Financial service providers (FSP’s) are required to take out indemnity insurance in terms of the Financial Advisory and Intermediaries Services Act, 2002 (FAIS Act). The FAIS Act stipulates that FSP’s should have an adequate level of professional indemnity insurance and it is the responsibility of the FSP to assess the risk associated with their professional services. The purpose of this type of insurance is to protect the FSP against legal costs and claims for damages to third parties which may arise out of an act, omission or breach of a professional duty in the course of their business. It is however common for insurance policies to contain exclusion clauses that reduce the scope of coverage by removing from coverage certain risks.
There is an abundance of case law dealing with the interpretation of contracts (including contracts of insurance) as well as exemption clauses. The court’s approach to the interpretation of contracts can be summarised as follows:
1. A contract of insurance has to be construed like any other written contract so as to give effect to the intention of the parties as expressed in the policy. The terms of the contract are to be understood in their plain, ordinary sense unless it is evident from the context that the parties intended them to have a different meaning;
2. Secondly, whilst the ordinary rule is that the insured must prove itself to fall within the primary risk insured against by the policy, an exemption clause should be interpreted restrictively against the insurer because it purports to limit what would otherwise be a clear obligation to indemnify.
3. Any provision which purports to place a limitation upon a clearly expressed obligation to indemnify must be restrictively interpreted. A policy normally evidences the contract and an insured’s obligation as well as the extent to which an insurer’s liability is limited must be plainly spelt out. In the event of ambiguity, the contra proferentum rule is applied and it requires that a written document be construed against the person who drew it up (ie the insurer).
Chapter IV of the FAIS Act provides for a code of conduct for FSP’s in terms of which they must, inter alia:
- ensure that clients to whom financial services are being rendered will be able to make informed decisions.
- ensure that such clients’ reasonable financial means regarding financial products will appropriately and suitably satisfied.
- require such providers to act honestly and fairly, and with due skill, care and diligence, in the interests of clients.
- require FSP’s to obtain relevant information from clients before advising them.
- require FSP’s to make full disclosure of relevant information to clients when advising them.
- ensure that in dealing with clients, FSP’s avoid misleading advertising and marketing.
Recently, the Free State High Court handed down a judgement in a case where the facts were briefly the following:
The plaintiff was a widow with a 2 ½ year old boy. Following a shooting incident in which her husband was fatally injured she wanted to invest R2 000 000.00 of the proceeds of a life insurance policy to make provision for the upbringing of her son. Her late husband’s broker advised to invest the money in the form of an investment offered by Sharemax Investments (Pty) Ltd (“Sharemax”) in respect of a scheme described as the Villa Retail Parkholdings 2 held in a company, Villa Retail Park Holdings 2 Limited. The plaintiff advised the broker that she could not afford to lose any of the money as it was intended for her son. At the time the broker drew the plaintiff’s attention to a newspaper article that appeared in the Rapport of the previous week, 24 July 2010, which was very critical of Sharemax investments in general. The broker then informed her that he personally did not place any credence in the article which in his view, had its origins in persons who were jealous of Sharemax’s success. He also informed the plaintiff that the investment was so safe, he would not recommend any other investment options. It was the safest investment available as it was an investment in property. The plaintiff proceeded to make the investment. As a result of the failure of Sharemax shortly thereafter (within approximately a month of making the investment) and no prospects of making a good recovery the Plaintiff proceeded to claim damages from the broker in the form of loss of capital of R2 000 000.00 together with interest on the capital amount from the date of the investment, less an amount of R1 400.00 which she received from the investment. It however appeared that at the time of making the investment there had already been a lot of negative media publicity and it was not limited to the single article in Rapport. This was in actual fact a property syndication investment which would normally entail that the investor does not invest in property as such but rather receives a share in a company that owns the property. At the time The Villa Retail Shopping Centre was still under construction and has, to date, not been completed.
The plaintiff’s claim is based on the broker’s breach of a contractual duties in that he, inter alia:
- Failed to act honestly and fairly in the interest of the plaintiff in recommending the Sharemax investment;
- Defendant misrepresented to plaintiff that media criticism of investments in Sharemax was motivated by envy in so far as the criticism was intentional, negligent and not honest and fair;
- The Sharemax investment was not in keeping with the plaintiff’s risk which required minimal risk whereas the investment in Sharemax was an investment of very high risk;
- Defendant failed to furnish objective financial advice to plaintiff appropriate to her needs and interest;
- Defendant knew that the plaintiff required a safe investment, but advised her to make the Sharemax when he ought to know that by taking reasonable care that the Sharemax was a very high risk investment.
- Defendant failed to exercise the degree of skill, care and diligence to be expected of an authorised financial services adviser furnishing investment advice.
The broker claimed indemnity from his insurer but the insurer repudiated the claim. The broker subsequently joined his insurer as a third party to the action. The insurer, however, denied liability to indemnify the broker, averring that the broker’s claim fell within the parameters of an exclusion clause contained in the insurance contract. The relevant part of the exclusion cause reads as follows:
“The insurers shall not indemnify the insured (the broker) in respect of any loss arising out of any claim made against them in respect of any third party claim arising from or contributed to by depreciation (or failure to appreciate) in value of any investments, including securities, commodities, currencies, options and future transactions, or as a result of any actual or alleged representation, guarantee or warranty provided by or on behalf of the insured as to the performance of any such investments. It is agreed, however, that this exclusion shall not apply to any loss due solely to negligence on the part of the insured or employee of the insured in failing to effect a specific investment transaction in accordance with the specific prior instructions of a client of the insured.”
The plaintiff’s claim against the broker is not based on a representation, guarantee or warranty as to the performance of the investment. The plaintiff’s claim did also not arise from, or was contributed to, by depreciation or failure to appreciate in value of the investment. Her claim is rather based on the broker’s breach of contractual duties in failing to act with the necessary skill and diligence to be expected from a broker.
Upon consideration of the relevant case law and authorities it was stated in the judgement that a term of the contract between the broker and client would be that the broker would carry out his mandate and the tasks associated with it with reasonable skill, care and diligence. He must exercise that degree of skill, care and diligence that would be exercised in the ordinary and proper cause of a similar business and employ the skill usual and necessary in the business for which he receives payment.
The company used as the investment vehicle for The Villa was registered in 2010 only – the same year in which the plaintiff made the investment. Evidence was led on behalf of the plaintiff by financial expert, Mr Magnus Haystek, indicating that many warnings had been published about the scheme and that it had been criticised in the media over a prolonged period.
It was held that the broker was in breach of his fiduciary duty towards the plaintiff in that he failed to take reasonable steps to satisfy himself of the safety of the Sharemax investment.
With regard to the exclusion clause it was held that it should be interpreted restrictively so that it makes business sense i.e. in the eyes of both insurer and insured. It cannot be applicable where the insurer advised a client to investment in a scheme that was a hopeless investment from the onset, contrary to legislation and probably a fraudulent and unlawful Ponzi scheme. The purpose of the first leg of the exclusion is to prevent an insured from claiming indemnification if his client has filed a claim because his or her investment had not grown by, for example 20% over a 3 year period as expected, but only by 15%, or remained static, or depreciated. The same applied to the second leg. An eager financial services provider should not be heard to admit that he or she has represented or guaranteed to an investor that a particular investment would increase by 100% in a year’s time. The insurer will be fully entitled to rely on the exclusion clause and refuse to indemnify the insured if the representation later appears to be off the mark.
In conclusion it was held that the broker is liable for the plaintiff’s damages. It was further held that the exclusion clause does not apply and that the insurance company should indemnify the broker.
Although your broker is required to have indemnity insurance to protect investors in cases of breach of professional duty, it is important to note that these insurance contracts invariably contain exclusionary clauses that act to limit the insurer’s liability.
** Following judgement, the insurer has given notice that it intends to apply for leave to appeal against the judgment.
By: Aneen de Wet (LL.B)(LL.M)