Financial advisers can be more confident about what is expected of them in relation to their duty of care to clients as a result of the recent Armitage v Church case.
The decision is likely to form the benchmark for future cases under section 33 of the Financial Advisers Act as the Judge took the opportunity to comment extensively on the standard of care expected of competent financial planners and advisers.
This Brief Counsel draws some practical guidance from the judgment, including a suggestion that financial advisers revisit their disclaimers.
Brief summary - Armitage v Church
The plaintiffs were Neil Armitage, a retired public servant with a portfolio of investment properties, and his family trust. The defendants were Carey Church, a financial adviser with 20 years experience, and her company Moneyworks NZ Limited.
Armitage approached Church for advice in 2005, on how best to invest around $360,000 he expected from selling a property. Despite a risk profile questionnaire ranking Armitage as a “conservative” investor, Mrs Church advised Armitage to invest in a narrow range of fixed interest investments: four (now failed) finance companies (Bridgecorp Holdings Limited, MFS Finance Pacific, Strategic Finance Limited and North South Finance Limited); and two ING products.
In 2006 Armitage again sought advice from Church on how best to invest the expected proceeds from selling his remaining investment property ($640,000) as well as $430,000 of his own funds. This time a risk questionnaire produced slightly more aggressive results – Armitage ranked as a “balanced/ growth” investor, with his family trust a “balanced/moderately aggressive” investor. Church advised Armitage to invest in more ING products.
Bridgecorp was placed in receivership in July 2007. Around the same time, Armitage terminated his and his trust’s relationship with Church and Moneyworks. Armitage commenced proceedings in 2009 for losses of $292,000 he claimed were caused by Church and Moneyworks breaching their duty of care in the spread and risk level of his and his trust’s portfolio.
Dobson J held that Church had breached her duty to provide competent advice in the following ways:
- her recommendation that Armitage concentrate his investments in finance companies, as this was inappropriately narrow and exacerbated risk. She was also found negligent in her advice to invest in ING’s Credit Opportunity Fund (COF) as part of the fixed interest portfolio, as this was really a growth asset. Given Armitage’s risk profile, neither of these investments was appropriate
- her failure to recommend alternative, less risky fixed interest investments, such as government or listed corporate bonds, and
- her failure to disclose that her advice was limited to certain categories of investment, and that she restricted her investment research to finance companies and ING products. Her disclaimer was not enough to exclude liability.
Due to her high level of contact and close relationship with Armitage, Dobson J found that the corporate veil of her company Moneyworks Limited could not protect her from personal liability. His Honour found she should have reasonably foreseen the damage that would result from her failure to provide competent advice.
Interestingly, Church was not negligent in recommending Bridgecorp on its own, as the existence of Lloyds insurance as well as a positive rating justified her advice.
She was also not negligent in recommending the ING fixed interest investments. Even though there was only a single fund manager, the product spread was sufficient, unlike a single finance company debenture. Church was entitled to rely on ING at the time “as being sound and of good reputation, with very substantial backing.” The drop in value of the funds was due to the global financial crisis, which Church could not have reasonably foreseen.
All up, Armitage and his trust suffered over $200,000 in capital losses from Church’s breaches. However, Dobson J reduced damages by 25% as Armitage was partly negligent, and again by 40% due to evidence that Armitage would still have invested in finance companies even if a wider range of options were available (even after Bridgecorp became insolvent and he terminated his relationship with Mrs Church, Armitage continued to place funds with finance companies). Church was ordered to pay nearly $60,000 compensation for loss on the finance company investments, and around $8,500 plus interest on losses from the COF.
Practical lessons for advisers – what can advisers learn?
A number of practical lessons can be learnt from the decision, and Justice Dobson’s commentary is particular useful in this context.
Risk/reward, and use of risk profiles
Assessing a client’s risk profile requires more than just a risk questionnaire
Financial advisers cannot solely rely on risk tools such as risk questionnaires. They must “stand back from the quantitative outcome” of the risk questions and form their own view as to their client’s appetite for risk, including looking at the client’s background and the way they present themselves.
Assessing the risks of an investment
Before giving advice, financial advisers have a positive duty to actively assess and research the risks arising in relation to an investment, and form an independent view about them. It is not enough for financial advisers to rely on disclosures made by the investee company itself, or (if the company is listed) continuous disclosure obligations. Dobson J held that “except in unusual situations, competent financial advisers must assess the relative merits and risks of a potential fixed interest investment by research with sources other than the investee company”. Financial advisers will be expected to do more than simply rely on the silence of the investee company as a sign that all is well.
If the financial adviser does not fully understand the risks involved, they have a duty to seek assistance from someone who does.
Recommending investments suitable to the client’s risk profile
Financial advisers must recommend investments appropriate to their client’s risk appetite to satisfy their duty of care. Church had breached her duty of care in recommending COF, and the concentrated investment in finance companies, which was too risky considering Armitage’s conservative/ balanced risk profile.
Ensuring client is aware of risk / reward relationship
Financial advisers must ensure that their clients are aware of the relationship between risk and reward.
Matching recommendations to client income needs
Although Church was not found negligent for failing to match the investment recommendations to Armitage’s income needs, it is clear that financial advisers should have a clear understanding of their client’s assessed cash flow requirements, and take those considerations into account when making their recommendations.
Armitage had a need for cash income in order to service his bank loans, and claimed Church was liable as she should have checked his cashflow “budgets” and was responsible for his low returns from the ING investments. However these claims were not successful, essentially because Armitage decided not to realise investment properties (and pay back loans), contrary to Church’s advice – and importantly Dobson J found that there is no positive duty on advisers to ensure that investments (in this case, investment properties) are disposed of and mortgages discharged.
Importance of diversification and availability of other options
Financial advisers must ensure their client is aware of alternative options for investment. In this context, Church did not raise the possibility of investment in listed bonds (and her defence - essentially that she was not a sharebroker - was not sufficient to allow her to ignore listed bonds and other types of fixed interest security).
Ignoring classes of investments will no longer be an option for authorised financial advisers, given Code Standard 10 (of the Code of Professional Conduct for Authorised Financial Advisers), which requires disclosure of any limits on the possible investments recommended. When recommending only one class of financial product, authorised financial advisers must warn their client of the narrow scope of their advice. They also have a duty to inform their client that other investment alternatives exist.
General disclaimer not an escape route
Financial advisers must also take care to use specific wording in their disclaimers. Although Church’s disclaimer stated “Moneyworks provides comprehensive, and partial financial planning services if these are required”, she still had an obligation to specifically inform Armitage that her advice did not take into account more conservative non-finance company investments.
Care should also be taken when using general wording in disclaimers, such as stating that projected returns are “merely an expression of opinion and are intended for illustration purposes only”. Whether these types of disclaimers are effective will depend on the context in which the advice is given. Here, Church had specifically stated that Armitage’s returns would be sustainable, consistent and predictable - which was enough to render her disclaimer ineffectual.
Other disclosure requirements
Finally, Armitage restates the importance of financial advisers informing their clients of the fees they will charge, and any other interests and relationships with the investee companies that might influence their investment advice and recommendations. Here, Dobson J was critical of the fact that Church did not disclose the amounts she was paid by investee companies in return for recommending the investments made by Armitage.
This is now enshrined in the FAA’s disclosure regime for authorised financial advisers.
What lies ahead
The findings in Armitage v Church are likely to shape future thinking on the duty in section 33 of the FAA. This may not be the last word on this topic however, as Church has indicated that she intends to appeal the decision.