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FINANCIAL ADVISORS – LIABILITY

The recent case of Atwealth (Pty) Ltd and Others v Kernick and Others 2019 (4) SA 420 (SCA) illustrates the difficulties of proving that a financial advisor was negligent in recommending an investment that subsequently fails. In Atwealth, a financial advisor (Ms Moolman) had recommended to the plaintiffs (the Kernicks) to invest in two financial products that Ms Moolman believed would yield higher returns in line with the plaintiff’s investment criteria. When the Kernicks lost their investments entirely, they sought damages against Ms Moolman and her employer for the losses they sustained. The SCA, per Davis AJA, found that the plaintiffs had failed to present evidence on (i) what kind of research and due diligence a reasonably skilled financial advisor would have done in the circumstances, and (ii) whether a reasonably skilled financial advisor would have made different investment recommendations, after having conducted adequate research. Since no evidence was presented on these points, the SCA found that the Kernicks had failed to establish liability on the part of Ms Moolman.

In the opinion of this writer, the second leg of the test used by the court in Atwealth is too subjective. If one were to bring ten experts to testify about whether a reasonably skilled financial services provider would have made a different investment recommendation after having conducted adequate research, one could expect a significant divergence of opinion. The reason for this divergence of opinion is that information about an investment is usually highly fluid and evolving, and it is furthermore difficult to establish whether the investment is actually aligned with the plaintiff’s investment criteria. For example, the plaintiff’s expert would need to assess and give evidence on (i) the plaintiff’s risk threshold at the time that the investment was being considered; (ii) what information about the investment was publicly available at the time when the advice was sought by the plaintiff; (iii) whether the available information about the investment pointed to risks that exceeded the plaintiff’s risk threshold; and (iv) whether a reasonable advisor would have advised the plaintiff not to invest in the investment.

A preferable approach to the question of what investment advice a financial advisor should give to his/her client is to be found in Durr v Absa Bank Ltd 1997 (3) SA 448 (SCA). This case is a locus classicus on the liability of financial advisors for negligent investments. In Durr, Schutz JA, took the view that two questions had to be answered:

1. What is the level of skill and knowledge required of a financial advisor? The court found that a financial advisor is not expected to bring to bear the highest possible degree of professional skill, but the level of skill possessed by the members of the branch of the profession to which he/she belongs.

2. Is the required level of skill to be considered from the vantage point of the average financial advisor, or a specialist advisor? Here, Schutz JA found that if the advisor was offering specialist advice, then the court could expect the advisor to have a comparable level of knowledge to other advisors in the specialist branch to which the advisor belonged.

Notably, the court in Durr stayed away from the issue (raised in Atwealth) of whether a skilled advisor would have made a different investment recommendation than the recommendation made by the defendant. The reason for this was succinctly stated at page 461A of the judgment: “ … the decision of what is reasonable under the circumstances is for the Court; it will pay high regard to the views of the profession, but it is not bound to adopt them.”

Instead, to reach its conclusion that the defendant financial advisor had acted unreasonably, Schutz JA focused on the following factual questions relating to the defendant's conduct: (i) did the advisor satisfy himself adequately that the investments in the company were safe? The court found that he had not. (ii) Did the financial advisor venture into a field that required skills that he did not have? The court found that he did. (iii) Could the advisor have sought assistance from a more knowledgeable person before recommending the investment? The court found that he could and should have sought this assistance, and his failure to do so was a breach of his duty to the plaintiff.

A final observation can be made about the nature of the expert evidence that the plaintiff produced in Durr to persuade the court that the defendant was negligent. The first expert produced by the plaintiff provided a detailed analysis of the true state of affairs within the company forming the subject of the investment. The second expert produced by the plaintiff gave evidence about what a reasonably competent financial advisor would have concluded concerning the company at the time that the defendant advisor advised the plaintiff to make her investment. This expert evidence enabled the court to draw the appropriate factual inferences about how a reasonable financial advisor in the position of the defendant should have acted.