Darryl Pereira | December 2011 | Financial Services & Life Insurance
How damages should be measured in a financial advice complaint can be a contentious issue. The release by FOS on how they measure loss contains useful pointers on their approach to calculating compensation. Licensees when preparing submissions should take into account the methodology FOS has stated it adopts in calculating loss in a financial advice complaint.
Who does this impact? Licensees, advisers and those in the wealth management industry.
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FOS release approach to calculating loss in financial advice disputes
What Action Should be Taken? Licensees should take into account how the Financial Ombudsman Service (FOS) has stated it will measure loss when preparing FOS submissions. Key points to consider are summarised in the conclusion.
Background FOS has recently published in Issue 7 of its Circular its approach to identifying and calculating loss in financial advice disputes. The guidance provided by FOS is timely given that from 1 January 2012 the compensation FOS can award for “direct financial loss� will increase from $150,000 to $280,000.1
How FOS will identify loss in Financial Advice Disputes For breach of duty and/or contract claims, FOS will identify whether losses claimed by an Applicant are too remote. If the losses claimed are too remote, FOS will not award any compensation. Where the losses claimed relate to misleading or deceptive conduct, FOS will only award compensation where the misleading or deceptive conduct materially contributed to the loss claimed.
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FOS release approach to calculating loss in financial advice disputes
The purpose of compensation FOS recognise that the objective of compensation where there has been a breach of duty is to place the Applicant in the position they would have been in if there had been no breach of duty.
>> if the Applicant sought the financial adviser’s advice – the reason why the advice was sought; and >> whether the Applicant had communicated an investment preference.
Loss is therefore measured by comparing the Applicant’s position after suffering the breach of duty with the Applicant’s position if the breach had not occured (subject to the compensation caps).
These factors indicate that FOS are less likely to assume an Applicant would have invested in a “suitable investment” where the Applicant did not seek the financial advice complained about.
Ascertaining what the Applicant’s position would have been if a breach of duty had not occurred
How does FOS determine the “suitable investments”?
FOS will usually consider the Applicant would have acquired a suitable portfolio of investments (the suitable investments) but for the breach in circumstances where an Applicant has received inappropriate advice causing them to acquire an unsuitable portfolio of investments. As a result FOS will measure “direct loss” by reference to the performance of the suitable investments in comparison with the performance of the unsuitable investments. For example if an Applicant lost $20,000 as a result of unsuitable investments, but would have only lost $10,000 with suitable investments, the direct loss for which FOS will award compensation would be $10,000. FOS indicate that “where it is not clear” what position the Applicant would have been if the breach had not occurred, they may consider the following factors to determine this issue: >> how the Applicant’s capital was invested immediately prior to the disputed investment; >> whether the Applicant was satisfied with the investments held immediately before the disputed investments; >> whether the Applicant actively sought the financial adviser’s advice or responded to an “unsolicited invitation” to obtain advice;
The methods FOS may use to identify the suitable investments can include:
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Darryl Pereira | December 2011
>> suitable investments the Applicant has switched to (where the Applicant has switched from the unsuitable investments); >> the suitable benchmark asset allocation used by the Licensee; >> the suitable industry benchmark asset allocation; >> suitable investments that were actually recommended by the Licensee to the Applicant; or >> other investments or indices that represent the suitable investments.
Loss calculation guidance in misleading or deceptive conduct claims The amount of the loss in misleading or deceptive conduct claims will depend according to FOS on whether the claim is a “no transaction” or a “different transaction” claim. FOS define a “no transaction” claim as a claim which arises where it appears the Applicant would not have entered into the disputed investments or any other investment if they had not been led into error.
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FOS release approach to calculating loss in financial advice disputes
In a “no transaction claim” FOS will measure the direct loss as the difference between the price paid for the disputed investments and their “end value”. A “different transaction” claim arises where it appears the Applicant would have entered into different investments than the disputed investments if they had not been led into error. FOS will usually measure the direct loss in such claims as the difference between how the alternative investments performed in comparison with the performance of the disputed investments.
Contributory negligence FOS outline that if it considers an Applicant has failed to take reasonable care of his or her own interests and that failure is a cause of the loss suffered, it will reduce the amount of compensation it will award.
Mitigation of Loss FOS confirm that Applicants have a duty to act reasonably to avoid or minimise losses caused by the breach of duty or contract. According to FOS the Applicant’s obligation to mitigate will arise after the breach of duty or contract has occurred and the Applicant was either aware of the breach or should reasonably have been aware of the breach. Factors FOS will consider when deciding whether or not an Applicant has suffered a loss they should have minimised will include whether there was any action the Applicant could have taken to avoid or minimise the consequences of the breaches.
Conclusion Key points arising from the release by FOS on how they measure loss are: >> FOS will usually measure “direct loss” as the difference between the value of the Applicant’s disputed investments and the value of the suitable investments (the investments an Applicant should have been in if there had been no breach). This approach is consistent with the rationale that an Applicant who sought financial advice would have followed appropriate advice into a suitable investment if it had been given.
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Darryl Pereira | December 2011
>> Licensees should, where appropriate, address in submissions what would have been a “suitable investment” (taking into account the matters FOS identify that they will look at when determining the “suitable investment”) and how that suitable investment would have performed. >> Where an applicant did not seek out the financial advice it appears FOS will be more likely to measure loss by reference to the loss sustained by the Applicant in being in the disputed investment or by reference to investments the Applicant was invested in prior to receiving the “unsolicited advice.” This approach may make a marked difference on the amount of compensation awarded compared to when FOS measures loss by reference to the performance of the suitable investment. Licensees should consider the circumstances in which an Applicant received the advice complained of when drafting submissions.
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FOS release approach to calculating loss in financial advice disputes
>> Where misleading and deceptive conduct is alleged, Licensees should identify whether the claim is a “different transaction” or “no transaction” complaint as different measures of loss will follow depending on which type of transaction the complaint falls under. >> FOS will take into account contributory negligence in determining whether an award of compensation should be reduced. FOS do not refer in the Circular to the decision of Middleton J in Dartberg Pty Ltd v Wealthcare Financial Planning Pty Ltd [2007] FC 116 which sets out that contributory negligence does not apply to inappropriate advice claims made under the Corporations Act 2001 (Cth). Determination number 21617 indicates that FOS considers that it retains a discretion to reduce any loss by virtue of an Applicant’s conduct if it finds it fair to do so despite the decision in Dartberg. In the circumstances Licensees should continue to raise contributory negligence (where applicable on the facts) in FOS complaints irrespective of the Applicant’s cause of action.
Endnotes 1
In disputes lodged on or after 1 January 2010, FOS may award up to $150,000 compensation per claim to an Applicant for “direct financial loss” and up to $3000 for consequential financial loss. From 1 January 2012, the compensation cap for direct financial loss will increase to $280,000. However, FOS may not award more than a total of $150,000 or $280,000 per claim (as the case may be depending on when the claim was lodged) for direct and consequential financial loss combined.
For more information, please contact:
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Darryl Pereira | December 2011
Darryl Pereira Partner T: 02 8257 5718 M: 0418 223 798 darryl.pereira@turkslegal.com.au
>> FOS confirm that an Applicant has a duty to act reasonably to avoid or minimise losses. The FOS approach to mitigation indicates that an Applicant may be taken to have failed to mitigate his or her loss where they do not take reasonable action when they become aware of the breach. Licensees should consider how the approach by FOS to mitigation of loss may impact on an Applicant’s quantum claim when preparing submissions.
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