Why it pays to keep an eye on your advisers

A far reaching recent court judgement is being viewed as a wake-up call for financial planning dealer groups, highlighting the need to keep an eagle eye on their adviser supervision and to protect them-selves against those who act without their authority.

A far reaching recent court judgement is being viewed as a wake-up call for financial planning dealer groups, highlighting the need to keep an eagle eye on their adviser supervision and to protect them-selves against those who act without their authority. Zilla Efrat reports.

A Federal Court decision handed down last month has highlighted the huge financial exposure licensed dealers face for unauthorised acts of their advisers.

"In light of the decision, licensed dealers will need to consider whether their supervision of advisers needs to be upgraded," says Elizabeth O'Sullivan, principal of the Sydney firm ET O'Sullivan So-licitors which specialises in financial services industry issues.

The case, Capricorn Financial Planners vs Australian Securities and Investment Commission (ASIC), revolved around the actions of a "proper authority holder" of licensed dealer Capricorn.

Referred to in the court papers only as "Mr White", the financial planner placed $60,000 of a client's money into products which were not on Capricorn's recommended list of products.

The investments, however, were in companies in which White had a per-sonal interest and, according to a judgement, they turned out to be "disastrous".

O'Sullivan says: "Capricorn was not aware of the transactions and re-ceived no commission or other financial benefit from them."

In a bid for compensation, the client claimed against a security de-posit which Capricorn had to lodge as a condition of its dealer's li-cence - and won.

In terms of the Corporations Law, the regulator (which is now ASIC) can reward all or part of the security deposit as compensation for losses incurred "due to the failure of the licensee, or an agent or employee of the licensee, to carry on business under the licence ade-quately and properly", O'Sullivan says.

Capricorn appealed to the Administrative Appeals Tribunal in April last year and lost.

O'Sullivan says: "Capricorn was liable for White's conduct on two grounds. Firstly, under the common law of agency, White had "ostensi-ble" - that is apparent - authority to act on behalf of Capricorn and, secondly, provisions under the Corporations Law make a licensed dealer liable for the conduct of its advisers."

The Tribunal said the following points indicated that Capricorn had represented to the client that White had its authority to act in the relevant transactions:

* Capricorn's sign was displayed in White's office.

* White used Capricorn's stationery.

* The client had not been given any notice of restrictions that ap-plied to White's authority.

* The matters the client discussed with White were within the type of area covered in their relationship with Capricorn because they in-volved investments of money.

* The client had not been warned not to invest in anything other than products on Capricorn's recommended list.

O'Sullivan says: "Capricorn's supervision of its proper authority holders included requiring advisers to undertake training and abide by its guidelines and procedures.

"It also gave advisers a compliance manual, advised them of relevant rulings by the regulator and required them to attend planning and education workshops.

"The Tribunal decided that these supervisory procedures were not ade-quate, but unfortunately was not prepared to specify what would have been adequate supervision."

The Tribunal did state though, that where a dealer appoints a proper authority holder who operates out of separate premises and operates on a part-time basis, the dealer's duty to supervise is higher than if the adviser was an employee within the immediate area of supervi-sion of the dealer.

Capricorn appealed to the Federal Court, and lost the appeal in May.

During the appeal, Capricorn argued that it was not liable because White was

not "carrying on business under the dealer's licence" when he per-suaded clients to invest in products that were not on Capricorn's recommended list.

O'Sullivan says the Federal Court did not agree with this argument, noting that the investments were made as a variation to a financial plan prepared by Capricorn.

The court added that the investments were arranged in the office of Capricorn's authorised representative, where Capricorn's name was displayed, and on his advice, in the course of a transaction in which the client had sought Capricorn's investment advice.

The Federal Court also agreed with the Tribunal's conclusion that White had Capricorn's ostensible (or apparent) authority to do what he had done.

O'Sullivan says the Capricorn case clearly demonstrates that courts will impose on licensed dealers, liability for the conduct of advis-ers, including where the conduct is not authorised by the dealer.

She warns that the financial exposure of dealers for unauthorised acts of advisers could be very significant.

"This is a critical point which licensed dealers need to bear in mind when putting together or reviewing compliance programs and other risk management strategies.

"In particular, there is a need to regularly review the adequacy of the steps that have been put in place to supervise advisers and the adequacy of insurance cover in the event of a claim being made against the dealer for the unauthorised acts of its advisers."

Argyle Partnership senior partner Peter Bobbin adds: "One of the im-portant things to come out of this case is that good business risk management in the financial services industry is not just about man-aging the dealer/ authorised representative relationship, but also about clearly defining that relationship to clients.

"One way for dealers to avoid a Capricorn type situation is to commu-nicate directly with the client that the dealer is only authorised to recommend authorised investments.

"It may also be necessary to go the next step and that is to list what these authorised investments are."

Bobbin adds that another way to handle the situation is to only deal with proper authority holders who have assets of their own and can be sued.

He also advises dealer groups to carefully review their professional indemnity policies to ensure that proper authority holders who act beyond their authority are still covered.

"One might also require that independent proper authority holders have professional indemnity insurance to protect themselves if they act outside appropriate manuals," he says.

"I often say that the financial planning industry is in its adoles-cence. It is cases like these which are emerging now, and only now, that will bring the industry to its maturity.

"The industry has yet to understand clearly the responsibilities and roles of its vari-ous players and only when this is done, will it be able to understand good risk management practices."