September 2011

Financial Advisor Liable for Negligent Advice

The High Court has recently found a financial advisor liable for losses arising from unsuccessful investments undertaken in reliance on their advice given to a client. In light of the plethora of finance company failures in recent years, the decision will be of interest, both to investors who have suffered as a result of investment in failed finance companies and to those who recommended such investments.

Factual Background

The Investor was a veterinarian who described himself as being quite inexperienced in investment matters. He was about to retire and was investing primarily to provide a retirement income. An initial meeting took place at which the financial advisor reviewed details of the Investor's investment properties.

Subsequently, the Investor sold one of his investment properties and contacted the financial advisor for advice on investments. The Investor was asked to complete a "Risk Profile Questionnaire" which was intended to gauge whether or not the Investor wished to pursue a conservative or a more aggressive investment strategy. The questionnaire completed by the Investor gave answers indicating a "conservative" approach to investments was required. Further questionnaires completed subsequently indicated that a more growth-focused investment profile was sought. Over a period of time the Investor sold his investment properties and reinvested the proceeds in accordance with the financial advisor's recommendations, investments were made between a mortgage trust, a fixed-interest investment in debenture stock and four finance companies, including Bridgecorp Holdings Limited. Bridgecorp subsequently failed and the other investment products that were recommended did not perform as well as expected.

Claims

The Investor alleged that the financial advisor:

• Recommended investments in finance company debentures and managed products that were riskier than appropriate;
• Recommended investments that involved a lack of diversification that exacerbated the risks to which the Investor was exposed;
• Negligently failed to appreciate the extent of the Investor's need for periodic income;
• Failed to recommend investments that produced sufficient income to meet calculated cash needs;
• Should have ensured that the Investor understood the risks associated with the investments recommended.

Duty of Care

The High Court held that the financial advisor had breached a duty to provide competent advice. The breaches were in recommending a concentration of investments in finance companies and failing to offer alternatives that provided options for less risky fixed-interest investments.

The High Court also found that the financial advisor left the Investor ill-equipped to make fully informed decisions on which fixed-interest investments to make. The High Court further held that although the risk assessment questionnaires were a useful tool, they could not absolve an advisor of responsibility for competently identifying the extent of risk involved in any particular investment and ensuring that there was no material mismatch between the investments recommended and the client's requirements. This was despite rejection of the Investor's claim that he was not properly advised that investments promising greater reward often carried with a greater degree of risk.

Non-Recoverable Losses

It was held that the remainder of the advice given by the financial advisor was not negligent. Furthermore, it was ascertained that the drop in value in some of the investments was attributable to the global financial crisis, which the financial advisor could not reasonably have foreseen.

Other losses for which the financial advisor was not liable were attributed to the Investor's election to withdraw early from managed funds resulting to capital losses where their value would have been restored if he had held them longer.

Personal Liability

In this instance, the financial advisor provided services through a limited liability company. However, it was held that notwithstanding the fact that the contractual relationship was between the Investor and the company, it was appropriate to attribute personal liability to the financial advisor as she was the principal point of contact and was the essence of a personal relationship between advisor and client.

Contributory Negligence

The High Court found that whilst the financial advisor was negligent, the Investor had nevertheless contributed to his losses caused by the decision to invest in the finance companies. The High Court also held that the Investor's decision not to repay bank borrowings after selling rental properties had been made against the advice of the financial advisor and contributed to the Investor's expectations as to the level of income that should be generated by fixed-interest investments and also to cash flow crisis that he subsequently encountered.

It was also argued by the financial advisor that the Investor would have proceeded with the same investment strategy even if he had been competently advised and that therefore any negligent advice was not the cause of this losses as they would have been suffered in any event. The Court found that even if the Investor had been competently advised, there was no higher than a 40% chance that he would have followed competent advice, effectively meaning that the Court was satisfied that the Investor may have pursued a riskier investment strategy in any event and suffered the same losses. Overall, it was found that the Investor was entitled to recover against the financial advisor 30% of the capital losses claimed.

Summary

The decision should provide some encouragement for investors who have suffered financial losses as a result of negligent advice to invest in finance companies and other investments where it can be shown that that advice was negligent by not taking into proper account of the investor's circumstances and offering alternatives involving less risk. However, the decision also confirms that financial advisors will not be responsible for losses that are not reasonably foreseeable (such as those caused by the global financial crisis). The decision also makes it clear that investors may be required to take some responsibility for investment decisions that have gone wrong.