Financial adviser's indemnity should give comfort, not spectre of litigation
Your adviser's professional indemnity insurance could land you before a lawyer instead of compensating you
As consumers, we are supposed be comforted by the fact that financial advisers have professional indemnity insurance. Most of us expect that if our adviser messes up, the indemnity insurance will make good.
But property syndication cases have revealed that not only should some advisers never have been giving advice, but that your adviser's professional indemnity insurance could land you before a lawyer instead of compensating you.
A recent Supreme Court of Appeal case illustrates this.
Centriq provided professional indemnity insurance to financial advisers who were members of the Financial Intermediaries Association of Southern Africa at a time when a number of association members were selling property syndications to investors - including some that crashed spectacularly. But when a widow who invested in the failed Zambezi property syndication promoted by Sharemax asked to be compensated for her broker's bad advice, the insurer took the case to court instead of paying up.
Now, some years later, Centriq has lost an appeal and is obliged to pay out Jose Castro, the broker who advised Marisa Oosthuizen.
Oosthuizen lost her husband, a farmer, in a shooting accident. She was paid R3.4m from a life policy. She bought some livestock and trusted Castro to invest the remaining R2m for herself and her two-year-old son, telling him she could not afford to lose a cent of the money.
The judgment reveals that despite media reports warning about problems at the Zambezi mall and no explanation about where a "magical stream of income" would flow from, Castro went ahead and invested Oosthuizen's money in the syndication.
Judge A Cachalia described the investment as having all the hallmarks of a Ponzi scheme - Oosthuizen bought shares in a company that owned only part of the centre, which was still being built and was nowhere near ready for tenants. Despite this, the investment was sold as one set to pay an income from the get-go.
Castro even referred Oosthuizen to news reports that the Reserve Bank had reservations about the Sharemax-promoted scheme. But according to the judgment he told her there was no substance to the criticism and "somewhat thoughtlessly and misleadingly" explained that "property cannot disappear".
He failed to tell her the property was not yet complete and that she was not investing directly in the property.
When Oosthuizen lost all her money and sued Castro, he in turn added Centriq to the proceedings, saying he was entitled to be indemnified under the policy.
But Centriq denied any obligation to pay the claim, saying the policy had an exclusion clause for claims arising from investments that depreciated or failed to appreciate in value. The insurer argued that though the Zambezi property syndication had some value initially, its value had depreciated, triggering the exclusion clause.
The high court said the investment was hopeless from the beginning and the main purpose of the professional indemnity insurance was to indemnify financial advisers against liability for negligent financial advice. It found this meant the policy did cover Oosthuizen's loss.
Centriq was unhappy and appealed. The Supreme Court of Appeal judge said though Oosthuizen got R1,400 five days after she invested, this was just a sweetener to dupe her and other unsuspecting investors into believing in the efficacy of the investment.
The court said the policy wording was intended to protect the insurer from market fluctuations and not from the kind of loss that occurred when Oosthuizen was ill-advised to invest in a scheme that was incapable of generating an income.
Centriq also tried to claim the policy excluded any investment advice, but the judge was not convinced, saying advisers would not take out insurance that excluded such a major portion of their business. He said the insurer should have stated this intention in clearer language.
Another adviser, Deeb Risk, with the backing of his professional indemnity insurer Stalker Hutchinson, fought for eight years not to pay out just over R1.1m that three pensioners lost after he advised them to invest in Sharemax-promoted schemes.
Financial advisers are required in terms of the Financial Advisory and Intermediary Services Act to have professional indemnity insurance and to tell you that they do.
But there are few guidelines on how much insurance they must have or what the policy should cover, other than that they should provide minimum cover of either R1m or R5m depending on whether or not the adviser collects money from you to invest directly.
Nicky Nairn, head of compliance at Masthead, says there are indications the Financial Sector Conduct Authority will in future ask advisers to justify why their amount of insurance is appropriate.
The National Treasury recently published the Conduct of Financial Institutions Bill, which will replace a number of acts including the FAIS Act. The bill will also revise the ombud system and be fleshed out with conduct standards for advisers and other financial service providers.
The bill provides an ideal opportunity to review the professional indemnity insurance requirements so that we, as consumers, get what we would expect from advisers who are insured.
• Du Preez is Money editor