Insurance implications of financial advisors´ duty of care: professional negligence in investment planning

Queensland Court of Appeal, 4 April 2008

CATCHWORDS

financial planner - financial advisor - negligence - duty of care - special relationship and duties - Australian Securities and Investment Commission Act (2001) - Westpoint Group Bayshore Mezzanine Pty Ltd

THE FACTS

On 6 April 2005 James Delmenico, retired commonwealth public servant, contacted Paul Brannelly, director of Brannelly Financial Pty Ltd, in response to certain advertised investments. One of the investments involved Bayshore Mezzanine Pty Ltd (Bayshore) and the issue of promissory notes by that company to fund a property development in Port Melbourne. Bayshore was part of the Westpoint Group. Delmenico asked Brannelly if he thought the investment was secure, and if so to send him further information. Delmenico declined Brannellys offer of a full financial plan and asked only for information on this particular investment. Delmenico specifically told Brannelly that he wanted a short term investment with a return of around 10% p.a. and that he had approximately $50,000 to invest.

On 18 July 2005 Brannelly sent a letter to Delmenico referring to the excellent opportunity to invest in high yielding promissory notes offering a 14% return on a minimum of $50,000 with a company who have an established record of over 20 years. The letter went on to say:

For specific projects, unsecured promissory notes are issued in a special purpose company. In each project, this company has a second ranking mortgage over the development property and a second ranking charge over the special purpose company. In addition, Westpoint Corporation and associated entities provide a guarantee for the companys obligation under the loan and security documents that will be released once all promissory notes have been repaid and all interest payments made.

Separately the letter referred to:

Security: guarantee from the Westpoint Group and a charge over the Bayshore Port Melbourne Trust Please note that the attached information is not financial advice and is for information purposes only.

Following receipt of that letter, Delmenico called Brannelly to let him know that he would be using borrowed money to invest and therefore required a return of around 10%. Brannelly said that Bayshore would be ideal for his purposes and was a secure investment. Brannelly sent an Information Memorandum¹ to Delmenico on 22 July 2005 and in the accompanying letter referred to the proposed investment as an excellent opportunity to invest . . . with a company who have an established record of over 20 years and went on to provide information on the size and operations of the Westpoint Group. This covering letter misstated the security of the investment. The Information Memorandum was itself variously described by the court as ambiguous, misleading and not comprehensible.

In August 2005 Delmenico made an initial investment of $50,000. Brannelly confirmed receipt in a letter which said in part, you have decided to make an investment based on your own research and that as you did not describe your current situation to me, you have not sought financial advice . . .. A few months later a second investment of $50,000 was made by Delmenico. Administrators were appointed to Bayshore on 6 December 2005. The promissory notes were valueless.

THE LITIGATION

The evidence came to show, and it was common ground that the promissory notes were not in fact guaranteed by Westpoint and that Bayshore did not have a charge over the development property. Delmenico said that if he had understood the lack of security protecting his investment in Bayshore, he would not have invested the funds. Delmenico commenced proceedings against Brannelly and Brannelly Financial Pty Ltd to recover his loss of $100,000 on the basis of a breach of the Australian Securities & Investments Commission Act 2001 (the ASIC Act)2 and in negligence.

Delmenico obtained a report from an expert financial advisor to the effect that the investment in Bayshore was a high risk investment as indicated by the high rates of commission paid to investment advisors and the high interest rate payable on the promissory notes. The expert also referred to an ASIC investigation into Bayshore which was not passed on to the plaintiff. In the experts opinion, the case was one of Brannelly not understanding his product. The report read in part:-

The scheme relied entirely upon the successful completion of a property development and yet was designed to give the impression of an interest bearing investment. The client was likely to believe that the investment was a fixed interest investment and thus was more secure than investments in the share market or the property market. A financial planner exercising reasonable care and skill would have ensured that the client would have been told that the success or failure of the investment relied entirely on the success or failure of a specific property development and was thus a high risk investment.

The defendants did not rely on expert evidence.

THE TRIAL

The trial judge found for Delmenico and held that:

If he had properly understood the lack of security involved with this investment he would not have invested at all. Delmenico was borrowing against his home and the security of the investment was important to him.
Brannelly in his letter dated 18 July 2005, had misinterpreted the terms of the Information Memorandum, and in so doing misinterpreted the entire structure of the proposed investment which went beyond merely providing information to providing advice.
While Delmenico was careless for not making further inquiries of Brannelly to clarify his lack of understanding of the structure of the investment, such carelessness did not preclude him recovering under the ASIC Act. His Honour also upheld Delmenicos claim in negligence.

THE APPEAL

The defendants appealed claiming, amongst other things, that Delmenico acted not upon advice or information provided by Brannelly, but upon a misunderstanding of the structure of the investment for which Delmenico alone was responsible.

The Court of Appeal disagreed and held that:

To the extent that the appellants argue that the respondents loss was the result of his failure to understand the position as it was stated in the Information Memorandum, the respondents confusion was itself the product, in substantial part, of statements by the appellants about the structure of the investment made in their letter of 18 July 2005.

The appellants letter misstated the structure of the investment in a way which was apt to encourage in the respondent a favourable view of the security of the investment. The disclaimer which accompanied the appellants letter of 18 July was in no way apt to convey to the respondent that the appellants description of the structure of the investment was not reliable. Further, the terms of the Information Memorandum were not such as to demonstrate unequivocally that the appellants had misstated the structure of the investment.

COMMENT

One very simple message to take from the decision is that even when financial planners are not providing advice to a client, they must still understand the circumstances of the client well and the features of the product better before offering it to a particular purchaser(s). Care must also be taken with the way in which investments are promoted to the world at large.
Where advice is not sought, a financial planner should still highlight any unusual features or risks in a product at the time of offering.
It may well have been the case that many financial planners were duped by Westpoint over the nature of the guarantees given by the company, but that is not a defence to a claim for breach of the Corporations Act.
All this is happening at a time when under ASICs Regulator y Guide 126, financial planners are required to have adequate PI insurance by July this year. We understand that the FPA has tendered submissions for group PI policy which it plans to have in place for members by June 2008.

Footnotes:

1. Document containing information required by a potential investor to make a satisfactory assessment of the investment opportunity. Copies required to be lodged with ASIC.

2. S.12DA ASIC Act: A person must not, in trade or commerce, engage in conduct in relation to financial services that is misleading or deceptive, or likely to mislead or deceive.

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