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What defences do investment advisors have?

Posted by admin on June 21, 2010 in Investment Information

Assuming that an investment advisor has breached their duties to the client, does the investment advisor actually have any defences? The short answer is that an investment advisor has a lot more than one thinks.

If, despite the advisor’s conduct, the client ended up in a better position than if the advisor had not engaged in the conduct, the client cannot prove that any actual damages occurred and there would be no legal basis to proceed in a claim; the payment of any damages would unjustly be enriching the client.  For example, if an advisor sold financial industry stocks in the summer of 2008 despite the client’s instructions to buy and hold all stocks, the client would be better off than if the advisor had done nothing. Thus, you end up in a peculiar situation whereby the client’s trust and faith may have been broken but, because there was no monetary loss, there are no damages and no claim to pursue. One wonders, however, whether a client would be well-served long term by a rogue advisor.

Similarly, if the advisor had engaged in wrongful conduct, such as selling a stock without authorization, if the client authorizes the conduct subsequent to the fact, the advisor has a defence that the breach of duty was approved by the client.

The less straight forward defence is that a client cannot prove the advisor’s allegedly wrongful conduct lead to a particular (bad) result. In legal lingo, there is no causation between the conduct and the result.  For example, from October 2008 to approximately March 2009, would an advisor’s action(s), in contravention of its duties, actually would have lead to any different of a result than if the advisor had performed their duties within reason (remember again, the advisor’s duty does not necessarily speak to portfolio performance).

One of the more commonly cited defences in an action against an investment advisor is known as the legal doctrine of contributory negligence. In the simplest terms, the person harmed caused part of the damages through some act or omission of their own and the damages to be award will be lessened to the extent the person harmed did something or failed to do something that made the situation worse.

For example, an advisor may give several options to a client- none of which really suit their risk tolerance. However, the client, being reasonably sophisticated,  fails to perform any due diligence on any of the options recommended such as reading the disclosure documents or financial statements and basically picked one of the options willy-nilly. While the advisor breached his duties by giving options inappropriate to the client, the client also failed to protect themselves which could result in the advisor’s potential liability being reduced.

Another example of contributory negligence may be that the advisor had engaged in improper trading for an extended period of time yet the client fails to check her financial statements or, in multiple meetings or telephone conversations to review the portfolio, fails to ask any questions about her holdings.

Finally, damages are capped by a legal concept known as mitigation. In plain English, the wronged party, once they discover they have been wronged, must take some reasonable action to reduce their losses. For example, if a client finds out that the advisor had been investing in money-losing speculative penny stocks against their stated preferences, the client should, within a reasonable amount of time of discovering the trades, give instructions to sell the stock (especially if it continues to go down), file a complaint, switch brokerages etc. The client simply cannot sit still and do nothing. If he/she does, the Courts tend not to award damages after the day they would consider a reasonable person would have taken some action to mitigate their loss.

The above is a quick and dirty over-view of some defences available to the investment advisor. The defences tend to have a common theme. Mainly, while the advisor should be held liable if they breached their duty of care, the client is delegating and not abdicating their authority. A client should continue to be active participants in their own portfolio and, being a completely passive in how their money is managed, can be used as a defence by the wayward advisor.