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ombudsman news

issue 55

August 2006

complaints about investment advice - where the investor did not own the funds invested

In some of the complaints about investment advice that are referred to us - the investors needed - quite legitimately - to invest money that they did not own. For example, the money may have been held within a trust, or it may have been held informally for the benefit of a minor. And in some cases, either acting independently or at the firm's suggestion, an investor may have borrowed part - or all - of the sum invested.

When making investment recommendations, financial advisers are required to ask investors a number of questions about their personal circumstances and financial needs, to ensure that any recommendation is suitable for the individual concerned. But if the investment is being made, quite legitimately, with money that does not actually belong to the investor, then there are clearly other factors that firms will need to consider.

In the complaints of this type that are referred to us, we are likely to look at whether the firm took the source of the money into account. We are also likely to look at whether the recommended investment was properly explained to the investor.

A particular consideration for firms to bear in mind could, for example, be a greater than usual need to preserve capital - if the money is pledged to one party but another party is being allowed to benefit from any ongoing investment income, as in case 55/10 below.

Another important factor that firms will need to consider is that there will be an added element of risk if the money being invested has been borrowed. With equity release schemes, for instance, there is the risk that a lifetime mortgage may so deplete an investor's capital that this cancels out the benefit of any investment income or growth.

And there could be additional risk where investors leverage their investment (in other words - borrow money to invest, in the hope that the investment return will exceed the total cost of the loan). As well as running the risk that this will not happen, such investors run the risk of increased losses because they will have to repay the loan in full, regardless of how the investment performs.

The following cases show how we have dealt with some recent complaints about investment advice, where the investor did not own the money they invested.

case studies

complaints about investment advice - where the investor did not own the funds invested

whether firm misrepresented level of risk when advising trustees on investment intended to produce increased income for beneficiary

Mrs O wanted to increase the amount of income she received from the trust set up under her late husband's will. So after taking investment advice about how best to achieve this, the trustees put some of the trust's money into risk-based investments.

Unfortunately, the recommended investments did not perform at all well. As a result, Mrs O had to accept a smaller level of income from the trust - rather than the increased amount she had expected. The trustees complained to the firm, saying it had misrepresented the level of risk involved.

complaint upheld
It was clear from the documentary evidence we saw that the trustees had agreed to accept a low level of investment risk, with the aim of achieving a higher level of income for Mrs O. However, the recommended investments carried a very high level of risk.

We were satisfied that the firm had failed to make this clear to the trustees. We therefore asked the firm to offer redress, based on the amount of income Mrs O would have received if it had recommended a less risky investment.

whether firm's advice appropriate for investor who borrowed two-thirds of the total sum invested and suffered large loss when forced to repay loan

Mrs B was a reasonably experienced investor and was prepared to take a greater than average amount of risk with her investments. She asked the firm for advice on investing £50,000 of her own money.

She later told us that, as well as giving her a recommendation for investing this amount, the firm had suggested she should take out a loan for £100,000. She said the firm told her she could then put this sum in an offshore bond, together with the £50,000 of her own money. (This was therefore a leveraged investment - one where the investor borrows some of the total sum invested, in the hope that the return on the investment will exceed the cost of the loan.)

Unfortunately, the investment did not perform as expected. The loan provider, which had a legal charge over the bond, arranged for it to be encashed. It then used the proceeds to repay the loan - as it was entitled to do.

Once the loan had been repaid, Mrs B was left with just over £6,000. Shocked by the extent of her loss, she complained to the firm, saying she would never have agreed to the arrangement if she had realised just how risky it was.

complaint upheld
The firm's initial recommendation - for investing Mrs B's own money - had been properly documented and we were satisfied that it was suitable for Mrs B.

But the firm denied recommending that Mrs B should borrow - and invest - the £100,000. Mrs B did not appear to have been given any written confirmation of this advice. However, we noted that the loan documents had been signed by both Mrs B and the firm's representative. We were therefore satisfied that Mrs B had taken the loan on the firm's advice.

We were also satisfied that the overall arrangement failed to match either Mrs B's risk profile or the balanced description of the investment in the firm's original recommendation. We asked the firm to base redress on the position Mrs B would have been in - had she placed the money in a suitable investment.

whether firm acted appropriately in recommending high-income bond to couple seeking means of repaying short-term interest-only mortgage

Acting independently, Mr and Mrs T arranged a short-term interest-only mortgage. They then approached the firm and asked it to recommend an investment that would produce enough income to cover their interest payments on the mortgage.

The firm recommended a high-income bond. Although this offered an attractive and guaranteed income, it placed the capital at risk.

The investment failed to perform as expected and when the bond matured, the couple found they had lost a substantial amount of their capital. They complained to the firm, saying they would never have gone ahead with the investment if they had realised it carried such a high level of risk.

complaint upheld
The firm could not be held responsible for the couple's decision to take out the interest-only mortgage. Mr and Mrs T had arranged this on their own initiative before consulting the firm. However the fact that Mrs and Mrs T were investing borrowed money increased the degree of risk. The firm should have taken this into account.

The bond was for a shorter investment term than the mortgage. And it exposed Mr and Mrs T to the risk that, when the bond matured, their borrowed capital would have declined in value. We were not satisfied that the firm had given sufficient consideration to how the couple would pay the mortgage interest if this happened. We said the firm should pay redress - putting the couple in the position they would have been in if they had invested in a product that preserved their capital.

whether member of Lloyd's underwriting syndicate was wrongly advised to put funds - on which Lloyd's had a 'call' - into with-profits bonds

As a member of an underwriting syndicate at Lloyd's of London, Mr D had provided a guarantee that he would make certain funds available if Lloyd's made a 'call' on them.

For some while Mr D kept the funds in a deposit account. However, he then decided that it might be a good idea to invest the funds in order to get an income. As a concession, Lloyd's agreed to this.

After taking investment advice, Mr D put the money into several with-profits bonds. Several years later Lloyd's made a 'call' on the money, so Mr D had to cash in the bonds.

Unfortunately, the bonds had done not at all well. And because Mr D was cashing them in before the end of their term, the product provider applied an MVA (market value adjustment - a charge often levied on those who cash-in a with-profits investment before the end of its term).

As Mr D found he was left with less than the amount he had invested, he had to borrow additional funds in order to meet his commitment to Lloyd's. After complaining unsuccessfully to the firm that it had given him unsuitable investment advice, Mr D came to us.

complaint rejected
It was clear from the documents we saw that the firm had been aware the money Mr D was investing was needed to support his liability to Lloyd's.

The firm had fully explained the possibility that he would have to pay a charge (the MVA) if he cashed in the bond before the end of its term. It had also explained how this could affect the final amount he received. And it had emphasised to Mr D that he would still be liable to Lloyd's for the full amount on which it had a 'call', even if the bonds produced a shortfall.

Mr D had appeared happy to take the risk in return for the income he expected to receive from the bonds. In the circumstances of this particular case, we did not think that the firm's recommendation had been inappropriate. We therefore rejected the complaint.

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ombudsman news issue 55 [PDF format]

ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.

The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.