The legal principle could be easily stated: Anyone who recommends investment products to his client, knowing that his client will rely on his recommendation, or in circumstances where it is reasonable for the client to rely on him, must do so with reasonable care and skill, otherwise he is liable to compensate his client for any losses that flow from such recommendation. 

The Common Contentions

Applying such principle to the many varieties of cases may not always be straightforward. In many court cases, the contentions are:-

(1)          whether and to what extent the client has relied on the investment adviser; and

(2)          whether the investment adviser has breached his duty of reasonable care and skill.

The two issues overlap with each other to a certain extent. For example, the investment experience and knowledge and general sophistication of the client himself is often in issue. And this issue will affect both the questions of whether there was reliance (by the client on the investment adviser) as well as whether there was a breach of duty of reasonable care and skill (on the part of the investment adviser). If the client himself is a highly sophisticated investor, it would be more difficult (but not impossible) for him to argue that he has relied on the investment adviser’s recommendation. Correspondingly, even if reliance was established, the standard of care and skill required of the investment adviser will be much lighter in the case of a sophisticated client than in the case of an uneducated/illiterate one.

The above abstract principles will be illustrated by the cases below.

Business Experience ≠ Investment Experience

In the case of Susan Field v Barber Asia Limited HCA 7119/2000, the plaintiff Susan Field was a successful business woman in the field of marketing and communications. She built up her own business which as at 1997 had a turnover of at least HK$3 million. She was also invested in a hotel industry publication. Understandably, the first line of defence raised by the defendant investment adviser Barber Asia was that Susan Field was a sophisticated investor. She was a business woman of many years of experience, she could read accounts and prepare financial plan and budget for her own company. She should be able to understand the risks in the investment products that Barber Asia had recommended to her.

The court did not buy such argument. It held that being a successful business woman had nothing to do with having investment knowledge, especially when complicated investment scheme is concerned. The truth is Susan Field had close to zero investment experience. Barber Asia also sought to make use of the fact that Susan Field had a multi-currency account. Again the court said it did not matter. The court found on the facts of the case that Susan Field had relied on the expertise of Barber Asia. The fact that she was a successful business woman did not detract from such reliance. Accordingly, Barber Asia owed her a relatively heavy duty of care and skill.

In contrast, in the case of Formosa Taffeta Company Limited v Banque Indosuez HCA 5165/1997, the plaintiff belonged to one of the biggest conglomerates in Taiwan (the Formosa Plastics Group) and had an in-house treasury department staffed with experts in finance. This does not mean that the defendant bank did not owe it a duty of care. However, the duty of care will be much lower in this case than in the Susan Field case. In cases like the Formosa case, the investment adviser will owe a duty at least not to negligently provide false and misleading information to the client. However, it may well be entitled to recommend complicated and risky investment products to such clients.

Duty of care to the unsophisticated clients

In the case of Susan Field, she had stated in the beginning of the relationship that she wanted her money to be invested in a conservative way. This was complied with at the beginning and Susan Field was satisfied with the performance of Barber Asia. However, about one year later, Barer Asia recommended a scheme to her which involved borrowing a loan in the Yen and investing in a product denominated in Pound Sterling. The loan was secured by Susan Field’s investment and had a leverage of several times. Since Yen carried a low interest rate whilst the Pound Sterling product paid a higher return, the scheme might considerably enhance Susan Field’s investment return. However, that would be on the assumption that Yen would not appreciate substantially against Pound Sterling, which assumption turned out to be wrong and Susan Field almost lost all her savings.

The court held that Barber Asia breached its duty of care and skill in two important aspects:

(1)          The product was clearly a risky one. It should not have recommended a product that was unsuited to the stated investment objective of the client.

(2)          It had not given sufficient warning of risk to the client.

Duty to “Know Your Client”

On the first charge, Barber Asia sought to defend that it was Susan Field who expressed the wish that she wanted her money to “work harder for her”. The court found that these general words uttered by a layman would not have meant that the she intended to change the risk level of her investment. In fact, the duty of the investment adviser goes further than that. Not only does he have to respect client’s stated preference of risk level, he has to take active steps to ascertain the investment experience of the client and advise the client on the appropriate investment strategy. The following is the guideline provided by the Securities and Futures Commission[1]:-

The Investment Adviser should:-

a)            know their clients;

b)            understand the investment products they recommend to clients;

c)            provide reasonably suitable recommendations by matching the risk return profile of each investment product with the personal circumstances of each client to whom it is recommended;

d)    provide all relevant material information to clients and help them make informed investment decisions;

e)            employ competent staff and provide appropriate training; and

f)             document and retain the reasons for each product recommendation made to each client.

Although the SFC Guideline is not a statement of law as such, if a investment adviser breaches the guideline, firstly, it is likely that he will be subject to disciplinary actions, and secondly, it would be difficult for him to argue that he has not breached his duty of reasonable care and skill to the client.

What Amounts to Sufficient Warning?

On the charge of insufficient warning of risk, Barber Asia argued that the risk warning was all stated in the application form for the investment product in question and signed by Susan Field. She should have noticed those warnings when he went through the form with her before she signed. The Court held that this was insufficient. The court held that where an investment product that was unsuited to the client’s stated risk appetite was recommended to her, very specific warning would need to be given. The Court noted that in the projections shown to Susan Field, none of them showed the possibility of loss, not to say substantial loss. The Court accepted Susan Field’s evidence that if she had been shown such risks, she would not have invested in the risky scheme.

The Court held that the investment adviser’s duty to advise on risk is akin to that of a doctor. In a doctor/patient situation:-

‘‘. . . a risk is material if, in the circumstances of the particular case, a reasonable person in the patient’s position, if warned of the risk, would be likely to attach significance to it or if the medical practitioner is or should reasonably be aware that the particular patient, if warned of the risk, would be likely to attach significance to it.’’[2]

Hence, in the Susan Field case, not only must the investment adviser advised her of the possibility of loss, but also the risk of using leverage and the risk of Yen appreciating against Pound Sterling. The possibility of margin call (because of the leverage) and substantial loss of capital must also be brought home to her.

A further point worth noting is that the front of the application form clearly warned Susan Field to take independent legal advice before entering into the scheme. Susan Field agreed that she was aware of this notice. The Court agreed that should Susan Field have taken legal advice, she might be warned of the risk. Yet the Court accepted that it was reasonable for Susan Field not to have taken legal advice in light of the trust that she had reposed on Barber Asia.

Giving Information v. Advising

Going back to the Guiding Principle stated above, the defendant owes a liability to the plaintiff if in the circumstances of case, it is reasonable for the plaintiff to rely on the defendant. The courts have often stated that this is a question of fact which must be decided by examining all the circumstances of the case. In many cases, this is not controversial. When a investment adviser charges a fee or earns commission from the sale and gives advice to his client who knows little about investment, the inference of reliance is almost irresistible. However, where the client is a highly sophisticated one and the investment adviser is merely providing information on investment products for the client, it would be difficult for the client to establish reliance on his part. This is what happened in the case of Formosa Taffeta Company Limited v Banque Indosuez HCA 5165/1997.