to consider whether the quantitative test was an Objective or Procedural Assessment, as on its own case Linear failed to carry out a proper Procedural Assessment, in any event. It should be noted however that the Court did refer to Spreadex Ltd v Sekhon [2008] EWHC 1136 (Ch) in which the Procedural Assessment was deemed appropriate under analogous COBS rules.
Ground 2
Using a retail investment index as the measure of damages was appropriate as C was not a professional investor and was therefore incapable of making the decision to invest in a risky professional grade of investment in the first place.
Ground 3
The Ombudsman’s finding that C’s misrepresentations were not causative were rejected. The Court found that - irrespective of what induced C to apply to invest with Linear - he was only able to participate in the investment strategy because of his misrepresentations as to his trading and professional experience. But for those misrepresentations he would not have been able to invest and incur the resultant losses; regardless of Linear’s failures to provide information and its mismanagement.
The Court also decided that whilst the Ombudman was not bound to apply the principles of constructive dismissal he had to take them into account and apply those principles correctly, in this case he did not.
Conclusions
First it is worth keeping in mind that in challenging an Ombudsman’s decision it is worth bearing in mind that judicial review requires one or more of the following to be found:
An error of law
Misinterpretation of the applicable rules
Irrationality
Perversity
The latter two findings are of course relatively high bars to clear. One also must keep in mind that the time limit for making an application for judicial review is three months.
What is clear from this case is however that in carrying out a qualitative assessment of a client, a regulated entity is duty bound to go beyond the client’s face value statements and make further inquiries where there is a lack of supporting evidence or reasonable lines of inquiry to pursue. This does not mean that there is an obligation to set the client tests or examinations to assess his level of competence but it does mean that a firm should verify the accuracy of their client’s statements by asking for supporting evidence and explanations. In other words a firm should be able to demonstrate that its reliance on the client’s representations, was in the circumstances, reasonable.
I would suggest that the question of whether the Procedural or Objective in nature perhaps misses the point from a practical perspective as a firm that asks the right questions, interrogates the client’s answers and looks for supporting evidence will satisfy the Procedural Assessment standard and in doing so has a very good chance, in the absence of of getting to the objective truth of matters in any event.
This post is not intended to and should not be taken as legal advice.
(c) by Liam Hemmings
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