Thousands of South Africans place their trust in financial advisers to professionally manage their money and their futures. Unfortunately, many of these investors lose their money but it is not always as a result of professional negligence on the side of financial advisers.
Investors need to clearly distinguish between losses arising from market or other risk versus those from professional negligence.
A critical consideration for financial advisers is the level of risk their clients are prepared to take on board when making investment decisions. There are trade-offs to be made between the level of risk and return that one receives and it is important that this is communicated to a client in a way that the client understands and accepts the implications of the decisions being made.
Risk means the chance of a loss in investment and not the actual loss – a deviation from the investor’s expected return.
TYPES OF RISK
Systematic or market risk – is the risk impacting all stocks, usually coming from national or global economic conditions.
Unsystematic risk – is usually event-based risk affecting one share only, such as a management change, reputational damage, fraud, etc.
Interest rate risk – where a change in interest rate affects value. Bond prices and their yields are inversely related. Thus, if the interest rate increases the bond price falls or drops to a discount, and if the interest rate drops the bond prices rises or is considered at a premium.
Inflation risk – comes about from inflation affecting prices and value and the buying power of money. For example, if you buy a bond with a coupon rate of 3%, then this would be the nominal return of your investment. However, if the inflation rate is at 2%, your purchasing power is only really increasing by 1%.
Business or financial risk – is the risk of deteriorating business conditions due to consumer demand, competition or industry disruption e.g. from new business models.
Political or social risk – is government policy affecting investments, or a complete political or security upheaval such as war or a revolution. Investors in Egypt would have encountered this risk in 2012/2013.
Currency risk – comes about through changes in the exchange rate relative to currencies which are detrimental to the value of the investment. For example, suppose that a U.S.-based investor purchases a German stock for 100 euros. While holding this stock, the euro exchange rate falls from 1.5 to 1.3 euros per U.S. dollar. If the investor sells the stock for 100 euros, he or she will realise a loss upon conversion of the profits from euros to U.S. dollars.
Credit risk – is when credit extended to a borrower or bank may be wholly or partially lost.
Concentration risk – occurs when investments or a business are locked into one region or one industry where the decline of the area or industry will affect value. For example, the price of airline stocks may be influenced by the cost of oil.
A financial adviser has a legal duty to exercise reasonable skill and care and liability may arise as a result of a breach of the duty of care or as a result of breach of contract.
Most of the clients of financial advisers have little knowledge of matters relating to finance and investment and place heavy reliance on their financial adviser.
In order to establish liability for a financial adviser’s professional negligence, it is necessary to show that the client actually placed reliance on the advice given. Where there is advice but no reliance in making an investment decision, no liability arises if loss results from the investment.
A financial adviser holds himself out as an expert or specialist. In cases alleging professional negligence where the financial adviser’s skill and competence are questioned, it is necessary to show that the financial adviser lacked the degree of skill and care ordinarily exercised by a reasonably competent professional financial adviser.
Conduct of financial advisers which may amount to professional negligence include:
- Failure to assess the client’s needs and financial situation;
- Failure to establish whether the client can afford the investment;
- Advising investment in products unsuited to the needs of the client;
- Failure to warn of the risks of the proposed investments.
APPROPRIATE FORUM TO CLAIM COMPENSATION
Investors can claim damages through a court of law, or refer the dispute to the “FAIS Ombud” (Ombudsman for Financial Services Providers) which can award compensation for financial prejudice or damage suffered up to its jurisdictional limit of R800,000.00. Deciding on which forum through which to claim depends entirely on the facts of each case.
Good investments can help people reach their financial goals and create long-term stability for themselves and their families. Yet, there is always some risk when people invest their money. The market fluctuates and high returns on investments cannot be guaranteed.
But not all losses are normal or are just the risk of doing business. Unfortunately, sometimes losses may be the result of professional negligence on the part of a financial adviser. Should the cause of an investor’s loss not be clear, it is advisable to seek legal advice promptly.
Opinion piece by:
Partner, Adams and Adams