Claims against financial professionals: The good, the bad and the prepared

Legal disputes can arise between financial professionals, their clients and/or third parties for a myriad of reasons. Claims tend to increase substantially in recessionary periods when clients seek to blame their advisors for their substantial financial losses. Many investors have found the value of the capital invested in financial products has been reduced, or wiped out entirely. As a result, financial advisors, financial institutions, investment intermediaries and promoters of financial products have found themselves subject to a much greater level of legal scrutiny in recent years than ever before.

The bulk of recent civil claims against financial service providers in Ireland have arisen from one or more of the following issues:–

·         Mis–selling of financial products to investors;

·         Failure to explain the terms of the product to investors properly;

·         Misleading and/or false representations made to investors;

·         Failure to maintain proper up to date investment mandates and to invest client money in accordance with client mandates;

·         The selection of investments inappropriate to risk appetites.

·         Conflicts of Interest arising from acting as promoter of particular product and investment manager at the same time;

The downturn has also brought to light a lot of fraudulent activity which might not otherwise have been spotted. This included misappropriation of client monies and alleged Ponzi schemes.

Dealing with a claim can be extremely stressful, time–consuming, costly and potentially devastating for a business. It would therefore be extremely wise to consider the risk and to try to minimise your exposure to it.

The duties of the financial services professional

When considering any claim the court will usually have to consider the duties owed by the Financial Professional and to whom they were owed. It will then consider if those duties were breached, the cause of the alleged loss, whether it is recoverable and how any proven losses should be calculated or measured.

Almost invariably, the first question that arises is what the financial professional was actually retained to do and whether it performed its agreed contractual duties. This is usually central to any dispute. Statutory provisions may impact this, such as the Sale of Goods and Supply of Services Act 1980, regulatory standards and codes of conduct. The Consumer Protection Code 2015 and the Markets in Financial Instrument Directive Regulations 2007, for example, set out extensive obligations. A Financial Professional will be under an implied, if not express contractual duty to exercise reasonable skill and care in carrying out its services. He or she will also owe a more general common law duty of care in tort not to cause clients and/or third parties foreseeable loss. Professionals may be held liable for negligence, negligent advice, negligent mis–representation and or deliberate fraud.

Terms of engagement

To minimise the risk of any dispute concerning your scope of services, one should issue detailed letters of engagement and/or terms of business to your clients at the commencement of any client relationship. These should identify clearly the following:

•           What you are being retained to do;

•           What services will be carried out by you and or any third parties assisting you;

•           How your fees will be calculated and charged;

•           Any exclusions, disclaimers or limitations on your liability;

•           Your general terms of business;

•           The client’s obligations e.g. in terms of any assistance you will require from it in order to properly perform your duties, or for the provision of accurate information;

•           If another party is providing related services this should also be addressed;

Common examples of clauses limiting liability would include exclusions of liability for indirect or consequential loss and/or loss of profits; monetary caps on liability and excluding liability arising from insufficient or deficient information being provided by the client. The latter requires careful consideration as the clause may not be reasonable if the information is subject to verification by you. Any exclusions on liability should also be brought specifically to the client’s attention. It is sensible to ask your client(s) to sign a copy of the letter of engagement and/or terms of business before any services are provided as this will demonstrate the client’s acceptance of those terms.

The standard of care and codes of practice

Significantly, both the Consumer Protection Code and the Markets in Financial Instrument Directive Regulations 2007 now require financial advisors to act “professionally”. The word “professional” has a particular significance at common law. Professionals are judged by reference to the standard of care that would reasonably be expected of a professional of her or her background and experience. As was noted by the Supreme Court in Roche v Peilow[1986]:

        “the duty imposed  by the law rests on the standard expected from a reasonably careful member of the profession, and a person cannot be said to be acting reasonably if he automatically and mindlessly follows the practice of others when by taking thought he would have realised that the practice in question was fraught with peril for his client.”

Breach of relevant regulatory standards may not give rise to a cause of action but is relevant in assessing whether or not a professional has met the standard of care that would ordinarily and reasonably be expected of him. The Consumer Protection Code and the Markets in Financial Instrument Directive regulations have effectively codified many of the duties that would otherwise be owed at common law such as the provision of information, ensuring the suitability of products and so on.

It is advisable to keep up to date with new developments and trends in your area of expertise, although it is important not to take a particular course of action if it could obviously harm the client’s interests even if other members of the profession are engaged in such practices. For example, one should not simply recommend investing in a particular product because it is very popular within the industry without first having properly investigated or considered its merits yourself. Equally, it is important not to advise on unfamiliar subjects at the risk of providing erroneous advice.

Know your client

What may be appropriate for one or more clients may not be suitable for others. Whether one is a medical, legal or financial professional, one cannot properly advise clients without a proper consideration of their particular needs and objectives. There is an obligation to know the client and to tailor ones advice accordingly. This is both a regulatory obligation under the Consumer Protection Code 2015 and the Market in Financial Instrument Directive Regulations 2007 but also arises at common law.  The case of James Haughey v J&E Davy trading as Davy, Bank of Ireland Mortgage Bank and Bank of Ireland is indicative in this regard.   In that case, Davy gave the plaintiff a standard account opening form to complete. This sought details of his attitude to risk, investment knowledge and experience, his existing investments, sources of income and pension arrangements, financial objectives and so on. The form also included a declaration that the detailed information in the form was correct and required the plaintiff to inform the Davy if there was any change in it. The plaintiff signed the declaration but the forms were otherwise left blank and contained none of the details required. According to the plaintiff, he had come to Davy to purchase shares but ended up trading in Contracts for Difference. He gained €2 million and lost €3.5 million, paying Davy close to €400,000 for its services. As the court noted:

“There was a complete failure to get to know James Haughey for what he was… That obligation is not one which arises at one point in time only and is then completed; it is a continuing obligation. In this case, at no stage was that obligation met.”

In the court’s view, the trading in contracts for difference would never have taken place if Davy had gotten to know James Haughey: “It would have been stopped, and replaced by conservative trading.” The High Court awarded Haughey damages of €2,099,621. This case highlights the importance of understanding your client’s needs before providing services to them. Clearly the client’s needs and circumstances may change over time and it would therefore be advisable to review and/or update the information you retain on file periodically to ensure it remains up to date so that any advice you provide remains appropriate for the client’s current circumstances. 

Maintain a paper trail

Once your business relationship has commenced, all new instructions should be confirmed in writing or recorded in some way. Depending on the nature of your business, it may be necessary to record telephone conversations/instructions.  The client should be advised of the costs before and as they are incurred. Keeping clear notes of all meetings, telephone calls and the advice given will also assist in the event that there is any subsequent dispute as to what was said or agreed. It also helps to follow up with a letter, or email to confirm all advice in writing. This is particularly important where the client is determined to take a risky course of action against your advice.  

Advice is often time dependent e.g. the purchase of shares at a particular value. One should therefore ensure your diary system is kept up to date and clients should be advised in writing of the risks if they do not meet any particular deadlines.

Conflicts of interest

Alleged conflicts of interest have arisen in several cases over the last few years. These often arise where the financial advisor is both the product producer and the party retained to advise the customer on an investment strategy. In such circumstances, there will inevitably be a question as to whether the advice to purchase the product was impartial and in the client’s best interests. Similar issues may arise if a Financial Professional enters into Distribution agreements whereby it obtains a fee or commission from a third party product producer for introducing its clients to them. If that product performs badly, clients may seek recourse from their advisors for recommending it.

Dealing with a claim and insurance issues

There is a possibility that despite being careful, an adviser may still make a mistake that results in a claim. It is therefore critical to maintain adequate professional indemnity insurance for the sort of work you are carrying out. This requires careful consideration. For example, what is the value of the transactions or advice you are carrying out, what level of loss could your business withstand if it was successfully sued. Most policies of insurance will have limits of indemnity and in the event of an award of damages in excess of that sum, your business will have to make up any shortfall. Policies will also include an excess or a sum that you are required to pay in damages in the event of an award of damages and or in defence costs. This figure should not be so large that if you were to be sued a number of times in a given year, that it would devastate your business. The policy excess is often payable on an “each and every claim” basis so if your policy excess were for a sum of say €50,000 and you got three claims in a given year, you might have to pay €150,000. Many businesses, could not afford this.   

Typically, the first hint of a potential claim a financial services provider may receive is a Data Protection Access Request from a client. As financial professionals retain a lot of personal data concerning their clients, clients will often seek a copy of this documentation to investigate whether or not a claim is merited and acquire supporting evidence prior to initiating a claim against you. Alternatively, the client may simply express dissatisfaction with your services, threaten to bring a complaint to the Financial Services Ombudsman or initiate legal proceedings.

If you become aware of circumstances that may give rise to a claim against you, check your insurance policy wording immediately and notify the matter to your insurers in accordance with the policy requirements to ensure you are covered for the claim.  Once you have done so, gather any evidence you have. This will be needed by your lawyers but discovery may also be requested.

Your checklist: Similar issues tend to arise in most professional negligence claims. If certain basic steps are taken the risk of claims may be reduced significantly. In summary, one should:

·         Familiarise yourself with the applicable regulations and codes and ensure they are followed as closely as possible.  

·         Issue detailed letters of engagement and or terms of business which will govern your relationship with the client and follow them;

·         Confirm all new instructions in writing and keep the client advised of the costs;

·         Document all advice provided to the client in writing.

·         Keep clear and thorough notes of all meetings and conversations with the client;

·         Not advise on something if it is outside your area of expertise or if you are unsure whether the advice is accurate;

·         Know your client and ensure the information you retain is updated regularly throughout the course of your relationship;

·         Advise the client of the risks if it does not meet deadlines or provide you with the information you need in order to deliver your service properly;

·         Avoid conflicts of interest.