Professional negligence… caution for advisers

It is a settled principle of law in South Africa that, a person who undertakes to provide professional services to a client, impliedly undertakes that, in the execution of their mandate, they will exercise reasonable care and diligence. Should they negligently fail to exercise the required degree of care and diligence, Siyabonga Mathe, Associate Designate at Norton Rose Fulbright South Africa said the client is entitled to damages for breach of contract.

In relation to financial services providers (FSPs) this duty is regulated by the common law and the Financial Advisory and Intermediary Services Act, 2002 (the FAIS Act).

The common law

Mathe noted that the landmark case of Durr versus Absa Bank Limited and Another 1997(3) SA 448 (SCA) dealt with professional negligence relating to a financial intermediary before the FAIS Act. 

“Durr had sought advice with her investments from Stuart, the regional manager of the bank’s broking division. Durr had told Stuart that she had no need of the highest return available; what she wanted were secure investments. Stuart recommended that she invest in debentures and preference shares issued by Supreme Holdings and Supreme Investment Holdings. Stuart described the investments as safe and very secure,” said Mathe. 

“Acting on the strength of Stuart’s advice, Durr invested R595 000 into these companies. The companies were subsequently liquidated, and the investment was lost. It transpired that at the time that Stuart gave this advice, these companies were already insolvent. The evidence indicated that Stuart had relied on the company’s publicity material and the assurances given to him by the companies’ directors regarding the financial soundness of the companies. Stuart had not, therefore, done any independent research on the companies. Experts testified that there were red flashing lights which should have prompted Stuart to make some enquires about the companies,” added Mathe.

“The Supreme Court of Appeal held that two issues had to be determined. Firstly, what is the level of skill and knowledge a particular financial adviser needs to demonstrate? The answer to this question must largely depend on the skills that the financial intermediary is held out to possess. Therefore, if a person holds himself or herself out as a financial expert, and there is a reputable financial institution to support them, that person must be judged according to the standard of the expert they are held out to be. This is regardless of whether or not such person does in fact possess those skills and expertise. Secondly, is the standard for judging the level of skill required that of the ordinary or average financial adviser at large, or that of the regional manager of the broking division of a bank professing investment skill and offering expert investment advice. The court found that Stuart was not an ordinary or average financial adviser because he was a regional manager of a reputable financial institution. Therefore, the appropriate standard of skill and diligence required was that of a regional manager of a broking division of a bank professing investment expertise,” continued Mathe.

As a point of departure, the court held that although the Durr judgment preceded the FAIS Act by several years, the principles set out in Durr remain authoritative and binding and are accepted by the legislature if the wording of the FAIS Act is considered.

The FAIS Act

“Failure to act reasonably when providing financial advice may also constitute a violation of the FAIS Act. The FAIS Act regulates the conduct of FSPs who provide financial advisory and intermediary services to consumers. Advice is broadly defined as any recommendation, guidance or proposal of a financial nature to a client or group of clients regarding the purchase of financial products; conclusion of transactions in which clients may incur liability; and investments, variation or termination of any term of a financial product (s1),” said Mathe.

The FAIS Act, Mathe added, places an obligation on FSPs to act honestly and fairly, with due skill, care and diligence in the interest of their clients in providing financial advice. This duty is further spelled out in the Code of Conduct for Authorised Financial Services Providers and Representatives (the Code).

Advice based on market gossip

According to Mathe, the case of Oosthuizen versus Castro [2017] All SA 876 reaffirmed that FSPs who furnish investment advice based on market gossip, without independent and proper research may be liable for professional negligence.

“Oosthuizen had sought advice with her investment from Castro, a duly licensed FSP. Oosthuizen had made it clear to Castro that she could not risk losing even two cents as the money was earmarked for her son’s upbringing. Castro had advised Oosthuizen to invest R2 million in the property syndication scheme offered by Sharemax Investments. Castro had drawn Oosthuizen’s attention to an article in Rapport newspaper which negatively depicted Sharemax’s products but informed her that the criticism was motivated by jealousy and did not have any substance. Castro emphasised that the Sharemax Investment was so good that he did not even want to introduce other investments to her,” said Mathe.

“The Sharemax Investment subsequently failed, and apart from the R1 400 she received, Oosthuizen’s total capital was lost. She successfully sued for damages. It transpired that prior to Castro advising Oosthuizen, several prominent writers on financial matters had severely criticised the Sharemax Investment strategy over the years. An expert further testified that insofar as the companies involved in the investment were unlisted, there was a lack of disclosure making it difficult for financial analysts to make proper comparisons. Accordingly, Castro advised an investment into something which he was not himself able to fully understand,” added Mathe.

“The court held that, having been aware of the criticism levelled against the Sharemax Investment, Castro should have insisted on financial statements such as income and expenditure accounts, cash flow analyses and a balance sheet. Further, Castro should have spoken to independent auditors, attorneys and financial analysts. A simple investigation or inspection would have been an eye-opener. The court therefore found that Castro should have seen red flashing lights and advised Oosthuizen accordingly,” said Mathe.

The court, Mathe continued, ultimately found that Castro’s substandard advice was an indication of lack of skill, care and diligence, and thus contrary to the provisions of s16 of the FAIS Act and the Code of Conduct promulgated in accordance with s16 of the FAIS Act. Therefore, since the facts of the case were similar to that in the Durr case, the outcome ought to be the same.

“A person who alleges that they suffered damages as a result of the FSP’s negligent advice is obliged to present sufficient evidence in support of that allegation. In Atwealth and others versus Kernick and others (116/2018) [2019] ZASCA 27 (28 March 2019) an FSP rendered financial advice to the plaintiff to invest their funds in certain products. When the said products collapsed, the plaintiff instituted an action for damages against the FSP. The court found that the plaintiff failed to present evidence to prove what a reasonably skilled FSP would have done in the circumstances. For this reason, the plaintiff’s claim for damages failed,” said Mathe. 

Fit and proper

“It is clear that the FSP is not expected to bring to bear the highest professional investment skills possible, but the law requires the FSP to employ reasonable care and skill that would be exercised by an FSP in a similar business and circumstance. However, not every error of judgment by a professional mandatary is negligence. Our law recognises the so-called reasonable professional error of judgement (see Honey and Blankenberg v Law 1966 (2) SA 43 (R)).  It goes without saying therefore, that insisting on financial statements such as income and expenditure accounts, cash flow analysis and balance sheets of the investment companies, amongst other things, may constitute reasonable steps. FSPs are also expected to conduct independent research and investigation into the financial soundness of the possible investment companies prior to recommending those investment companies,” emphasised Mathe.

“Furthermore, although lack of skill is not necessarily negligence, accepting mandate without the necessary skill is. The law holds that a reasonable person must not undertake to do an activity for which he or she does not have the skills and capabilities necessary to execute that mandate,” added Mathe.

“In relation to the FAIS Act, ‘much professionalism is now required by the legislature, all in the interests of the public, then was the case when Durr was decided’ (Oosthuizen at para [33]). The FAIS Act requires, amongst other things, that any person seeking to venture into the business of an FSP must apply for authorisation (s7) and must be a fit and proper person (s8). However, in relation to the FSP’s duty to exercise reasonable care and skill, the FAIS Act simply codifies the common law position,” concluded Mathe.

Writer’s thoughts:
Failure to act reasonably when providing financial advice may constitute a violation of the FAIS Act. Let us take the examples used above as a wise lesson to learn… there is often a need to identify and understand the implications of the potential effects of the actions and decisions we make. Do you agree? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts myra@fanews.co.za

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