Hartley Poynton lessons continue

It has only been a couple of weeks since the Supreme Court of Victoria ordered Hartley Poynton to pay Rahmat Ali slightly more than $1 million. While that may cause concern to Hartley Poynton, of greater concern are the issues raised in the judgment and the status of this decision as the next step in the road of defining the duty of licensees or dealers to their clients and the supervision requirements over their advisers.

Hartley Poynton learned its supervision systems were inadequate at an additional cost of $260,000 in exemplary damages. That is, had Hartley Poynton’s supervision systems been adequate, the amount it has to pay Ali would be $260,000 less.

This case is a notice to licensees and dealers that they should conduct a legal risk due diligence of their business and systems to avoid not only Hartley Poynton’s fate, but additional blame for inadequate supervision systems.

Hartley’s broker, Christopher Martin, had been introduced to Ali by a mutual acquaintance and being eager to secure the confidence of his potential new client, made various representations including the potential return he could achieve.

While Hartley Poynton did not condone or promote the actions of Martin, it was found wanting on the actions of its agent, so much so, that exemplary damages were awarded — the court made a penalty order above the determination to compensate the client.

Promoting yourself is part and parcel of any adviser’s daily business, as an adviser you are selling yourself and your skills, but at what point do your statements become misleading or binding representations, and not merely promotional? Justice Tim Smith made the following comments on Martin’s self promotion:

“Martin strongly promoted himself, and the defendant, and did so with special reference to their access to what he called privileged information not generally available to the market. This would greatly assist in profit making and significantly reduce risk in trading securities. He played down the risks involved, assuring Barba and Liyakat Ali that to invest through the defendant would be as safe as in the bank but generate greater returns. He represented that the risk of loss could be virtually eliminated because of the strategies he would employ, in particular, the stop loss and averaging strategies and his fast footwork and counter punching. Remarkably, he still projected the view that the risks were minimal when giving his evidence.”

Representations can be made to promote an advisers services, but when these representations becoming misleading, advisers will breach their duty to their clients. There is, however, a fine line between permissible aggressive promotion and misrepresentation.

The role of an adviser is complex, you must advise the client and make recommendations, you should not make their decisions. By making yourself the decision-maker, you increase your risks.

During the course of the trial, the defence stated that the client was an aggressive investor, and as such the losses sustained was an inevitable part of trading on the stock exchange. Had that been the case, then perhaps Hartley Poynton would have been successful, but it was not.

The position of Martin in the relationship with the client was more than adviser, it was that of the decision-maker.

“I am satisfied that throughout the period of the retainer, Liyakat Ali maintained and Martin accepted that there was an agreement that the Telstra shares would be repurchased. Martin skilfully managed to avoid doing so by relying upon the ascendancy that he had gained in the relationship as a result of the terms of the trading aspect of the retainer — he was the one in control . . .

“In my view, the plaintiff did not at the outset intend or wish to be an aggressive high return trader. The plaintiff did not expect that. But the plaintiff was persuaded by Martin to engage the defendant on the basis that Martin, as broker, would trade to obtain the target returns. He did so as a result of the negligent and misleading representations made about return and risk,” Justice Smith’s judgement says.

The role of an adviser is to assist and to steer their client with the benefit of their skills to meet the client’s objectives. An adviser should not override the client’s objectives or will with their own, even where they believe it is in the client’s best interests. An adviser holds a privileged position with their client, they should not use their position to succumb the client to their views.

Where an adviser is instructed to do more than execute the client’s orders, then they bear significant obligations. Where an adviser is to advise or conduct trading on behalf of a client, a client relies upon their adviser, thereby giving rise to fiduciary obligations. Justice Smith stated that such a relationship requires the highest level of integrity.

“It has been held that such a relationship between stockbroker and client demands ‘high standards of integrity’. The stockbroker acts ‘not for himself but for his client’. It has been said that clients are ‘entitled to expect from a broker not only competence, but also integrity and absence of conflicting personal interests. His position is one of trust and responsibility.’”

Quite clearly, any adviser who falls short from that standard will have breached his or her duty to the client. This duty exists independently of the retainer agreement an adviser has with the client and cannot be negated by the agreement — it arises from the relationship. But what does this mean for a dealer or a licensee? Is it enough to have compliance systems in place?

The Corporations Act makes it clear that a dealer or a licensee is responsible for the action of its advisers. Nevertheless, what requirements are placed on a dealer or licensee for it to meet its professional requirements?

Hartley Poynton had a compliance system, but they were found to be wanting in its duty to its client. It is of no benefit to have a compliance system that is not acted upon. While having a compliance system is important, acting on the information disclosed under the compliance system is critical. Justice Smith stated that Hartley Poynton had a duty to exercise reasonable care and control of their agent, something that it failed to do despite the existence of its compliance system.

“A stockbroker employing brokers cannot supervise each dealing they make as they make it. It can, however, set down policies. This the defendant did through its Compliance Committee in Perth. Policies, however, are worthless without systems and people in place to enforce those policies by checking from time to time that they are being applied ...

“There was, more particularly, no supervision and control of the way Martin carried out his trading activities, except for debt aspects and possibly, at one point, his short selling activity . . . There is a singular lack of evidence from the defendant, or submissions, on the monitoring, if any, of brokers by the Compliance Committee.”

Exemplary damages are a form of penalty, to punish a defendant and to deter others from repeating such conduct. As such, exemplary damages are not often awarded, and the conduct of a party has to be so disgraceful as to warrant such an order.

While an adviser may sign an agreement with their client, the relationship with the client is not an ordinary commercial arms-length arrangement, as an adviser owes a fiduciary duty to his or her client. Where a person has a fiduciary duty, then that person must act in the best interests of his or her client. It is because the adviser/client relationship is fiduciary and not merely contractual that gave rise to an order for exemplary damages.

Justice Smith determined that Hartley Poynton not only failed to take sufficient steps to look after the interests of their client, but had no effective system to monitor the actions of their broker. Accordingly, exemplary damages equal to the sum of all brokerage that Hartley Poynton had received from the client were awarded, thereby removing any benefit that Hartley Poynton had received from the client.

It is not enough to only ensure that appropriately qualified persons are appointed as advisers, but rather continuous review and compliance is necessary, otherwise a licensee’s duty to their client will be breached.

I think many will agree that the representations and actions by Martin are exceptional and not indicative of all advisers, but this case will be remembered not for the representations made by Martin, but for its position in further clarifying the direct responsibility a licensee or dealer has to its clients. To meet its duty, a licensee or dealer will have to become proactive.

This means that licensees and dealers must do more than review their supervision systems. This may mean dismantling and rebuilding systems and procedures. Diligent supervision controls require more than file audits. Possible strategies that may be utilised include documenting procedures, increased field audits and dummy clients testing the actual advice provided, the later being an inexpensive, yet effective quality control. The Australian Securities and Investments Commission believes in the effectiveness of dummy clients testing, so much so, that it recently announced that it will be conducting 500 dummy client tests across Australia.

Chris Tsovolos is an associatewith The Argyle Partnership,Lawyers.