In our last Insight we discussed the way that liability is apportioned under investment management agreements (IMAs) (see Pension Fund Investment: Where to Next? October 2008) and how pension schemes can improve their contractual position. With the latest round of trustee meetings revealing, in almost all cases, very poor asset performance, trustees might well be casting further afield and asking if the advice they relied upon in setting their strategies might not only have been better but might have contributed to their losses. However, successfully bringing a claim for poor investment advice is far from straightforward - we examine below the difficulties that trustees will encounter and the hurdles that they must overcome in order to pursue this course of action.
Trustees may begin by looking to their contractual agreements with investment advisers for a remedy. However, investment advisers are very unlikely to give any kind of contractual guarantee or even representation about performance. It is true that there is a trend among the major consultancies and some boutique firms to link remuneration to performance (the so-called “implemented consulting” model, where part of the day-to-day asset allocation is delegated to the consultant). However, this is not yet the norm. Most advisers will be careful in their contractual arrangements and are not going to take a risk for which they are not rewarded. They will also generally cap their liability under their terms of engagement.
The situation is, of course, different if the advice is found to be negligent, but even there trustees would have to show that the standard of care owed to them had been breached (i.e. that no reasonable professional adviser would have made the same recommendations) and that it was this breach which led to the loss. Because virtually all asset classes and therefore nearly all managers will be showing negative returns, establishing a breach of the standard of care for general performance is very unlikely: if every adviser and manager failed to foresee the extent of the markets’ decline then the test will not be satisfied.
What about particular investments which went awry? Investors who were exposed to the Bernard Madoff hedge funds are a good case in point, as are any who lost money when Lehman Brothers collapsed. Had Standard Life not compensated investors for losses in its Sterling Cash Fund (which was far more exotically invested than the word “cash” might suggest), it would be another example. They are bound to ask, should my adviser/manager not have known what was going on? Why did some banks, for instance, refuse to invest in Madoff funds or deal with Lehmans as a counterparty?
A similar test to the one described above, would be applied by the courts to a negligence claim brought in these circumstances: was the choice of counterparty so unreasonable that no other adviser would have made it? If this argument fails, however, there may be more scope to argue that the manager or adviser misrepresented the thoroughness of its due diligence processes in counterparty selection. This may require a detailed evaluation of the relevant contract(s) in order to understand what was said to the investors before they contracted.
If there is a potential claim for misrepresentation, it is important to categorise the nature of the misrepresentations first. The remedies sought by a victim of an innocent misrepresentation, where the misrepresentation was believed to be true, will be damages or rescission (i.e. setting aside) of the contract in lieu of damages, but not both. At the other end of the spectrum, the remedy for fraudulent misrepresentation is damages for all losses directly following from the misrepresentation (even if those losses are unforeseen). These losses can also include the loss of potential profits. Damages for fraudulent misrepresentation are awarded on a tortious basis, with the aim of putting the innocent party in the position they were in before the representation was made.
Other potential targets
Investment advisers are, by definition, expressly engaged to provide investment advice, but trustees deal with many other professionals so it makes sense to ask whether those professionals have any duty to give such advice to their customers. For investment managers such a right to give advice might be expressly covered under an IMA, which is a practical provision designed to assist if, for instance, the terms of some investment restrictions become impossible to comply with because of market movements. However, the wording under an IMA is usually that the manager “may” give the customer advice, not that he must do so. Banks and insurance companies are, if anything, less likely to include any reference to advisory services in their contracts, partly because it is safer (to avoid the risk of mis-selling) to disown the duty or ability to advise in a positive way and partly because they may not be authorised to give such advice (see below).
If there is no express duty, is there any ground to imply a duty to advise? Financial institutions are regulated in the UK by the Financial Services Authority (“FSA”) and are subject to its rules. Key to this issue is the category of investment business for which the firm is authorised, but also the FSA’s general principles for business, which apply to all authorised persons. These general principles include conducting business with integrity and exercising due skill, care and diligence in the process. The FSA principles are supplemented by the Conduct of Business Sourcebook. However, whilst the FSA principles are clear enough, they do not contain a positive duty to advise clients particularly where there is no authorisation to give investment advice, and proving a breach of the principles by an authorised person can be a difficult task. This is because the claimant has two hurdles to overcome, the first of which is showing the loss incurred was caused by the breach and secondly showing that the loss was a type the legislation is intended to prevent.
Establishing a claim for poor investment advice, whether given by an investment consultant, investment manager or another party such as a bank or insurer, is not easy. Whilst the natural urge to look for a scapegoat in the current market circumstances is strong, in most cases trustees would be better engaged in making sure they understand the risks in the investment process (such as the choice of a counterparty) and in tightening up the obligations of third parties contractually. This may take the form of more frequent reporting or a closer examination of selection processes.