Taking defensive action

There is much focus on the Australian Securities and Investments Commission’s (ASIC) requirements in regards to statements of advice (SOAs). Complying with these is essential. However, while planners may find a false sense of comfort in satisfying ASIC, this may not prevent a client suing you.

The only claims my company has ever settled, relating to investment advice, arose from the recommendation of unlisted property trusts in the 1980s. I have never forgotten the shock of the lessons learnt from those experiences.

Client attitudes

Planners can explain to a disgruntled client that ASIC is comfortable with the form of disclosure of risk used in the SOA, and the client can reply: “That’s nice for them, but I’m not happy. And I’m the client.”

In the client’s mind, the attitude of ASIC is irrelevant. Planners are subject to ASIC regulation, but clients are not. Protecting oneself from claims is an entirely separate issue.

This raises the question of the brevity of SOAs. ASIC wants advisers to communicate clearly. This is desirable, because it prevents important information being buried in verbiage and it fosters effective client relationship management.

However, it can mean that planners omit material which, if they ever find themselves being sued, they might wish they had included.

A case in point

Here is an example, based on real-world experience.

A client has a diversified portfolio, most of which performs well. The overall portfolio’s return is sound, but one asset class does badly. The client sues for losses produced in that asset. The planner points out that the rationale for diversifying was to allow for the fact that some investments will do badly at times.

The claimant responds that they have no problem with the overall portfolio, just the poorly performing part. The planner feels it is unreasonable to expect that every asset class in a diversified portfolio will perform well. All textbooks acknowledge this and ASIC acknowledges this. The trouble is, the client doesn’t care.

The reader may feel that this claim is so unfair that it would be easy to defeat. If so, the reader has not been on the receiving end of litigation. In this case, we engaged a Queens Counsel suggested by the private indemnity (PI) insurer — in other words, a highly skilled defence.

However, in any claim there is enormous pressure to settle. PI insurers know that it is expensive to go to court, and the outcome is a lottery. If they can settle for less than the cost of the case, they are very inclined to do so, almost irrespective of merits.

We experienced four claims, based on advice in the 1980s. One of them, in my view, was reasonable. The other three were outrageous. We settled them all.

Use of disclaimers

Another lesson is that a disclaimer is all but useless. We have recently had all our disclaimers updated by our lawyers, who have reiterated to us their limited value.

We also discovered that some claimants will lie outrageously, and the burden of proof is effectively on the planner. For example, one claim contained multiple statements from the client stating that they had made clear that they wanted advice with “no risk to capital”.

I knew this was false because this individual had attended a seminar I ran, shortly after the crash of 1987. The seminar focused heavily on volatility — as you do when shares have just fallen 25 per cent in one day. These clients knew that assets fluctuated in value.

But how do you disprove such a claim? Everything rests on what you have in writing. What do you have in your SOAs? Is there no more than a warning that assets are volatile and need to be held for the long-term?

If so, how do you defend against an attack along the following lines: “Mr Planner, your bland reference to volatility and statements that shares must be held for a minimum 3-5 year period withholds information that my client was entitled to know. You failed to mention that shares could produce a significant real loss over a decade. Your reference to ‘fluctuations’ really didn’t make clear that a market could lose 25 per cent in a day. Were you not aware of these facts or did you prefer not to disclose them?”

Expert witnesses

The PI insurer has to assess whether a judge will accept your explanation or those of the independent expert, who will be swearing you were negligent. The claimant will have no trouble finding someone willing to support even the most outrageous allegation.

We found ourselves facing such an “expert” who worked for an opposition company. He was not even in the industry at the time the advice was given, which he saw as having then been negligent. Why was this “expert” not destroyed in cross-examination?

These matters are rarely resolved in court, but rather in mediation. Mediation is basically a process where a third party tries to facilitate both parties settling. You might know the opposition is lying or incompetent, but it is matter of commercial judgement about whether it is worth the time, stress and risk of outcomes.

This is the greatest asset for the claimant. There is almost always a price at which it is worthwhile to make the issue go away.

Taking cover

How is the SOA relevant? Both sides assess their vulnerability. You look at what you have in writing.

This is regrettable. You find yourself including material, not to help clients, but to defend yourself against them. Most of your clients are reasonable. However, to some extent, you need to write the SOA recognising the existence of the minority who are not. This is a widespread problem in society. We need laws against fraud or rape because of a tiny minority.

I have previously written of the experience of being sued on the grounds that it was professionally negligent to construct a portfolio in accordance with a client’s instructions, when doing so caused losses. Many advisers imagine they are protected if they specify in writing that they are following instructions. You can defend yourself only if, among other things, you have in writing that you disagree with the instructions and why.

Without doubt, to include such statements is ‘ass-covering’. Regrettably, to not include them leaves your ass uncovered.

Advice for planners

I want to make clear that I believe clients are entitled to sue for poor advice. Many claims are reasonable and settlements appropriate. I am simply arguing that you need to write your SOAs to make sure you can defend against unreasonable attacks.

This will work against the desire for brevity. Certainly, any protective elements should be written simply and clearly. However, it is dangerous not to write them at all. Planners must be able to pass three tests by asking themselves:

n Is their conscience clear?

n Have they met ASIC’s requirements?

n Are they protected from unreasonable claims?

Doing all three may take more words than is otherwise ideal.

The best form of defence is to present the downside of your advice. Don’t gild the lily — for your client’s sake or your own.

Robert Keavney is chief executive officer of Centrestone Wealth Advisory .