With investment funds taking a hit in tough economic times, frustrated investors are looking for someone to blame. In this case, the applicants made several complaints to the Financial Ombudsman Service (FOS) against our client, a financial services provider (FSP), all of which were rejected by the FOS. 

Background

The FSP’s primary business was the provision of financial planning advice. Its licence to provide financial services commenced on 22 June 2006. Prior to that date (from 2002), two of the FSP’s former clients (the applicants) received financial services from the FSP’s predecessor. 

The applicants were assessed as ‘balanced’ investors, with an investment time horizon of in excess of 10 years. Based on their identified goals and objectives, investment risk profile, and other data collected, the FSP’s predecessor recommended a long term investment strategy involving double gearing to the applicants, which they agreed to implement in 2003. 

The FSP took over the ongoing advice relationship with the applicants in July 2006.

The complaint

The applicants raised a number of issues in their complaint against the FSP, summarised as follows: 

  • The double gearing strategy recommended to them in 2002 was not ‘good practice’ and inappropriate for them (the gearing complaint).
  • They were advised to sell down part of their portfolio at the bottom of the market, and their remaining portfolio was also switched from shares to cash at the bottom of the market (the timing complaint).
  • On two occasions in 2010, their portfolio was switched from cash to shares without their approval (the authority complaint).

The applicants could not articulate the loss they allegedly suffered as a result of these issues.

FSP’s response

In relation to the gearing complaint, we submitted that the strategy recommended to and implemented by the applicants was reasonable and appropriate, based on their goals and objectives, personal circumstances, and risk profile. We further asserted that, in any event, the appropriate analysis was of the FSP’s conduct after its licence commenced and the advice relationship commenced in 2006, and that the recommended strategy remained appropriate for the applicants, based on their goals and objectives, personal circumstances, and risk profile as identified on review in 2006 and 2007.

We submitted that the strategy performed positively and was sustainable from 2002 until the effects of the GFC began to be felt in 2008, it was affordable for the applicants, it was performing as expected, and the applicants were satisfied with the advice given.  Even after the applicants ceased to be clients of the FSP, they chose to persist with the same strategy until at least February 2013.

In relation to the timing complaint, we submitted that the switch from shares to cash was reasonable and necessary to avoid a margin call.  Corrective action was required at the time due to the unavailability of any other means of financial contribution from the applicants and the applicants agreed to the FSP’s switch recommendations.

In relation to the authority complaint, we submitted that the applicants gave the FSP a power of attorney before any portfolio switch was requested or effected, and that the applicants subsequently accepted and endorsed the composition of their portfolio.

FOS’s determination

FOS found wholly in favour of the FSP.

In particular, FOS concluded that the recommended double gearing strategy was appropriate for the applicants. FOS appropriately focused on the applicants’ position, and the FSP’s acts and omissions, after its licence commenced in 2006, and determined that:

“A prudent adviser would not recommend that a client cease a long term geared investment strategy after only being in the strategy for four and a half years unless the clients’ circumstances or goals and objectives had changed. Generally, long term strategies need to be implemented for the full investment timeframe (approximately seven to 10 years) to experience the full benefits and rewards of the strategy.”

FOS was satisfied that the FSP had a reasonable basis to recommend that the applicants continue with the double gearing strategy, for the following reasons:

  • The applicants’ financial goals and objectives and risk profile remained the same as that in 2002;
  • From October 2002 to September 2007, the applicants’ existing mortgage reduced by $258,152;
  • From October 2002 to September 2007, the applicants’ investments held outside of superannuation increased by $121,171;
  • From October 2002 to September 2007, the applicants’ debt increased (by $106,893), but FOS considered this was due to the applicants unexpectedly taking leave without pay, repayment of default interest on their pre-existing investment loan, and significant draw downs on their loans for personal use; and
  • As at September 2007 the margin loan, or double gearing portion of the scheme, only represented approximately 12% of the overall borrowings undertaken by the applicants.

FOS noted that “the above factors do not take into consideration the significant additional benefits received by the applicants during the period January 2003 to September 2007 from the interest savings on their mortgage as a result of the significant reductions in the loan principal”.

FOS considered that the strategy continued to meet the applicants’ goals and objectives and risk profile from 2007 to the date of exit (in January 2013), and that, although their overall net debt position increased during the period in dispute, this was not shown to be a result of any inappropriate advice provided by our client.  Rather, FOS considered the negative impact was more likely attributable to a combination of:

  • The volatility in the markets; and
  • The level of personal drawings made by the applicants.

In relation to the timing and authority complaints, FOS determined that:

  • Given the volatility in the markets, it was appropriate for the FSP to recommend that the applicants switch managed funds into cash to avoid any margin calls; and
  • The applicants had authorised the switches from cash to managed funds under a power of attorney issued to the FSP, and by their conduct.

Conclusion

Particularly in the wake of the GFC, many disputes have arisen between financial planners and their clients involving the appropriateness of gearing and margin lending strategies. Often, these disputes are simply run from the general perspective that such strategies are unsuitable for particular classes of investors.

However, as declared by FOS in the determination discussed above:

“There is no consensus in the financial planning industry regarding whether a double gearing strategy is appropriate for balanced investors. The appropriateness of double gearing must be considered in the context of each client’s circumstances.”

The determination is a useful and welcome reminder from FOS that a particular investor’s personal and financial circumstances, and goals and objectives, must always be the starting point for an analysis of the appropriateness of financial planning advice.

Richard Leahy