Investors who have lost money in the current financial crisis will inevitably be thinking about whether they have grounds for making a complaint against their financial advisers. The FOS, in its budget for 2009- 10, envisages the volume of complaints next year will increase by two thirds. How will such complaints be determined?
Last October, the FOS published a series of case studies involving endowment savings plans. In the course of these, the FOS set out what appears to be a statement of general principle: “Our rules let us dismiss complaints about the performance of an investment. But often, although the consumer expresses the complaint in terms of performance, the underlying issue is whether the policy was suitable for them. So when we receive a complaint such as this one – about an investment providing little or no return – we will examine the evidence to see why the investment was sold, and whether it was a suitable recommendation”.
Thus, the Ombudsman will investigate complaints that allege no more than that investments have been performing badly. Mere bad performance will not establish liability, but full investigation of the complaint may show that the investment was unsuitable. The question of suitability should be investigated by reference to the facts as they were at the time of the investment, but it is impossible in practice for that investigation to be carried out without the benefit of the wisdom of hindsight
The FSA Rules create two gateways through which a justifiable complaint may be brought2
First, a firm must take reasonable steps to ensure that any personal recommendation or discretionary management trading decision is suitable for the client. In determining suitability, the firm must obtain information about the client’s knowledge and experience, financial situation and investment objectives. In determining whether the investment is suitable, the firm must consider whether the investment meets the client’s investment objectives, is such that he is able financially to bear any related investment risks and that he has the necessary experience and knowledge to understand the risks involved. Suitability is based on the client’s investment objectives but the rest of the test is objective. Needless to say, there have been frequent cases where the Ombudsman has said that, although a client knows of the risks he is entering into, nonetheless the transaction was not suitable because these were risks he ought to have been advised not to take.
Second, the Rules require that the investor must be provided with a suitability report. This must specify the client’s demands and needs, explain why the recommendation was considered suitable and must “explain any possible disadvantages of the transaction for the client”. The latter obligation may create considerable difficulties. Strict compliance would require a suitability report of encyclopaedic length. Most advisers have in the past warned of the key and most significant risks, and, in practice, of the risks where specific warning was required under previous generations of PIA and FSA Rules. Other risks which might now be perceived as obvious have not traditionally been addressed. Most significantly, any investment carries an element of counterparty solvency risk but this has rarely been the subject of express warning. On a strict reading of the rules, this means that every suitability report has failed to comply.
Defence lawyers will argue that the Rule must be treated as subject to a reasonableness test, but that is not what the Rule says and this particular rule contrasts starkly in its use of the words “must” and “any possible disadvantages” from many other rules which require reasonable steps to be taken.
In any court proceedings to gain compensation the claimant would need to establish that the breach caused his loss – in short, would a fuller risk warning have made any difference to his investment decision. If the adviser’s final conclusion would have been the same, it is most likely that the client would have made the same investment even with fuller risk warnings so there will be no justifiable claim.
However, it can be expected that clients will say they would have made a different decision if they had been warned of additional risks – and they may be believed by a judge. Where complaints are adjudicated by the FOS, there are only rare and limited opportunities to crossexamine the complainant to test what they would have done if they had been given fuller advice, and the FOS determines complaints on the basis of what “is fair and reasonable in all the circumstances” rather than strict application of legal principles. Where the FOS on this basis has declined to apply the normal law of causation, the applications for Judicial Review in the courts have failed.
In reviewing the economic situation in October/November 2008 the Chief Ombudsman, Walter Merricks wrote: “The impossible has become the probable”. Many firms and their professional indemnity insurers fear that they may be castigated for failing to predict and warn of risks which at the time would have been dismissed as so unlikely as to be negligible.