1. My remarks this morning, which are directed to the professional. negligence of financial advisers, will extend to the proposed new

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1 SPAA SMSF NATIONAL CONFERENCE, BRISBANE February 2011 PROFESSIONAL NEGLIGENCE 23 February 2011 The Hon Sir Anthony Mason AC KBE * Introduction 1. My remarks this morning, which are directed to the professional negligence of financial advisers, will extend to the proposed new statutory duty to act in the best interests of the client and what that may entail. The common law duty 2. A financial adviser, like traditional professional advisers, is liable, at common law, to his client in tort, for negligent counselling on the broad principle that if someone possessed of a special skill undertakes quite irrespective of contract, to apply that skill, a duty of care arises 1. The standard of care is one of reasonable skill appropriate to the position and status of the adviser. The standard is an objective standard; the court determines what that standard requires in the particular case. * Sir Anthony Mason is a former Chief Justice of the High Court of Australia and SPAA Patron 1 Midland Bank v Hett [1979] Ch.384 at 411.

2 3. A Hong Kong case, Susan Field v Barber Asia Ltd 2, is a good illustration of what is involved. In that case, the defendant, an independent financial adviser, was held liable for breach of a duty of care to the plaintiff who was an inexperienced investor and wished to invest conservatively. The defendant advised her to borrow in one currency and invest in another, without explaining the risks. The Court held that the defendant failed to give effect to the plaintiff s wish to invest conservatively and in circumstances where the plaintiff was known to be investing the whole of her savings. Further, the defendant did not warn of the currency and gearing risks, while advising an investment which was unsuited to the plaintiff s circumstances. A reasonably prudent investment adviser would be expected to warn of particular risks and should not recommend an investment which is or should be known to be unsuitable for the intending investor. 3 The decision points up the importance of tailoring the advice to the client s instructions which the adviser knows or ought to know. There have been similar cases in Australia where customers have sued banks who have advised customers to take up foreign currency loans without explaining the risks. 4. In the Hong Kong case, Deputy Judge Barma said: 2 [2003] HKC 712; affd. on appeal [2004] 3 HKLBD NMFM Property Pty Ltd v Citibank Ltd (No.10)(2001) 156 CLR 442 at [423]-[444]. 2

3 In general, where a defendant assumes the responsibility of providing advice to a plaintiff, and knows or ought to know that the plaintiff is likely to rely on that advice, a duty of care is likely to arise. Pertinent factors to take into account will also include the relative skill and knowledge of the parties, the context in which the advice is given, whether the giver of the advice is doing so completely gratuitously or is getting a reward, whether in some direct or indirect form, and whether or not there are any express disclaimers of responsibility (which would negative any assumption of responsibility by a defendant). 4 The Judge s reference to disclaimers draws attention to the ability of a party to a contract at common law to include in the contract between adviser and client of a clause excluding liability for negligence. Although the courts scrutinize such a clause very closely, it is possible to exclude liability for negligence by a clause clearly excluding such liability. It is not, however, possible to exclude or avoid liability for breach of the statutory duties to which I shall refer shortly. 5. The common law duty extends to the provision of information as well as advice. But the distinction between seeking information and advice will be critical in some cases, particularly cases where an experienced or sophisticated investor is seeking information rather than advice and making his own investment judgment on the basis of the information supplied. In such a case, if there was no negligence in the provision of the information, then the adviser cannot be held responsible 4 Ibid at [155]. 3

4 if the investment is a dud. Of course, in some such cases, the client may claim that he relied on the adviser s advice as well as information. Another Hong Kong case, Formosa Taffeta Co. Ltd. v Banque Suez 5, is an example of such a claim which was rejected on the ground that the plaintiff, a experienced investor, was merely seeking information (which was correctly provided) and was making its own judgment on whether to make the investment. 6. The fact that an adviser is selling products to a client does not mean that the adviser is not under a duty of care. Even a salesperson may be under a duty not to recommend a high risk product without pointing out that risk. A representation that a product is suitable to an investor and risk free may well be a representation that an investor is entitled to rely on If a financial adviser has a conflicting interest e.g. if he recommends a product for which he is remunerated by the product provider, the adviser is more vulnerable to a finding of negligence, simply because a court or tribunal may conclude that the adviser put his own financial interest ahead of the client s. Here it is important to 5 [2009] 1 HKLRD ibid; see also J P Morgan Chase Bank v Springwell Navigation Corp [2008] EWHC 1186 (Comm) at [108]. 4

5 appreciate that the disclosure of the adviser s interest is not of itself an answer to a claim of negligence. Full disclosure may enable the adviser to retain the remuneration from the product provider but it does not avoid a claim for negligence as a watertight exclusion of liability would. The statutory obligations 8. First, s.12 ED of the ASIC Act 2001 (Cth) provides that, in every contract for the supply of financial services to a retail consumer (as defined) in the course of business, there is an implied warranty that the services will be rendered with due care and skill. This provision reinforces the common law duty of care. Section 12 EB renders void clauses which seek to exclude or limit the liability of a financial adviser under s.12ed. 9. Second, ch.7 of the Corporations Act 2001 (Cth) imposes various obligations on Australian Financial Services Licensees (AFSLs) and their authorised representatives with respect to financial product advice and other matters. Section 945A(1) requires the adviser not only to determine the client s relevant circumstances but also to make reasonable inquiries in relation to those circumstances. The adviser is then required to give such consideration to, and conduct such investigation of, the subject matter of the advice as is reasonable in all the circumstances and to give 5

6 advice that is appropriate to the client, having regard to that consideration and investigation. The Regulatory Guide provides guidance on what those obligations involve. It is an offence not to comply with the obligations and a client can recover loss or damage sustained as a result of non-compliance. These obligations also cannot be excluded by contract. 10. Section 945B imposes an obligation on a licensee or his authorised representative to warn the client if the advice is based on incomplete or inaccurate information. 11. The obligations imposed by ss. 945A and 945B apply only to licensees and their authorised representatives. The proposed statutory duty to act in the best interests of the client 12. The proposed new statutory duty to act in the best interests of the client arises out of Recommendation 1 in the November 2009 Report of the Parliamentary Joint Committee Inquiry into financial products and services in Australia ( the Ripoll Report ). Recommendation 1 was in these terms..that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an AFSL requiring them to place their clients interests ahead of their own. 6

7 13. The Ripoll Report assumes that an adviser can provide advice not in the client s best interests yet comply with s.945a (see Report para.6.28). This problem should be put at rest by amending s.945a as the Report suggests. It would, however, be confusing to call the new statutory duty a fiduciary duty as such a description will only suggest, quite wrongly, that the new duty is associated with the negative duties of a fiduciary (a) not to put himself on a position of conflict of interest and duty and (b) not to make an unauthorised profit out of the fiduciary relationship. 14. In essence the obligation to act in the best interests of the client requires the adviser to put the client s interests ahead of the adviser s interests (e.g. his entitlement to remuneration on recommended products) and the interests of any third party. But the duty of the financial adviser to his client cannot be limited to the obligation to put the client s interests ahead of the adviser s interests and the interests of others. The financial adviser must be required to provide advice that is appropriate having regard to the client s instructions and his circumstances which the adviser knows or ought to know. In this respect, one alternative is to marry the duty to act in the best interests of the client with the existing provisions of s.945a. 7

8 15. Another alternative would be to mould the new s.945a in the light of the provisions of ss dealing with the duties of directors of corporations. This alternative would require some surgery on ss because the complex duties of a director are different in kind from the specific duty which a financial adviser owes to a client. What is more, there is no reference in the context of a director s duties to a requirement for the exercise of skill which is an express or implied element in any formulation of a financial adviser s obligations. Moreover, the references in s.180 to business judgment and proper purpose, while appropriate to a director are by no means apt in the case of the financial adviser. That said, s.945a could build on the defence provided for in s.180(2), though modifications would be needed, as I shall point out. 16. It is proposed that a financial adviser should be able to avail himself of a defence of having taken reasonable steps to give appropriate advice to the client. Under this defence, an adviser would need to establish that, in considering the client s circumstances, he went beyond the adviser s list of remunerated products and identified a reasonable range of products outside that list, though he would not be expected to have knowledge of every product. He might well need to show that he 8

9 made appropriate inquiries to ascertain whether there were particular products to meet the special needs of the client. And, in most cases, he might need to show that he drew the client s attention to products not on his remunerated list. The onus of establishing a defence would be on the adviser. 17. If an adviser were to recommend a product on his own list, he would need to establish why it is better-suited than, or as well-suited to the client s needs as, available competing products. If he is not prepared to recommend a product beyond his own list, he should refer the client to another financial adviser. Indeed, the proposed new rėgime may well impose such an obligation on the adviser. 18. The defence in s.180(2) of the Corporations Act which, subject to modifications, could form the basis of a statutory defence for financial advisers. The defence refers inaptly to the making of a business judgment (it is defined by reference to the business operations of a corporation) and proper purpose (an expression which is related to the complex purposes of a corporation). The defence also sets standards by reference to the reasonable belief and rational belief of the adviser in relation to informing himself of the subject matter of his judgment and whether the judgment is in the best interests of the 9

10 corporation (client. The question here is whether the prescribed standards should be set by reference to the adviser s subjective beliefs or an objective reasonable standard. Both the common law approach and the existing s.945a mandate an objective reasonable standard. The reasonable or rational subjective belief may be appropriate standard for the director but is it appropriate for the financial adviser? The common law and the framers of s.945a would answer this question in the negative. 19. It is very important, however, to note that the common law and s.945a proceed on the footing that a plaintiff client bears the onus of establishing his case against the financial adviser, whereas the proposed statutory defence seems to proceed on the footing that the financial adviser bears the onus of establishing the elements of his defence. It is by no means clear what the plaintiff client needs to establish in order to bring about a situation in which the financial adviser is called on to make out the proposed defence perhaps it is envisaged that the plaintiff simply shows a prima facie case that the financial adviser did not put the plaintiff s interest first. If so, the statutory duty would be separate from and, in addition to, the adviser s common law and existing statutory obligations and constitute another layer of duty. 10

11 An exception for intra-fund advice? 20. It has been suggested that intra-fund advice should be excepted from the proposed statutory duty. If the exception is strictly confined to the provision of information about a contributor s existing entitlement in a fund, that is one thing. But to grant an unqualified exception for the provision of financial advice by a fund to a contributor would be to drive not only a horse and cart but a road-train through the statutory duty. Conclusion 21. It is important that the new provisions be clearly drafted and as simple as possible and that they clearly identify the class of persons on whom the duty is imposed e.g. AFSLs and their representatives. The relationship between s.12ed of ASIC and s.945a should be spelled out. It is undesirable to have an adviser s statutory obligations to a client set out in different statutes without any attempt to bring them together. 11