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WHEN CAN YOU SUE YOUR FINANCIAL ADVISER FOR LOSS? JEAN-PAUL RUDD says you must distinguish between losses arising from risks you were aware of and losses arising from professional negligence. THOUSANDS of South Africans place their trust in financial advisers to professionally manage their money and their futures. Unfortunately, many of these investors lose their money, but it is not always as a result of professional negligence on the side of financial advisers. You need to clearly distinguish between losses arising from market or other risks versus losses arising from professional negligence. INVESTMENT RISK A critical consideration for financial advisers is the level of risk their clients are prepared to take on board when making investment decisions. There are trade-offs to be made between the level of risk and return that one receives and it is important that this is communicated to you in a way that you understand, and accept the implications of the decisions being made. Risk means the chance of a loss in investment, not an actual loss, which is a deviation from your expected return. There are various types of risk: ● Systematic or market risk is the risk impacting all shares, usually coming from national or global economic conditions. ● Unsystematic risk is usually event-based risk affecting
one share only, such as a management change, reputational damage, or fraud. ● Interest rate risk is where a change in interest rate affects value. Bond prices and their yields are inversely related. Thus, if the interest rate increases the bond price falls or drops to a discount, and if the interest rate drops the bond price rises or is considered at a premium. ● Inflation risk comes about from inflation affecting prices and value and the buying power of money. For example, if you buy a bond with an interest rate of 3%, this would be the nominal return of your investment. However, if the inflation rate is at 2%, your purchasing power is only really increasing by 1%. ● Business or financial risk is the risk of deteriorating business conditions due to consumer demand, competition or industry disruption from, for example, new business models. ● Political or social risk is when government policy affects investments, or there is a complete political or security upheaval such as war or a revolution. Investors in Egypt would have encountered this risk in 2012/2013. ● Currency risk comes about through changes in the exchange rate relative to
currencies which are detrimental to the value of the investment. For example, suppose that a US-based investor purchases a German stock for 100 euros. While holding this stock, the euro exchange rate falls from 1.5 to 1.3 euros per dollar. If the investor sells the stock for 100 euros, he or she will realise a loss on conversion of the profits from euros to dollars. ● Credit risk is when credit extended to a borrower or bank may be wholly or partially lost. ● Concentration risk occurs when investments or a business are locked into one region or one industry where the decline of the area or industry will affect value. For example, the price of airline stocks may be influenced by the cost of oil. PROFESSIONAL NEGLIGENCE A financial adviser has a legal duty to exercise reasonable skill and care, and liability may arise as a result of a breach of the duty of care or as a result of breach of contract. Most of the clients of financial advisers have little knowledge of matters relating to finance and investment and place heavy reliance on their financial adviser. In order to establish liability for a financial adviser’s professional negligence, it is necessary to show that you
