To what extent must financial advisers know their clients?
Jun 2019 | InsuranceIntroduction
A recent Supreme Court of Queensland decision in the case of Bankier v HAP2 Pty Ltd1 has highlighted the need for financial advisers to enquire into their clients’ personal circumstances and warn of the material risks of implementing their advice, particularly when they are aware of issues that may impact their clients' future earning capacity.
Background
In 2002, when the plaintiff was 21 years old, she received a $2 million award of damages for the serious spinal and internal injuries she suffered in a car accident in which her father was killed. The award was to compensate her for future loss, medical expenses and associated matters.
Shortly after the award, the plaintiff engaged the defendant financial planning firm, HAP2, to provide advice on investing part of the award. Importantly, HAP2’s advisor had previously acted for the plaintiff’s father, who died in the car accident. The adviser was therefore aware of the circumstances leading to the plaintiff seeking financial advice.
After paying her mortgage and amounts to her family, the plaintiff invested $1.132 million on HAP2’s advice. While not clear from the judgment, this amount appears to have been invested in shares.
From time to time, between 2002 and 2005, the plaintiff instructed HAP2 to withdraw various amounts totalling around $85,000 from the portfolio. During that time she also:
- Established a surf photography business, including leasing a premises, which required some international travel and does not appear to have been profitable. The adviser was consulted from time to time about her spending associated with the business; and
- Bought an investment property financed with a loan. She sought advice from the adviser regarding her ability to afford the investment.
In June 2006 the plaintiff’s portfolio was valued at around $1.5m, but fell in value to around $700,000 by December 2008, which was during the global financial crisis.
The plaintiff relevantly pleaded that HAP2’s investment advice was negligent and in breach of the Corporations Act because its adviser failed to:
- Warn the plaintiff of the risk of capital loss;
- Establish the plaintiff’s needs, goals and budgets and manage the damages award to give effect to them;
- Warn the plaintiff against excessive expenditure; and
- Advise the plaintiff of alternative low-risk strategies that could have been implemented in lieu of the portfolio recommended by the adviser.
Content of the duty
While HAP2 contended that it owed the plaintiff a duty to take reasonable care and skill only in the performance of the services which it provided, the court did not agree and found that a wider duty existed to warn of ‘material risks’. Whether something is a ‘material risk’ depends on the particular circumstances of the client.
Enquiries and investigations
In establishing the particular circumstances of the plaintiff, the judge found that HAP2 (by its adviser) should have taken steps to obtain a comprehensive understanding of the plaintiff’s constraints upon her capacity to invest, and the future expenses she would likely incur. While the adviser had a general understanding of the plaintiff’s circumstances, the duty to enquire further was heightened by his awareness of the means by which the plaintiff had acquired the funds to invest.
The judge found that, in the plaintiff’s circumstances, the duty to enquire further required the adviser to read the judge’s decision in which the damages award was made. Because he hadn’t read the decision, or made further enquiries, the adviser did not know, and did not allow for, the following matters:
- The plaintiff’s inability to engage in full-time employment and limited earning capacity;
- The cost of future surgery and medical care, which would likely cost around $1 million;
- The plaintiff’s need for significant assistance with household and domestic tasks in the future; and
- The need to modify any accommodation to suit the plaintiff’s disabilities.
If the award funds were dissipated the plaintiff was at risk of not being able to afford the above costs. The adviser knew of these matters, as demonstrated by a file note which said that she had significant medical expenses and 'this money had to last her the rest of her life'.
The warnings that should have been given
The judge held that in the plaintiff’s particular circumstances, the adviser should have warned the plaintiff of the full potential consequences of the ‘relevant action’, which included not only the recommended investments, but the matters concerning the failing business and the purchase of an investment property.
The judge found that the adviser (and therefore HAP2) breached the duty to warn by failing to:
- Warn the plaintiff that her spending on the failing business, and generally, could impact on her ability to fund her future medical expenses; and
- Advise the plaintiff in 2005 of the risks of buying the investment property and entering into the lease for the business.
The judge did not accept the adviser’s assertion that he had made various oral warnings from 2004 onwards, because of the lack of corroborating file notes. The judge found that the adviser’s first warning occurred in October 2008, by which time the portfolio had fallen in value to around $800,000. At that time, the adviser records in a file note that he told the plaintiff that the photography business was ‘going broke’ and she could not continue funding the business or her lifestyle with her capital, which had been intended to fund her for the ‘rest of her life’.
Section 945B of the Corporations Act - incomplete or inaccurate information
The judge also found that HAP2 breached s 945B of the Corporations Act by failing to warn the plaintiff that the information the adviser had was incomplete as it did not take into account matters which were ‘essential’ in formulating an investment strategy, including:
- The costs of future surgery and equipment;
- The costs of future domestic assistance; and
- The loss which would occur in the future due to her inability to obtain a level of financial certainty.
Causation
The judge found that, had she been warned of the consequences of her spending, she would not have gone ahead with her 2005 fully-geared investment in Great Southern’s agri-business products (totalling $12,500), the purchase of an investment property and her entry into the photography business.
Damages
Some points to note in relation to damages:
- The damages were calculated until HAP2 ceased advising the plaintiff in June 2010;
- While not clear from the judgment, it appears that the loss associated with the investment property was the loss of capital equal to the amount of interest associated with the loan.
- The fact that the property increased in value from $395,000 in 2005 to $637,508 in June 2010 does not seem to have been taken into account when quantifying the plaintiff’s loss, because she was to be returned to the position she would have been in had the breach of duty not occurred (the position under the Corporations Act was not considered).
- Tax and fees were to be taken into account in calculating the plaintiff’s loss. The judge invited submissions on grossing up, and his finding in this regard is not known.
Summary
While financial advisers can take some comfort in knowing that the decision turned on its own facts, it nevertheless highlights the need for financial advisers to ensure they have properly enquired into their clients’ personal circumstances and warned of the risks associated with implementing their investment recommendations. That need is arguably heightened if the adviser is made aware of circumstances that could impact a client’s capacity to meet future investment expenses or achieve their long-term financial goals.
The judgment has been appealed and we await the outcome with interest.
.....
1 [2019] QSC 101.
This article may provide CPD/CLE/CIP points through your relevant industry organisation.
