Sue directors, not advisers: Lawyer

Investors in failed finance companies should look first to sue the directors of fraudulent finance companies when seeking damages, not the financial advisers who relied on supposedly credible prospectuses to base their recommendations, according lawyer Brian Henry.

Tuesday, June 2nd 2009, 7:35AM

Hundreds of investors are seeking legal reparation for financial losses incurred as a result of investments based on advice given by financial advisers. However Brian Henry, barrister and Chairman of funds management firm Goldman Henry Capital Management says investors would more likely receive compensation if they targeted Directors instead of the financial advisers who are not currently covered by their insurers. Directors have their own indemnity insurance which is better placed to compensate investors if courts determine that the directors have been negligent.

Henry says the trend in legal circles to sue investment advisers is of significant concern and is likely to yield little satisfaction for investors. One of the issues driving this dissatisfaction is the extent of insurance coverage financial advisers have with their indemnifiers.

Most financial advisers took out Professional Indemnity (PI) insurance with the view that it would cover the loss caused by cases of negligence. However, in many cases, the losses suffered by investors was as a result of loss caused by another person's negligence, or the Directors of the finance companies.

"PI insurance covers losses as a result of the adviser making a mistake. This could be for example putting the money in Bridgecorp instead of placing the money in the bank as the investor had instructed. The insurance industry has $3 billion reasons not to agree to cover this financial adviser and investors are highly unlikely to get compensated as a result."

There are a series of cases at different stages raising this issue and Henry believes the investment advisers are currently carrying the litigation risk for these cases. Some of these cases will go all the way to the Supreme Court.

"I am assuming in these cases that the investment adviser was diligent in doing his or her job," Henry says. "Advisers who directed clients to funds because of prize inducements are in a different category. They simply have not done their job and can well be sued. The issue in these cases will be whether it is the recommendation that is likely to have caused the damage, or the finance company's operational practices."

Henry is supporting prudent investment advisers. "The professional investment adviser would have received the material published by the Company, and that material would have included statutory material. This is the key information advisers would have relied on to base their decisions and this would have all been in the prospectus."

The prospectus is a document signed by all directors. It is an important document which requires approval by the companies' office. It includes audited accounts and an auditor's certificate.

"When the directors sign the prospectus, they are not signing a formality. What they certify on signing is that the prospectus is not misleading," says Henry.

"This will be a key phrase because the test of all company activity in the public fund raising business is ‘thou shalt not mislead'. So the prospectus when filed must not mislead."

Henry quotes from section 34 of the Securities Act relating to the prospectus. It encompasses a continuous disclosure obligation.

The law states that "no registered prospectus shall be distributed.....if it is false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances (whether or not it became so misleading as a result of a change in circumstances occurring after the date of the prospectus)."

Henry says, "The obligation is an ongoing one for those who issue and distribute the prospectus, and it exists every time they distribute the prospectus to an investor."

So how serious is a breach?

Henry says the investment advisers are depending on the information to be accurate at the time of delivery to them. "This is the absolute cornerstone of the Securities law. The financial adviser should not need to go behind the statutory information which is required by law to not be misleading on the day the prospectus is delivered to them."

Unlike auditors, trustees and rating agencies, apart from newspaper clippings and street corner gossip, financial advisers generally cannot go behind the directors' statutory obligation. Henry says auditors, trustees and rating agencies have access to information that the public, which includes financial advisers may not see.

It all comes back to the integrity of the directors. Henry says auditors depend on the integrity of the directors, so do rating agencies, so do trustees and so do advisers who also rely on the auditor, the trustee and the rating agency.

"So investors and advisers are entitled to accept that the directors are complying with the Securities Act at the time they receive the prospectus."

So who should the investors sue to be reimbursed for their losses in failed securities?

Henry says investors should sue the people that breached the start of the good faith chain, namely the directors of the failed company. "Firstly, the directors are ultimately responsible. Secondly, the directors are likely to hold insurance policies that insure against losses caused by their negligence. The loss of the value of the company's security paper is a loss caused by their negligence and difficult to exclude."

Henry says the allegation of the investor's counsel will have to address the key issue, namely; is an investment adviser who relies on the statutory obligations of the directors to not mislead in the prospectus at the time of delivery of the document in breach of the duty of care owed to a client?

"It would, in my view, be perverse if the Courts held that an investment adviser who relied on the directors to have complied with the securities act continuous disclosure obligation was negligent."

In order to sue a financial adviser for losses arising from the investment in Bridgecorp, Henry says the investor's lawyer would need to prove that the financial adviser was aware that the directors of Bridgecorp was known to be misleading investors before the collapse.

"Hindsight admirals will abound, but in reality, their opinions need to accept both the law and accept the perceived integrity of the directors. Only then can they assert that the adviser in that factual mix was in breach of the care of duty."

Henry questions how any prudent financial advisers could have been aware before the collapse that the Bridgecorp directors were misleading investors. He says before the collapse of Bridgcorp, there would have been very few, if any, investment advisers that would have believed that Bruce Davidson, the chairman of Bridgecorp; an ex president of the ADLS, a senior partner in Minter Ellison, a distinguished solicitor of over 30 years experience, a man whose integrity was hitherto unblemished was as chairman of directors of Bridgecorp breaching the Securities Act by misleading the market when distributing the prospectus.

"To assert the prudent investment adviser, as part of the duty of care, would understand Bruce Davidson was not on top of what Bridgecorp was doing, without the benefit of hindsight, is preposterous," says Henry.

"The truth we now understand may be different. That is for the courts to decide, but no expert can dispute that right to the final moment Bridgecorp, which was under the stewardship of the Chairman and other directors, was not only continuing to distribute the latest prospectus but was asserting at every opportunity that it was financially sound."

Tags: finance companies financial advisers FMA professional indemnity regulation