When can you sue your financial adviser for loss?
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By Jean-Paul Rudd
Thousands of South Africans place their trust in financial advisers to professionally manage their money and their futures. Unfortunately, many of these investors lose their money, but it is not always as a result of professional negligence on the side of financial advisers.
Investors need to clearly distinguish between losses arising from market or other risks versus losses arising from professional negligence.
A critical consideration for financial advisers is the level of risk their clients are prepared to take on board when making investment decisions. There are trade-offs to be made between the level of risk and return that one receives and it is important that this is communicated to you in a way that you understand and accept the implications of the decisions being made.
Risk means the chance of a loss in investment, not an actual loss, which is a deviation from your expected return.
There are various types of risk:
• Systematic or market risk is the risk impacting all shares, usually coming from national or global economic conditions.
• Unsystematic risk is usually event-based risk affecting one share only, such as a management change, reputational damage, or fraud.
• Interest rate risk is where a change in interest rate affects value. Bond prices and their yields are inversely related. Thus, if the interest rate increases the bond price falls or drops to a discount, and if the interest rate drops the bond prices rises or is considered at a premium.
• Inflation risk comes about from inflation affecting prices and value and the buying power of money. For example, if you buy a bond with an interest rate of 3%, this would be the nominal return of your investment. However, if the inflation rate is at 2%, your purchasing power is only really increasing by 1%.
• Business or financial risk is the risk of deteriorating business conditions due to consumer demand, competition or industry disruption from, for example, new business models.
• Political or social risk is government policy affecting investments, or a complete political or security upheaval such as war or a revolution. Investors in Egypt would have encountered this risk in 2012/2013.
• Currency risk comes about through changes in the exchange rate relative to currencies which are detrimental to the value of the investment. For example, suppose that a US-based investor purchases a German stock for 100 euros. While holding this stock, the euro exchange rate falls from 1.5 to 1.3 euros per dollar. If the investor sells the stock for 100 euros, he or she will realise a loss on conversion of the profits from euros to dollars.
• Credit risk is when credit extended to a borrower or bank may be wholly or partially lost.
• Concentration risk occurs when investments or a business are locked into one region or one industry where the decline of the area or industry will affect value. For example, the price of airline stocks may be influenced by the cost of oil.
A financial adviser has a legal duty to exercise reasonable skill and care, and liability may arise as a result of a breach of the duty of care or as a result of breach of contract.
Most of the clients of financial advisers have little knowledge of matters relating to finance and investment and place heavy reliance on their financial adviser.
In order to establish liability for a financial adviser’s professional negligence, it is necessary to show that you actually placed reliance on the advice given. Where there is advice but you did not rely on the advice in making an investment decision, no liability arises if loss results from the investment.
A financial adviser holds himself out as an expert or specialist. In cases alleging professional negligence where the adviser’s skill and competence are questioned, it is necessary to show that the financial adviser lacked the degree of skill and care ordinarily exercised by a reasonably competent professional adviser.
Conduct of financial advisers which may amount to professional negligence include:
• Failure to assess your needs and financial situation;
• Failure to establish whether you can afford the investment;
• Advising that you invest in products that are unsuited to your needs; and
• Failure to warn you of the risks of the proposed investments.
Investors can claim damages through a court of law, or refer the dispute to the office of the “FAIS Ombud” (Ombudsman for Financial Services Providers), which can award compensation for financial prejudice or damage suffered up to its jurisdictional limit of R800 000. Deciding on which forum to use depends entirely on the facts of each case.
Good investments can help people reach their financial goals and create long-term stability for themselves and their families. Yet, there is always some risk when people invest their money. The market fluctuates and high returns on investments cannot be guaranteed.
But not all losses are normal or are just the risk of doing business. Unfortunately, sometimes losses may be the result of professional negligence on the part of a financial adviser. Should the cause of your loss not be clear, it is advisable to seek legal advice promptly.
Jean-Paul Rudd is a partner at law firm Adams and Adams.
This article appears in the October 2021 edition of our free monthly IOL MONEY digital magazine. To access the magazine go to the issuu website.