Financial mis-selling in Ireland and the importance of knowing the consumer

 MARKET VIEW – LITIGATION 

John O’Riordan of Dillon Eustace explains what advisers should bear in mind

There has been a significant increase in recent years in the number of claims relating to the alleged mis-selling of financial products to consumers in Ireland. These claims have been varied in their nature but essentially they have a common theme, the sale of an unsuitable financial product to a customer, on the basis of incorrect and/or misleading advice.

A consequence of this is the importance of every financial adviser knowing and understanding exactly where the consumer, their client, is coming from when they advise them to purchase a product or make an investment. This includes fully explaining the product being sold and all of the terms and conditions attaching to the product, making sure that the nature of the product matches the consumer’s particular needs and wishes and a full explanation of the fees, charges and penalties that apply.

The importance of knowing and understanding your customer is particularly important in circumstances where it is the suitability of the recommendation for the consumer at the time the product is entered into or the investment is made, and not the investment performance of the product that is the key factor in considering what blame, if any, lies at the hands of the financial adviser.

Consumer protection

In Ireland, consumers have been protected through the enactment of consumer protection legislation and in addition to this legislation the Central Bank of Ireland plays a crucial role in the protection of consumers of financial services. The Central Bank imposes conduct of business rules through codes of conduct such as the Consumer Protection Code, among others. The code aims to ensure that financial services firms provide clear information along with suitable and appropriate products to consumers.

The general principles which are set out in the code provide a guideline for regulated entities to follow. These principles provide that a regulated entity must ensure that in all its dealings with customers that it, among other things:

• acts honestly, fairly and professionally, and acts with due skill, care and diligence in the best interests of its customers;
• does not mislead a customer about the advantages or disadvantages of any product or service;
• employs systems and control checks to ensure compliance with the Consumer Protection Code;
• requests from, and provides to, its customers information relevant to the product or service requested;
• fully discloses all material information, including information relating to charges;
• handles complaints speedily; and
• does not exert undue pressure or undue influence on a customer.

Know your customer

In addition to these general principles, the code also sets out a key requirement for regulated entities on ‘knowing the consumer’.

Before providing a product or service to a consumer, a regulated entity must gather and record sufficient information from the consumer to enable it to provide a recommendation or a product or service appropriate to that consumer.

The particular information that should be gathered should be appropriate to the type of product or service being sought by the consumer and it must allow the regulated entity to provide a professional service by advising the regulated entity on the consumer’s needs and objectives, their personal circumstances, their financial position, their investment experience and their attitude to risk.

In addition to these duties, the common law also imposes duties on those selling investment products and there are three key elements which must be present to constitute the tort of negligence as it would relate to an investment adviser:

• the existence of a duty of care;
• a failure by the adviser to conform to a required standard; and
• actual loss or damage caused as a foreseeable result of the failure by the adviser to conform to a required standard.

These duties and the importance of ‘knowing the consumer’ were recently considered in the Irish High Court in the case of Haughey v J&E Davy t/a Davy, Bank of Ireland Mortgage Bank and Bank of Ireland.

The plaintiff in this case was an advisory client of J&E Davy who invested in contracts for difference and ultimately suffered considerable losses from his investment. The plaintiff subsequently sued J&E Davy, claiming damages for both negligence and breach of contract.

The plaintiff had suffered a number of strokes at a young age and in his ruling, Judge Charleton placed emphasis on the fact that the plaintiff was not a person in the full of his intellectual, physical and mental health. The court also found that the plaintiff’s manner of speaking, his choice of words and the way in which he physically held himself would put any observer on warning that his condition was different to that of an average man of his age. His knowledge of the investment product at issue, contracts for difference, was seriously defective. The court was satisfied that decisions on contracts for difference involve a high level of intellectual functioning and require complex decision making which were beyond the intellectual capacity of the plaintiff.

In terms of the duty of care owed to the plaintiff by J&E Davy, Judge Charleton commented that it owed the plaintiff the duty of care that is appropriate to an experienced stockbroker towards a particular client when, pursuant to that duty of care, the stockbroker has taken appropriate steps to get to know the client and what their aims are, what their means of knowledge are, what their financial circumstances are, what the attitude of the client is to risk and importantly, judged objectively, whether that level of risk is appropriate to that particular client.

‘The Consumer Protection code sets out a key requirement for regulated entities on “knowing the consumer”.’

While accepting that share transactions invariably involve risk, the court was of the view that it does not necessarily absolve a stockbroker of liability if a client agreed to that risk without the needs, background and knowledge of that client being first properly probed and the advice tailored accordingly. The judge quoted the case of ACC Bank plc v Johnston, where the court held that while the duty of care of a professional person is often described by reference to the standards that would normally be applied by a professional of equivalent experience, the mere fact that a practice is universal does not, of itself, absolve the professional concerned from potential liability, if it is a practice which, on reasonable consideration, the professional should have identified as giving rise to a significant risk.

Judge Charleton emphasised that central to any view that might reasonably be held as to the nature of the stockbroker’s duty towards his client is that clients are different and before a client can be advised, reasonable efforts must be made to get to know the client. He referred to the binding obligation contained in the rules of the Irish Stock Exchange and cited rule 4.5.3, in particular, which provides that:

‘Before… [entering] into a relationship with a private client, other than an execution-only client, it must take reasonable steps to obtain information in writing from that client, details of his:

(a) personal financial situation;

(b) investment objectives;

(c) attitude to risk;

(d) investment experience;

(e) investment restrictions;

(f) any other facts about which the member firm reasonably believes it needs to know, or which it ought reasonably be expected to find out.’

The court was of the view that it was crucial to the relationship of stockbroker and client that the client paid for these services, and that the basis on which the client paid was that appropriate investigation should be carried out and the service tailored accordingly. The fees of J&E Davy were paid for discharging duties particular to the specific client and the court concluded that it failed to meet that standard.

Judge Charleton noted that the client has to be looked at in terms of what the client is and has, and if someone has an inheritance, as in the Haughey case, then that person may not be as shrewd as a person who has earned their money and worked their way into a level of wealth. If a client is taking too much risk, an execution-only service should be provided so that no advice or management is provided and investments are simply made according to the instructions of the client.

The court went on to summarise the correct way in which J&E Davy should have dealt with the plaintiff. Firstly, it should have made efforts to get to know the plaintiff properly. Secondly, if there was a desire, coupled with the appropriate knowledge, to engage in some form of trading in contracts for difference, the type of investment at issue in this case, someone with the plaintiff’s background should have been advised in writing against trading in contracts for difference. Thirdly, the court was of the view that the correct approach for any investment for the plaintiff with his particular needs and disabilities would have been to structure a share portfolio that was spread over time and over investments that would minimise risk.

The court was satisfied that the concept and ramifications of contracts for difference were never properly explained to the plaintiff by J&E Davy and ruled that there was a failure on its part to discharge its duty of care to the plaintiff which amounted to negligence and breach of contract over the relevant period of the relationship.

Steps an investment adviser should take to avoid mis-selling claims

Each consumer is different, with their own particular needs and objectives, and while it is not possible to provide an exhaustive list, in an attempt to avoid potential mis-selling claim, investment advisers should at a minimum ensure that they:

• act with due skill, care and diligence in the best interests of their clients;
• assess the particular needs of the client, including a review of their financial situation, investment knowledge, experience and investment objectives;
• know the consumer and have assessed the suitability and appropriateness of the investment; and
• ensure that the client understands the nature and risks associated with the investment.

Close attention should also be paid to the terms and conditions and the other documentation provided to consumers that forms the basis of the contractual relationship. Time should be taken to explain these and ensure that the consumer understands what they are signing up to, including a full explanation of the applicable investment policy and, importantly, categorising and agreeing the risk profile and level of sophistication of the consumer. In addition to these express terms advisers should be aware that the court will imply certain additional terms into the relationship, such as the Consumer Protection Code referred to above.

Conclusion

It is likely that in the current financial climate, the number of financial mis-selling claims will continue to increase. For firms offering investment advice, this should cause them to review their internal procedures and controls and risk management policies. For consumers, they should be aware that there is significant protection available to them. The Haughey case emphasises that the investment adviser must get to know its clients. If it fails to do so and subsequently recommends an inappropriate investment product for a client, it is open to a financial mis-selling claim notwithstanding the performance of the financial product.