Recent judicial support for the Financial Ombudsman’s alleged use of hindsight and personal experience of previous industry practice could not have come at a worse time for a sector waking up to all sorts of potential exposures in the aftermath of the credit crunch and associated economic downturn.
In July, the High Court upheld an Ombudsman decision against an IFA who had argued that the Ombudsman was wrong to make an award of compensation against him in respect of traded endowment policies (TEPs) on the basis of the Ombudsman’s own knowledge and in the face of written, contemporaneous evidence that such investments were considered low or low to medium risk by the financial services industry in 20021. The IFA, who has since retired, advised a 65-year-old architect (who was contemplating retirement) to invest in geared TEPS. The IFA argued that the decline in the market for TEPS and the returns from endowment policies in general was caused by tighter controls imposed by the FSA later in 2003 which resulted in with-profit fund managers reducing the equity content of their funds. He said, with the support of an article from the Financial Adviser publication, that the industry view in 2002 remained that TEPS were low risk investments.
Nonetheless, the Ombudsman upheld the complaint on the basis that the complainant was not to accept a significant risk. This is circular logic – referring to the risk about which the IFA said the industry did not know. However, the Ombudsman felt that the interest rates under the loan taken out to provide the gearing exposed the complainant to a risk of losses that was potentially unlimited given the value of the loan kept increasing until repaid at a time when returns from endowments were in doubt. The solitary article to which the IFA referred the Court did describe endowment policies as essentially low risk but made clear that the risk increased where the investor borrows to fund the purchase of premiums. The Ombudsman noted that the article was written by the managing director of the company who sold the policies and did not do any further research into the contemporaneous material but relied upon his own knowledge and experience of the relevant period. The Court expressed some sympathy with the IFA and the risk of hindsight but contented itself with a warning to the Ombudsman to guard against “any use of the retrospectoscope” when assessing what was known at a given historical point.
As so often seems to be the case, the underlying unsuitability of the investment in geared TEPS for this complainant may have justified the Ombudsman’s decision (at least in his own mind). Advisers and their insurers must guard against indiscriminate use of hindsight (or the ‘retrospectoscope’) in reviewing the investment recommendations that are now leading to losses. What most would describe as a judgement of hindsight can always be dressed up as a failure to appreciate the risks inherent at the time. A reminder of the legal principles in this area is therefore timely. LJ Megarry said in 1972 that advice may, with the benefit of hindsight, be shown to have been utterly wrong “but hindsight is no touchstone of negligence”. Professionals are to be judged by the standards applicable at the time of their advice. The ascertainment of the state of knowledge at the material time is therefore sometimes a central issue in any claim. It is determined not only by the recollection of expert witnesses but (more likely in FOS cases in which reliance on experts is rare) also by reference to contemporaneous published material. (In recognition of this, the AIFA has developed ‘Stakes in the Ground’ to provide documented evidence of current financial services practice.) Professionals are duty-bound to keep themselves informed but in practice they will not read or remember all relevant publications. For example, the Court of Appeal has held that an anaesthetist was not negligent for failing to read a particular article in The Lancet. Questions of liability are likely to be determined by whether the adviser reasonably relied upon a supportive body of professional opinion in their sector.
When highly-rated product providers (like AIG) or high street banks are no longer deemed as safe as they once were, complainants are bound to allege that their advisers should have known and warned of the risks (however small). Already people are saying “cash should be cash”, and “the information was there for those that wanted to look”. The defence to many of these allegations may well be simply to ask the complainant “would you really have done anything different if I had advised of those then small risks?”