Risky Business: Avoiding negligence claims when giving investment advice

News

01.12.2016

The High Court has reiterated the importance of investment advisers giving adequate information to clients about the risks of investments. In doing so, the Court has also clarified the test for professional negligence claims against investment advisers.

In this briefing note, Kate Allass and Jolyon Connell review the important recent decision in O'Hare v Coutts & Co [2016] and discuss its implications for those advising investors.

The existing test

A financial adviser has a duty to exercise reasonable care and skill when advising a client to make investments. But how does one determine whether the adviser has fallen short of the requisite standard?

For many years, the test for professional negligence claims derived from the seminal case of Bolam v Friern Barnet Hospital Management Committee [1957], namely whether the professional has acted "in accordance with a practice of competent respected professional opinion" that is to say "in accordance with a practice accepted as proper by a responsible body of… men skilled in that particular art". What became known subsequently as the 'Bolam Test' is therefore to assess whether, irrespective of the outcome of the advice given, a reasonable practitioner professing the expertise of the professional in question would have given advice in the terms that they did?

The facts of this case

Mr and Mrs O'Hare were clients of Coutts & Co, which was retained to provide: (i) private banking services; and (ii) advice about investment services offered by Coutts and the kinds of investments that Coutts considered would be most appropriate for the O'Hares. Between 2007 and 2010, the O'Hares made a series of substantial investments, each time following Coutts' advice. The investments were not successful and the O'Hares suffered considerable losses. The O'Hares issued High Court proceedings against Coutts for breach of contract (implied duty of care and skill), professional negligence, breach of statutory duty (those arising under COBS) and negligent misrepresentation. While each cause of action was different, they shared a common allegation: Coutts' advice to the O'Hares was negligent as the investments recommended were unsuitable and/or too risky for the O'Hares. Coutts denied each of the allegations and the claim proceeded to trial before the High Court.

The Judgment

The judgment covered several interesting issues, including the extent to which investment advisers can rely on salesmanship and persuasion as part of their 'advice'. However, the key issue for the purposes of this note is the Court's findings as to the test for professional negligence when providing investment advice.

The Court held in favour of Coutts. In doing so, it adopted what was effectively a two-stage test. The first question was whether Coutts had taken the necessary steps to ensure that the O'Hares understood the risks of the investments proposed. When considering that question, the Judge held that the long-standing Bolam Test does not apply. Instead, rather than the objective Bolam Test as to what steps a reasonable practitioner ought to have taken to ensure an investor understood the risks, the Court favoured a subjective test looking at precisely what steps the adviser (in this case Coutts) did actually take to make sure the investor (the O'Hares) was aware of the risks. In doing so, the High Court followed the recent decision of the Supreme Court in Montgomery v Lanarkshire Health Board [2015] which set out the need for an adviser "to take reasonable care to ensure the [investor] is aware of any material risks involved…and of any reasonable alternative". As to what constitutes a 'material risk', the test is "whether, in the circumstances of the particular case, a reasonable person in the [investor's] position would be likely to attach significance to the risk, or the [adviser] is or should be aware that the particular [investor] would be likely to attach significance to it".

In support of that approach, the High Court pointed to the fact that (as demonstrated by the conflicting expert evidence presented at trial) there appeared to be no industry standard within the private banking sector as to what constituted the (objective) steps that a reasonable practitioner might have taken with regards to the investor's appetite towards risk. On the other hand, the statutory duties of investment advisers under COBS were deemed to be more consistent with the (subjective) 'Montgomery Test'. The Court held that Coutts had taken the necessary steps to ensure that the O'Hares understood the risks of the investments proposed and, as such, Coutts passed the subjective 'Montgomery Test'.

Having done so, the second question was whether the investments were suitable for the O'Hares. This question extends beyond risk alone and the Court made clear that the standard to which an investment adviser is to be judged in terms of suitability of investments remains the objective 'Bolam Test': ie would a reasonable practitioner professing the expertise of the professional in question consider the investments to be suitable? Again, this is in keeping with the equivalent duties under COBS – especially Rule 9.2. In answering that second question, the Court held that the investments recommended by Coutts were suitable because competent practitioners at the time (without the benefit of hindsight) would have regarded them as suitable for investors in the O'Hares' position.

Conclusions and implications

An investment adviser's obligations have not changed: a duty to exercise reasonable care and skill is still owed under both the contract and the statutory regime (COBS).
However, the Court's test for assessing whether the adviser has discharged that duty has now changed in respect of ensuring the investor understands the risks of the investment. No longer can the investment adviser rely on what other practitioners in the industry would have advised at the time about risk. Following the 'Montgomery Test', the adviser must ensure that sufficient advice is given so that this particular investor understands the risks of this particular investment.
The 'Montgomery Test' is subjective and so there is no hard and fast rule as to what level of advice about risks will be sufficient and what will be inadequate: it will depend on the facts of the case. At the very least, however, advisers must ensure that they explain to investors any risks to which a reasonable investor ought to attach significance.
Record keeping is key. Coutts was able to discharge the subjective 'Montgomery Test' because it was able to point to considerable evidence – in the form of written advice, meeting notes, emails, attendance notes, etc – which demonstrated the dialogue into which they had entered to ensure the O'Hares were adequately advised about risks. In the absence of good record-keeping, it will be much more difficult for an investment adviser to satisfy the Court that adequate and regular risk warnings were given.This case reiterates that, provided that the investor has received adequate risk warnings from the adviser and the investments were objectively suitable for the investor at the time, the Courts are likely to determine that the ultimate risk for the investment decision falls onto the investor and not the adviser. Consequently, advisers that have explained the risks satisfactorily (and kept records of that advice), and recommended investments which would have been considered by competent practitioners at the time to be objectively suitable, should be very well placed to withstand claims for negligence from disgruntled investors who have suffered losses from having followed that recommendation.

If you require further information about anything covered in this briefing note, please contact Kate Allass ([email protected]; 020 3375 7220), Jolyon Connell ([email protected]; 020 3375 7205) or Grania Baird ([email protected]; 020 3375 7443) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Disputes page of our website.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.