PROFESSIONAL LIABILIT Y
UPS AND
DOWNS OF
FINANCIAL
ADVICE
FINANCIAL ADVISERS NEED
TO TAKE GREAT CARE WHEN
ADVISING CLIENTS AND
RECOMMENDING INVESTMENTS,
OR RISK EXPOSURE TO A
HOST OF LEGAL ACTIONS.
BY ANDREW KIRBY
T
he current turmoil in financial
markets from the so-called “financial crisis”, and the collapse of
various property funds such as
Westpoint and stock-lending companies such
as Opes Prime, has resulted in an increase
in “spin off” cases involving the liability of
financial advisers who advised their clients
to invest in these companies and funds.
In these circumstances, financial advisers1
may be liable to their clients under statute,
at common law and in equity in relation to
“financial products” and the provision of
“financial services” in the case of negligent,
misleading or false advice.
Financial Services Reform
Act 2001 (FSRA)
The principal statutor y reg ulation of
financial advisers is contained in ch 7 of
the Corporations Act 2001 (Cth), which was
amended by the Financial Services Reform Act
2001 (Cth) (FSRA). Chapter 7 is a lengthy
and complicated piece of legislation which
contains many defined terms and cross references. The key provisions in terms of the civil
liability of a financial adviser are as follows:
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ss953B and 1022B – statutory rights to
damages for clients in connection with
defective disclosure documents or a failure
of the adviser to follow the “know the client”
and “know the product” rules contained in
s945A;
● s1041H – liability for misleading or deceptive conduct in relation to financial products
and financial services, leading to damages
or other relief under ss1041I and 1325;
● s991A – liability for unconscionable conduct
in relation to the provision of financial services; and
● ss917A–917F – deemed or vicarious liability
of financial services licensees for the conduct
of their authorised representatives.
Certain products/investments and investors (non “retail” investors) are excluded,
including:
●
financial products or investments which
exceed $500,000 in value;
● financial products or financial services
provided for use in connection with a business that is not a small business;
● financial products or the financial services provided to an individual whose
accountant has certified has net assets of
at least $2.5 million or gross income of at
least $250,000 per annum for the previous
two years (including companies or trusts
controlled by such individuals); and
● professional investors. 2
The key concepts for identifying what
types of financial products/investments are
caught by ch 7 are the definitions of “financial products” (ss763A–765A) and “financial
services” (ss766A–767A).
These definitions apply to the provision
of financial or investment advice in relation to, or a dealing in, financial products
such as shares/securities (ss764A and 92),
managed investments/units in unit trusts,3
promissory notes, 4 managed investment
schemes, insurance products, superannuation products, retirement savings accounts,
debentures, stocks, bonds, futures, derivatives and options.
●
PROFESSIONAL LIABILIT Y
Defective disclosure documents
There is a statutory right to damages under
s953B in the following circumstances:
● where no, or a defective, disclosure statement or document is provided – this relates
to a financial services guide (FSG) or statement of advice (SoA); and
● contraventions of ss945A, 945B, 949A or
949B.
Under s1022B there is a corresponding
statutory right to damages in connection
with defects relating to the provision of a
product disclosure statement (PDS).
Chapter 7 places some onerous disclosure
provisions on licensees to provide retail
clients with an FSG which requires disclosure of any remuneration, commissions,
benefits, interests, associations or relationships of the adviser in relation to the relevant
services; an SoA when giving personal advice
to a retail client; and a PDS when making a
recommendation, sale or issuing a product to
a retail client including, among other things,
the benefits, significant risks and costs
associated with the product, as well as its
characteristics, features, rights, obligations,
terms and conditions.
ILLUSTRATION SONIA KRETSCHMAR
“Know the client” and “know
the product” rules
As to the possible contraventions, s945A
encapsulates the requirement for the adviser
to “know the client” and “know the product”
in the context of giving personal advice to a
retail client.
ASIC Policy Statement 175, Licensing:
Financial product advisers – conduct and
disclosure, provides some guidance on the
obligations imposed by this section.
Under the policy statement, the relevant personal circumstances of the client
must be ascertained. The level of investigation required will vary, depending on
the complexity of the advice and financial
literacy of the client. For example, less extensive inquiries will be required for advice
provided for a simple purpose or product.
The obligations on the adviser will increase
where the potential negative impact on the
client is more serious – for example, in the
case of higher-risk and more complex financial products which may be structured for tax
purposes or involve high debt levels.
Other factors that need to be considered
include the need for regular income (e.g.
retirement income); the need for capital
growth; the desire to minimise fees and costs;
tolerance of risk of capital loss; the existing
investment portfolio; the need to be able to
readily cash in the investment; the capacity
to service any loan for a financial product;
the tax position; social security entitlements;
family commitments; employment security;
and expected retirement age.
Warnings or disclaimers as to risks or
incomplete or inaccurate information etc. will
not relieve the adviser from the obligation to
make reasonable inquiries: s945B.
In addition to personal circumstances, the
adviser will need to consider other relevant
matters and risks, which might include
broader economic matters, industry risks
and credit risks.
The adviser’s analysis of these risks, or
lack of it, will be critical when considering
whether there is any liability to the client for
a failed investment.
Who is liable?
Chapter 7 contains a detailed licensing regime
for the licensing of financial services licensees and their representatives. Under Part 7.6
a person who carries on a financial services
business must hold a financial services licence
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covering the provision of the relevant financial services: s911A. Under ss916A–916G the
licensee may appoint authorised representatives to conduct, or to assist in conducting,
the business. However, even if the business is
conducted by the authorised representatives,
the onus remains on the licensee to properly
provide the financial services. For example,
under s912 the licensee must, among other
things, take reasonable steps to ensure that
its representatives comply with the financial
services law, are adequately supervised and
are trained and competent.
Under ss917A–917F the licensee is deemed
to be liable for the conduct of their authorised representative and any resultant loss
and damage suffered by a client due to the
representative’s conduct, whether or not
the representative’s conduct is within their
authority: s917B.
The intention of Part 7.6 appears to be to
give the client the same remedies against
the licensee as they have against the representative and to make the licensee and
representative jointly and severally liable to
the client for those remedies: s917F.
If a person is the representative of more
than one licensee, the vicarious liability of
those licensees becomes more complicated.
Under ss917B and 917C licensees will not
be able to avoid liability by reason of traditional concepts of agency. The derivative or
vicarious liability of multiple licensees was
the subject of the decision in Newman v Financial Wisdom.5
In general terms, legal advice given by
a lawyer in their professional capacity is
deemed not to be financial product advice:
s766B(5). However, lawyers who provide
financial advice will not fall within this
exception. The distinction between legal and
financial advice has been drawn in the area
of professional indemnity insurance.6 Under
the Legal Practitioners’ Liability Committee’s policy terms, lawyers are covered only
in respect of their “legal practice”. There is
also a specific exclusion in respect of a claim
arising from the insured providing a financial service in respect of which the lawyer
was licensed or authorised under ch 7 of the
Corporations Act.7
Misleading and deceptive conduct
Section 1041H(1) of the Corporations Act
provides a cause of action for misleading
and deceptive conduct in relation to financial services and financial products. Section
51AF of the Trade Practices Act 1974 (Cth)
(TPA) expressly excludes the operation of
Part V of that Act from applying to financial services as those services are covered
by equivalent provisions in ch 7 and also
ss12DA and 12GF of the Australian Securities and Investments Commission Act 2001
(Cth) (ASIC Act). The definition of financial
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services in the TPA refers to the definition in
s12BAB of the ASIC Act. Relief for misleading
and deceptive conduct under the Fair Trading
Act 1999 (Vic) may also be available as there
is no general exclusion for “financial services” in the state legislation. 8
As with s52 of the TPA (“Misleading or
deceptive conduct”), s1041H(1) of the Corporations Act provides a very useful legal
tool for the client, as the reasonableness
or intent behind the proscribed conduct
is not relevant. The test as to whether the
conduct is misleading or deceptive or likely
to mislead or deceive is an objective one for
the court. 9 It therefore may be easier for
the client to succeed when compared with
an action under s953B as discussed above,
which involves concepts of “reasonableness”, “considerations” and “investigations”.
As with s52 of the TPA, non-disclosure or
silence can give rise to misleading or deceptive conduct.
In this context, s1041H(1) may be useful if,
for example, promises as to future returns
of an investment, or the lack of risk in an
investment, are made. Under s769C there
is a presumption, as with s51A of the TPA,
that a representation as to a future matter
is taken to be misleading if the adviser did
not have reasonable grounds for making the
representation.
Damages are available under s1041I if
actual loss and damage is suffered by the
misleading or deceptive conduct. Under s1325
a plaintiff is entitled to a wide “smorgasbord”
of relief if they are likely to suffer loss and
damage, including future loss and damage,
by the misleading or deceptive conduct.
Loss and damage need not be limited to
monetary loss.10 It could, for example, involve
the removal of tax benefits which cannot
easily be quantified, if at all. 11 The relief
under s1325 could conceivably involve the
unwinding of a transaction, in substitution
for, or in addition to, damages.
Other possible statutory
causes of action
Under s991A of the Corporations Act a licensee
must not, in or in relation to the provision of
a financial service, engage in unconscionable conduct. A contravention of s991A may
give rise to damages and other relief under
ss1041I and 1325.
Damages under s1041I are also available for contraventions of s1041E (false or
misleading statements), s1041F (inducing
persons to deal in financial products using
false or misleading information) and s1041G
(dishonest conduct in relation to a financial product or financial service). Proof of
contraventions under these provisions may,
however, be more onerous than proof of
contraventions of ss1041H or 991A, as these
provisions also constitute criminal offences
and incorporate concepts and language from
the criminal law.
Section 12ED of the ASIC Act also implies a
warranty in every contract for the supply of
financial services to consumers12 that the services will be rendered with due care and skill.
Liability in contract and in tort
There will be an implied term in the retainer
of a financial adviser that they will exercise
such reasonable care, skill and diligence as
might be expected of a reasonably competent financial adviser. Such a duty will also
usually be owed at common law in negligence:
see Ali v Hartley Poynton Ltd13 (Hartley Poynton)
and Newman v Financial Wisdom (above).
In Hartley Poynton, a firm of stockbrokers’
representatives engaged in discretionary
trading on behalf of the plaintiff. Smith J
was particularly scathing of the inadequacy
of the firm’s systems of monitoring, supervision and control over brokers.14 His Honour’s
findings in this regard were a central part
of his finding of negligence against the
firm. The requirement for licensees to have
adequate types of systems in place to monitor,
train and supervise authorised representatives is now enshrined in ch 7.15
Breaches of this term/duty will give rise to
an action by the client for damages, subject to
ordinary contractual and tortious concepts
of causation and remoteness etc.
Damages may also be available for lost
commercial opportunities,16 mental anguish
and distress.17 Exemplary damages may also
be available.18
Breach of fiduciary duty
Daly v Sydney Stock Exchange Ltd 19 concerned a
claim by a client of a stockbroking firm who
sought advice about share investments and
was instead advised to lend money to the
firm in circumstances where there was a
failure by the firm’s employee to disclose the
firm’s parlous financial position. The High
Court held that the firm owed a fiduciary
duty to the client such that it had an obligation to make to the client a full and accurate
disclosure of the broker’s own interest in
the transaction. The broker/adviser could
not assume a position where its self-interest
might conflict with the honest and impartial
giving of advice.20
If the adviser/planner fails to disclose
commissions, benefits or payments from
a recommended investment, it may well
breach its fiduciary obligations, in addition
to contravening ss942B(2) and 947B(2) of the
Corporations Act. If the adviser has failed to
disclose such matters and described themself
as “independent”, “impartial” or “unbiased”,
they may have contravened s923A.
PROFESSIONAL LIABILIT Y
False promises or exaggerations as to
predicted returns and associated risks may constitute
misleading or deceptive conduct.
Conclusion
Financial advisers need to consider carefully
any investment recommendations to clients
and their clients’ personal circumstances,
particularly retail clients. If a client is advised
to invest in a complex or higher-risk financial
product, then the adviser will need to fully
understand the product, consider whether
the product is appropriate for that client and
explain the risks appropriately to the client.
In summary, they need to know the product
and know the client.
In explaining the product to retail clients
in particular, financial advisers have onerous
disclosure obligations which require them to
set out in writing, by way of an FSG, SoA and
PDS, the risks, benefits, features, characteristics, commissions and fees associated with
the recommended products. False promises
or exaggerations as to predicted returns and
associated risks may constitute misleading or
deceptive conduct.
A failure to comply with these obligations may lead to the financial adviser being
liable to compensate the client under ch 7 of
the Corporations Act or under the general law
for any subsequent losses arising from the
recommended products. The financial services licensee may also be vicariously liable
for the wrongful conduct of their authorised
representatives. ●
ANDREW KIRBY is a Victorian barrister practising
predominantly in commercial law. He is the secretary
of the banking & finance section of the Commercial
Bar Association.
The numbers in square brackets in the article refer to
the paragraph numbers in the judgment.
1. The terms “financial planner” and “financial adviser”
are used interchangeably in this area and refer to a
financial services licensee or authorised representative
who provides financial services or advice on financial
products as defined in ch 7 of the Corporations Act.
2. See s761G, the definition in s9 and the Corporations
Regulations 2001.
3. Cachia v Westpac Financial Services Ltd (2000) 170 ALR
65; (2000) 33 ACSR 572; (2000) 18 ACLC 293; confirmed
on appeal: Cachia v Westpac Financial Services Ltd [2000]
FCA 1576.
4. Financial Industry Complaints Services Ltd v Deakin
Financial Services Pty Ltd (2006) 157 FCR 229; (2006) 238
ALR 616; (2006) 60 ACSR 372; (2006) 24 ACLC 1595 at
[53]ff; ASIC v Emu Brewery Mezzanine Ltd (2004) 187 FLR
270; (2004) 52 ACSR 168.
5. Newman v Financial Wisdom Ltd (2004) 183 FCR 164;
(2004) 56 ATR 634; on appeal: Financial Wisdom Ltd
v Newman (2005) 12 VR 79. The case concerned the
previous provisions under the Corporations Law.
6. Solicitors’ Liability Committee v Gray (1997) 77 FCR 1.
7. Refer to the definition of “legal practice” in cl 28.13
and the exclusion in cl 20.19 of the contract for professional indemnity insurance for solicitors 2008/2009.
8. However, see s1041K of the Corporations Act which
excludes the operation of the Fair Trading Acts in relation
to disclosure statements or documents within the
meaning of ss953A and 1022A.
9. Fraser v NRMA Holdings Ltd (1995) 55 FCR 452 at
554-555; ASIC v National Exchange (2003) 202 ALR 24
at [11]–[12].
10. Akron Securities Ltd v Lliffe (1997) 41 NSWLR 353;
I & L Securities v HTW Valuers (2002) 210 CLR 109 at
125 and 143.
11. Akron Securities Ltd v Lliffe, note 10 above.
12. Defined in s12BC.
13. (2002) 20 ACLC 1006; (2002) Aust Torts Reports
81- 665; [2002] VSC 113.
14. See, for example, [365]–[368].
15. See, for example, s912A.
16. See Sellars v Adelaide Petroleum NL (1994) 179 CLR 332.
17. See Newman v Financial Wisdom, note 5 above (trial
decision), at [618]ff.
18. See Ali v Hartley Poynton Ltd, note 13 above.
19. (1986) 160 CLR 371.
20. See Gibbs CJ at 377; Brennan J at 385-6.
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