The Professional Duties Of Financial Advisers

Wed, 16 Jan 2013

By Olivia Chaffin-Laird

INTRODUCTION

I “Financial Advisers”

I shall deal with only one category of financial adviser and will not attempt to deal with the myriad of individuals that may fall within the title. This paper is limited to those who provide services to ordinary members of the public in relation to investments such as blue chip stocks and shares, unit trusts, open-ended investment companies, investment trusts, personal pension schemes etc.

II “Financial Advice”
The term is usually used to describe the nature of the service provided by the relevant categories of financial adviser. The word “advice” however in the sense of offering counsel or opinion as to action, is not always correct.

A financial adviser is required to provide their client with independent, objective advice. On the other hand, a representative is essentially a sales person who can sell only the financial products offered by their principal. It follows it is generally more accurate to describe what is said to the client as recommendations rather than as advice.

The “advice” in question is likely to be given as a preliminary to selling an investment of some sort.

III The Legal Framework

The system under the Financial Services Act 1986 Act has now been superseded following that Act being repealed. Most areas of financial services therefore, including investments, insurances and mortgage business are now regulated by virtue of Financial Services and Markets Act 2000 [“FSMA”]. 

FSMA is based on statutory regulation by a single regulator, namely the Financial Services Authority [“FSA”]. Section 19 imposes a general prohibition on the carrying on of any regulated activity without being authorised under the Act to do so, or exempt from the requirement.

It is a criminal offence to carry on a regulated activity contrary to the general prohibition or to wrongly claim to be authorised or exempt.

Regulated activities are defined in statutory instrument, Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, SI 2001 No 544. This is known as the “Regulated Activities Order” or “RAO.” The detailed rules by which all regulated activities are governed are set out in the FSA’s handbook which is freely accessible on the FSA website, ww.fsa.gov.uk. The Handbook is updated daily but it is possible to ascertain the text of the rules applicable as at a particular date by setting the search criteria.

To be authorised, the person needs to have been granted permission under Part IV FSMA to carry on one or more regulated activities. Such authorised person must not act outside the scope of the permission granted. If they do, they will be in breach of the FSA’s rules and liable in damages in respect of any loss arising therefrom.

Notwithstanding that, it is important to note the breach will not necessarily make the resulting transaction void or unenforceable.

IV Regulated Activity

Under FSMA there are two limbs to the definition of “regulated activity.” The first is that the activity itself has to be specified in the RAO; for example giving investment advice. The second is that the activity has to relate to an investment of a specified kind. These are also set out in RAO and include all the usual investments such as deposits, stocks and shares, debentures and government and local authority securities. They also include rights under insurance contracts, collective investment schemes, derivatives.

A financial adviser is independent of product providers and does not represent any of them. They are consulted and act for members of the public who become their clients. The adviser will enter into a contract with his client under which he advises his client in relation to the problem or requirement they may have, in consideration of a fee or the opportunity to earn commission on any business resulting from the advice

The FSA has decided to set new standards for the provision of independent advice. With effect from 1 January 2013 there will be a new definition of independent advice which will require the advice to be unbiased and unrestricted, and based on a comprehensive and fair analysis of the relevant market. 

This is intended to reflect the fact of a genuinely independent adviser being free from any restrictions that could affect their ability to recommend whatever is most suitable to the client. Advice which will not be independent in the above sense, will have to be labelled as restricted advice and clients will have to be told that that is what is being provided, FSA Factsheet for financial advisers “Improving your understanding of the Retail Distribution Review [RDR] – Independent and Restricted Advice” (09/10)

CONTRACTUAL AND TORTIOUS DUTIES

Unlike a representative, which is not dealt with in this paper, a financial adviser will be in a contractual relationship with his or her client. Part at least of the express terms of this contract will be in the document known as terms of business or terms of engagement or client agreement. It follows that the financial adviser will be subject to contractual duties as well as duties imposed by the regulatory regime created by statute. 

Financial Advisers are also subject to the duties imposed by the general common law (including, of course, the rules of equity.) Many of the rules of the FSA overlap with the common law rules, but it is necessary to consider the common law rules separately as each set of rules may give rise to a separate cause of action.

A COMMON LAW

At common law, an IFA may become liable to a client under one or more of the following heads:

(i) breach of contract;
(ii) negligent misstatement under the principle in Hedley Byrne v Heller [1964] AC 465. In this context, a misstatement includes both the provision of wrong advice and the provision;
(iii) for deceit under the rule in Derry v Peek [1889] 14 App Cas 37

Although financial advisers are subject to the same rules of the general law relating to misrepresentations as representatives, section 2(1) of the Misrepresentation Act 1967 operates in a different way in claims against them. The wording of that section gives the representee a cause of action for the misrepresentation only if the misrepresentation was made by another party to the contract which resulted from the misrepresentation. Of course, the financial adviser will not, ordinarily, be a party to the investment contract. 

Further, since the financial adviser was acting as agent of the client at the time, the other party to the investment contract will not be vicariously liable for them. But, in such a case the misrepresentation will probably have involved a breach of the financial advisers duty to act with skill, care and diligence and it follows that the client will be able to recover for any damage suffered in that way.

On the other hand, there will be cases in which the product being sold by the financial adviser is actually the product of the financial adviser. For example, the product may be a discretionary investment portfolio operated by the financial adviser. In that case, the adviser will be a party to the agreement which is in essence the product itself. If that agreement was induced by a material misrepresentation then a claim pursuant to the Misrepresentation Act 1967 will be available to the investor.

B IN CONTRACT

IFAs must enter into a written basic agreement with the client setting out the essential rights and obligations of the firm and the client. The terms of business or client agreement will continue to govern the relationship between the IFA and the client until ended by notice. But the terms of business or client agreement will not necessarily set out what the IFA has been asked to do at a particular time; it merely provides the framework within which the IFA will work. Thus, although an IFAs primary duty is to carry out what he has agreed with the client who is his principal, it may not be easy to ascertain precisely what the IFA was asked to do on a particular occasion. In such circumstances the scope of the mandate will be inferred by surrounding circumstances.

• Duty to Exercise Reasonable, Skill, Care and Diligence

The contract between the IFA and the client will include an implied term, if not an express one, that the IFA will carry out his mandate and the tasks associated with it with reasonable skill, care and diligence. He must exercise that degree of skill, care and diligence that would be exercised in the ordinary and proper course of a similar business and employ the skill usual and necessary in the business for which he receives payment.

In ICS Ltd v West Bromwich Building Society (No2) [1999] Lloyds Rep PN 496 at 504 Evans-Lombe J said that in carrying out its tasks for a client, an IFA: 

“…owed to its clients contractual duties to exercise the care and professional skills appropriate to an organisation presenting itself as an expert independent financial adviser; to provide its clients with independent advice in their best interests and not to allow its own interests to conflict with those of its clients…”

The rules of the FSA require that the contractual terms of business must not exclude or restrict any duty or liability and IFA may have to a client under the regulatory system. This duty of skill, care and diligence arises primarily in contract but its breach will also amount to the tort of negligence.

The contractual duty to exercise due skill, care and diligence will apply to those tasks in respect of which judgment of experience or analysis is necessary, such as analysing the facts and circumstances relating to the client and his objectives, giving advice and making a set or recommendations. There may however be other contractual duties of an absolute nature, and the mere failure to carry them out will create a liability to the client. 

The standard of skill, care and diligence required to discharge that duty is that exercised by the reasonably competent IFA. The test applicable to all professionals is the test in the direction given by McNair J in the case ofBolam v Fiern Hospital Management Committee [1957] 1WLR 582 at 586-587:

“…where you get a situation which involves the use of some special skill or competence, then the test as to whether there has been negligence or not is not the test of the man on top of the Clapham omnibus because he does not have the specialist skill. The test is the standard of the ordinary skilled man exercising and professing to have that special skill…”

• Execution-only transactions

Occasionally, the client will know exactly what he wants. For example, they will know exactly how a particular sum of money is to be invested. The IFA will be instructed to effect the investment. There will be no question of a client asking for, or the IFA giving, any advice or exercising any judgment as to the suitability of the investment for the client. The IFAs only duty is to carry out the instructions accurately and with reasonable expedition.

In those circumstances, the IFA will be liable for a failure to execute the instructions given to him, but not for a failure to advise or exercise any judgment as to the suitability of the transaction for the client. Further, the duty of care in tort would be negative by the fact the client did not rely on the IFA to exercise any skill or judgement, or give any advice.

It should be emphasised that the FSA and the courts will accept an assertion that a client was instructing a financial adviser on an execution-only basis only after close examination of the facts. This is because true execution only transactions by members of the public are comparatively rare.


• Fiduciary Duties

An IFA acts for their client in respect of the transactions carried out on behalf of the client. In other words, the IFA is the agent of the client. The relationship of principal and agent is one of trust and confidence, and is an example of a fiduciary relationship.

One of the consequences of this fiduciary duty is that when the IFA decides which product to recommend to the client, the IFA must not let that decision be influenced by any differential rates of commission applicable to the competing products. Another consequence of the fiduciary duty is that an IFA must disclose any commission he may be paid by a product provider, the FSA has detailed rules relating to the disclosure of charges, remuneration and commission, COBS 6.4

C IN STATUTE 

The Financial Services Act 1986 Act
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