Most professional financial advisers know when they are giving advice but the line between what is and is not advice is not always easy to draw.
Like all professionals, the financial adviser is under a duty imposed by ordinary law to exercise care when giving advice. However, unlike most other professionals, financial advisers are also under a number of duties imposed by FSA rules to make sure advice is suitable for the client.
There are many firms that sell financial products without giving advice. For example, banks sell various types of structured products without advice. When things go wrong, the client will say he or she was given advice to enter into the transaction but the firm may maintain that the transaction was execution-only.
The current definition in the FSA handbook of an execution-only transaction is: “A transaction executed by a firm upon the specific instructions of a client where the firm does not give advice on investments relating to the merits of the transaction and in relation to which the rules on assessment of appropriateness (Cobs 10) do not apply.”
The question of where to draw the line between advice and execution-only was considered by the courts in three cases last year.
In the first case of Rubenstein v HSBC, one of the issues Judge Havelock-Allan, QC, had to decide was whether the bank had given its customer advice. In 2005, the customer, Mr Rubenstein, wanted to deposit the proceeds of the sale of the family house somewhere where it would earn a good rate of interest and be accessible within a year.
Mr Rubenstein approached the bank for advice. The bank suggested he put his money in a single-premium bond. The bond was linked to a fund, the value of which fell substantially when Lehman Brothers collapsed. Mr Rubenstein sued the bank to recover his losses and said it had given him negligent advice. The bank said the transaction was execution-only.
The judge said: “The key to the giving of advice is that the information is either accompanied by a comment or value judgement on the relevance of that information to the client’s investment decision, or is itself the product of a process of selection involving a value judgement so that the information will tend to influence the decision of the recipient. In both these scenarios, the information acquires the character of a recommendation.”
He went on to say: “The starting point of any inquiry as to whether what was said by an IFA in a particular situation did or did not amount to advice is to look at the inquiry. If a client asks for a recommendation, any response is likely to be regarded as advice unless there is an express disclaimer to the effect that advice is not being given.
“On the other hand, if a client makes a purely factual enquiry, such as ’What corporate bonds are currently yielding X per cent?’, it is not difficult to conclude that a reply which simply provides the relevant information is no more than that.”
The judge decided that the bank had given advice and that it was negligent.
A month later, in the case of Zaki and Others v Credit Suisse, Teare J had to decide whether the bank had made a personal recommendation to the claimant to buy some structured products. The judge first noted that the bank was required by the FSA’s Cobs 9.2.1 rules to take reasonable steps to ensure a personal recommendation was suitable for its client.
The “first, and fundamental question” he had to decide was whether the bank made a personal recommendation. He said: “A recommendation is defined as advice on investments and advice is defined as advice on the merits of buying a particular investment”.
He added: “Advice on the merits of purchasing a structured product must refer to the advantages and disadvantages of purchasing the product. What may be regarded as an advantage for one client may not be regarded as an advantage for another and so Cobs provides that the recommendation (that is, advice on the merits) must be suitable for the client.
“However, advice on the merits is to be distinguished from the mere giving of information but what amounts to advice will also depend upon the context.”
The judge then quoted the FSA’s views in its perimeter guidance manual (PERG 2.7.15): “The context in which something is communicated may affect its character. For example, if a person gives information on share price against the background that, when he does, that will be a good time to sell, this will constitute advising on investments.”
He ended by saying: “Advice requires an element of opinion on the part of the adviser.” He too decided that the bank had given advice and therefore made a recommendation.
In regard to the above judgments and the definition, it is unlikely that a defence based on a transaction being execution-only would succeed in the absence of clear evidence. However, one such case was City Index v Balducci, in which Proudman J delivered her judgment a few days after the previous case was decided.
The background was that the claimant firm was claiming the sum of just over £313,000 plus interest. The debt was said to have been incurred by the defendant, Mr Balducci, in spread betting on the price of heating oil. That sum represented the negative balance outstanding on an account with the claimant.
Mr Balducci counter-claimed for the sum of $1.625m on the basis that his spread-betting losses were wrongfully incurred because the claimant unlawfully gave him advice relating to spread bets. The claimant offered its customers spread bets in financial derivative products. Trading was, or was supposed to be, conducted on an execution-only basis. Therefore, the claimant was not authorised to give advice, as opposed to information.
The customer was supposed to make his own trading decisions and trade at his own risk while the claimant’s role was limited to opening and closing spread positions on instruction and providing market information.
The judge found that the claimant had not crossed the line from providing information to giving advice. She said: “The whole tenor of the recorded conversations at this time indicates not only that there was no advisory relationship but that Mr Balducci did not regard the relationship as an advisory one”.
In a long relationship, such as existed between the firms and their clients in the last two cases, it requires great care on the part of the firm not to cross the line from information to advice. Not every firm is going to be able to avoid giving advice when trying to sell a product and the decision in the City Index case is more likely to be the exception rather than the rule.
Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk