A recent Queensland Court of Appeal case will cause lawyers, compliance managers, professional indemnity insurers and authorised representatives to rethink their risk management processes and procedures.
On April 4, 2008, the Full Court of the Queensland Supreme Court handed down its decision in Delmenico v Brannelly & Anor [2008] QCA 74.
The appeal arose in response to an August 2007 judgment by the Queensland District Court, which upheld the client's claim against three defendants:
* Deakin Financial Services Pty Ltd, the relevant Australian financial services (AFS) licensee;
* Brannelly Financial Services Pty Ltd (BFS), the corporate authorised representative of Deakin; and
* Paul Brannelly, the relevant individual who was sub-authorised by Deakin to provided advice and dealing services to the client, and who was a director of Brannelly Financial Services.
The District Court found the three defendants had caused the client financial losses by reason of the defendants' negligence at common law, and a breach of section 12DA of the ASIC Act (misleading or deceptive conduct, or conduct likely to mislead or deceive).
It is instructive to note Deakin was not a party to the appeal. Deakin is under external administration. The actual individual adviser (representative) and the authorised representative company faced the full force of the client action in the appeal.
This case clearly shows there are circumstances where an individual adviser may be held personally liable for advice and dealing done on behalf of their AFS licensee.
Background facts
In April 2005, Delmenico - the client - answered an advertisement placed by BFS about investments available through the firm, and dealt directly with Brannelly.
At the time, BFS was a corporate authorised representative of Deakin, a Victoria-based AFS licensee.
The judgment wording refers to the client as a former "relatively senior" Commonwealth public servant who now works part-time in the tourist industry. He had built a "modest" real estate portfolio, and after his retirement had invested in shares as part of his self-managed superannuation fund (SMSF), which he appears to have managed in consultation with his stockbroker.
BFS offered to provide the client a "full financial plan", but the client declined. Instead, the client stated he only wanted advice on the products BFS was offering.
The client was initially offered an unlisted property trust, but he declined it due to the early withdrawal penalties related to the product.
The client asked for something suited to the shorter term, and was offered Westpoint Group promissory notes by Brannelly in a letter to the client dated July 18, 2005.
While providing the client with Westpoint Group promissory notes documents (including information memoranda that contained client application forms), Brannelly provided certain information, which included factually incorrect information about the promissory notes.
This incorrect information related to comments about the existence of a second mortgage and to whose benefit the mortgage applied, as well as comments relating to whether a guarantee was provided by Westpoint Group, and to whom the guarantee was provided. This incorrect information formed the main element of the claim of negligence and breach of section 12DA of the ASIC Act.
It is important to note the breach of section 12DA relating to misleading and deceptive conduct applies irrespective of whether the conduct is innocent or a mistake.
In fact, there does not appear to be any finding in the two judgments of anything other than a mistake or misunderstanding by the adviser, who then subsequently provided the incorrect information to the client.
Nature of the client: To what extent is the client deemed able to look after themselves?
The background information in the case highlights that the client:
* had good English language skills;
* had a reasonable level of understanding of investments as evidenced by the acquisition and management of a portfolio of real estate, running his own SMSF and investing in a share portfolio (with the assistance of his broker); and
* was relatively independent in that he (i) did not want comprehensive financial planning assistance - just product specific advice; (ii) operated a significant part of his overall investment assets on a do-it-yourself basis; and (iii) was clearly independently-minded enough to reject certain investments offered to him that he regarded as unsuitable to his own needs. His reading and understanding of the product information was sufficient to appreciate the effect of early redemption penalties attached to the property trust he was originally offered.
Some advisers may categorise clients who have these characteristics as knowledgeable, and may make certain assumptions when dealing with them, particularly in terms of the clients' understanding of financial products and the nature of the contemplated transaction.
This is arguably the basis of the new section 761GA of the Corporations Act as it relates to the ability of advisers to treat clients with certain levels of previous investment experience as "sophisticated".
However, these provisions generally relate to the administrative procedures involved in transacting with the clients and to the levels of disclosure ASIC prescribes as relevant to the clients, that is, as retail clients.
There appears to a schism between this regulatory approach and the approach of the Courts and dispute resolution bodies' when considering client compensation and adviser liability matters.
In this case, the District Court judgment rejected the suggestion the client was either knowledgeable or sophisticated.
The court stated: "In cross-examination and in the written submissions there was an attempt to cloth the [client] with the wisdom of an astute investor. The fact that he held a senior position in government and that he ran a self-managed superannuation fund does not give him that qualification."
The lesson for financial advisers is to distinguish between the regulatory approach versus the legal liability approach as to the deemed nature of the clients. Advisers should understand this important lesson from the Brannelly case, and when it arises err on the side of conservatism.
Did the client contribute to their losses by carelessness, thereby reducing the authorised representative's potential liability?
The lawyers for the authorised representative stated the covering letter provided to the client by BFS containing incorrect information was inconsistent with the information contained in the product's information memorandum document that was provided to the client at the same time.
They argued the client may have been careless as to the discrepancy between the two documents. Alternatively, the client failed to make proper enquiries about the discrepancy or his possible lack of understanding of the matter. In that sense, it was suggested the client may have contributed to his own losses and any damages awarded should reflect the extent to which the client contributed to his own losses.
The courts specifically rejected this position. The judgment in the District Court stated that:
"The fact that the [client] has been careless or could have discovered the misrepresentation had he made proper enquires of the [adviser] does not allow the latter to avoid liability for such misrepresentations. ...It will commonly be the case that a person who is induced by a misleading or deceptive representation to undertake a cause of action will have acted carelessly, or will have been otherwise at fault, in responding to the inducement. The purpose of the legislation is not restricted to the protection of the careful or the astute. Negligence on the part of a victim of a contravention is not a bar to an action . unless the conduct of the victim is such as to destroy the causal connection between contravention and loss or damage."
The Court of Appeal also stated:
"...it is also well-established by decisions of the High Court, of which the most recent is I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd, that the circumstance that a consumer, who is in fact induced to rely upon a statement which is objectively misleading, could have avoided the loss consequent upon that reliance by the exercise of reasonable care does not mean that the consumer did not act in reliance upon it so as to be entitled to recover damages by way of compensation for that loss."
The previous case law on this matter referred to by the courts related to the common law and the Trade Practices Act.
It should be noted Brannelly and BFS did not appear to have pleaded the provisions of section 12GF of the ASIC Act to allege contributory negligence on the part of the client to allow a "just and equitable" assessment of damages (a potential reduction in damages).
As a consequence, that provision appears to remain untested on this point. Therefore, as the law currently stands, if the adviser makes a misleading or incorrect statement to a client, that the client could reasonably be expected to act on, the adviser could be fully liable.
The 'no advice' defence
Brannelly sent the client certain documents, in his July 18, 2005, letter, which included an information memorandum through which the client could invest.
The letter contained a statement to the effect that:
"Please note that the attached information is not financial advice and is for information purposes only. As you did not describe your current situation to me, have not sought advice nor were given advice by any authorised representative of Deakin Financial Services Pty Ltd, Australian financial services licensee, number 231158 ('the licensee'), it is possible that the chosen product is not approved for use by representatives of the licensee. It is also possible that there may be products available from other financial product provider(s) that are more suitable to your needs."
The so-called 'no advice' assertion was repeated by Brannelly in a confirmation letter to the client dated August 1, 2005, which confirmed the client's cheque had been received. This letter stated: "... you have decided to make an investment based on your own research ... as you did not describe your current situation to me, have not sought advice."
However, the letter did in fact summarise the attractions of the Westpoint Group promissory note investment under the heading "Investment Highlights".
The letter also contained the following words: "... an excellent opportunity to invest in high yielding promissory notes offering a 14 per cent return on a minimum of $50,000 with a company who have an established record of over 20 years."
Financial product advice is defined, in section 766B(1) of the Corporations Act 2001, as: "... a recommendation or a statement of opinion ... that is intended to influence a person or persons in making a decision in relation to a particular financial product ... or could reasonably be regarded as being intended to have such an influence."
Brannelly's statement of opinion about the "excellent opportunity" appeared to fall within that definition of advice. The court appears to have treated Brannelly's conduct as contrary to the disclaimer, which stated the "information" was not advice.
It is apparent that even the provision of what an adviser would like to describe as "merely factual information" may arguably form a representation by an adviser, inviting a client to enter into a contract.
It is important to note counsel for the client submitted that the first sentence of the disclosure statement provided by Brannelly did not specifically say the client could not rely on the information given to him by Brannelly.
To that extent, counsel submitted that the disclosure document was ineffective to negate representations of fact, that is, the investment highlights and the alleged positive benefits relating to the promissory notes. The court accepted that submission as correct.
The lesson advisers should learn from this point is to ensure adviser conduct is consistent with, and does not contradict, relevant disclaimers.
The courts will go to the substance of what has happened in a case and not merely how it is described.
Authorised representative may also wish to consider whether it is appropriate for them to obtain their own professional indemnity insurance policies since most licensee policies typically only compensate the licensee for the authorised representative's conduct.
However, in the current market that may be easier said than done.
Mark Halsey is a principal of Halsey Legal Services, a Perth-based lawyer specialising in financial services.
