CASE: Law of Investment and Financial Markets

Morgan worked very hard to land a middle management job with a casino and gambling company in Melbourne. His upbringing was rather difficult, growing up in a dysfunctional family with an alcoholic mother and an absent father. He always took care of his younger siblings. The children had to be removed by social services and placed in the care of their maternal grandmother, who died in her late 80s leaving Morgan and his siblings with an inheritance of $50,000 each.

He dreamed about becoming financially secure since his early teen years. He frequented newsagents to purchase lottery tickets. He spent many hours gambling, which was one of the most important social and leisure activities for him. He had a mistaken belief that one day he would actually hit the jackpot.

His girlfriend Mary advised him to seek professional help to stop the gambling addiction. Gambling addiction can be best described as the compulsion to gamble or place bets. This behavior has a negative impact on the gamblers life. Debts begin to climb, and other negative consequences start piling up and yet, those who are addicted to gambling cannot resist the overwhelming urge to place another bet. The repeated action of gambling has been found to cause changes in the addicts brain like that seen in the brain of someone addicted to drugs or alcohol. Once this occurs, professional treatment is usually the only way to overcome the obsessive need that accompanies gambling addiction. Financial consequences such as loss of money and assets, as well as high levels of unmanageable debt, are the most obvious effects of gambling addiction. Without treatment, those suffering from gambling addiction may find themselves selling off major assets including cars and homes, borrowing money from loan sharks, and even stealing money from friends, relatives, the workplace, or anywhere else they can.

Based on Marys advice, Morgan enrolled in a state-supported addiction program. Morgan feared that his addiction would spiral out of control and result in the loss of his inheritance. To increase his financial knowledge, he attended a seminar on investments organized by a financial business called Wealth Pty Ltd. At that stage, he was not sure what he wanted to do with the inheritance. Fifteen people attended the seminar. The presenter Rick provided a general description of the different types of financial products that are available for investment purposes. He also shared information about stock market volatility, post-Covid recovery of financial markets, etc. After the seminar, Morgan approached Rick to ask questions about investments, salary sacrifice arrangements, and superannuation. Rick gave Morgan his business card stating that he was an authorized representative and broker of the licensee Wealth Pty Ltd. He advised Morgan to give him a call to arrange a meeting. Later that day, he emailed an FSG.

When they met, after a detailed examination of the FSG, Morgan signed a contract with Wealth Pty Ltd. Rick asked several questions about Morgans financial circumstances, current debts, and earnings, which created an impression of a highly experienced financial advisor. Morgan was impressed and confessed about his gambling addiction and stress. He also expressed his fears about gambling away the inheritance and that he wanted to invest the money. His preference was low risk and steady returns as he did not like high-risk investments even though he dreamt about becoming wealthy.

Rick explained while it was good to be cautious and risk-averse, there was one company Ependysi Ltd, which was able to produce impressive returns for investors. Rick added that the company was extremely profitable, and he had personally examined its reports and profit results, and the company would definitely deliver profits at 30% this financial year. He further advised there was always risk with any investments, but the company was a solid company that had been around for many years and would likely be financially viable for many years to come. However, Rick advised Morgan to borrow another $100,000 to amplify the performance of the portfolio with Ependysi Ltd as the inheritance money was not sufficient to yield significant benefits.

During the meeting, Morgan was a little hesitant and asked if he could learn more about other investment options particularly, managed funds. He mentioned about Vanguard that has a range of ESG funds (socially responsible investment funds) that are aligned with his values and beliefs. He believed that Vanguard would meet his long-term financial goals with low-cost investment solutions. When an investor invests in a managed fund, the money is pooled together with other investors. A fund manager then buys and sells assets, such as shares or bonds, on the investors behalf. Some managed investment funds can be relatively low-risk.

Rick replied that investing in managed funds like Vanguard would not bring any long-term financial benefits to Morgan as these funds can be high risk as well and he needed to look at long term because even if a fund performs well in one year, there was no guarantee that it would the next year. Rick mentioned investing in Ependysi would change his life and make him wealthy. He repeated that the offer was limited time only. Morgan felt overwhelmed by Ricks emotional manipulations and pressure, and he followed the advice. He mortgaged his house and borrowed $100,000 to invest $150,000 in the company.

Soon Ependysi was placed in liquidation. Evidence revealed that:

• The company promised commissions and non-monetary benefits to licensees and their advisers to attract investors. None of this information was disclosed to potential investors. The company was suffering from a monthly decline in returns.
• Vanguard offers safe and low-risk investment options and has a great reputation for having many ESG funds. As an investor with up to $50,000 Morgan would have received a high level of service and would have found investments that met his needs and the financial help he needed.
• Wealth Pty Ltd never conducted training of its representatives. They were advised to use high-pressure sales tactics and manipulations to sell financial products. Some investors were generally caught up by the promise of high returns and were motivated by greed to enter into risky investment arrangements. However, some clients key aims in investing through Wealth Pty Ltd was simply to generate an independent income during their retirement.
• Wealth Pty Ltds advisers worked in the way that they failed to conduct reasonable investigations into clients relevant personal circumstances and did not take any steps that would reasonably be regarded as being in the best interest of the clients, they often misconstrued the actual subject matter of the advice. They did not accept that a clients risk tolerance and risk profiles are essential considerations. Evidence found that their clients were dealt with as balanced investors, yet their profiles were that of conservative and risk-averse investors.
• Wealth Pty Ltds advisers treated family homes of their clients as an asset in the clients investment portfolio, which is incorrect. This resulted in devastating consequences for people like Morgan, who may lose his house. The courts recognize that family homes are differentiated from investment assets because they are an asset that provides shelter and accommodates peoples physical, emotional, and family needs.
• Wealth Pty Ltd permitted its authorized representatives to audit their own advice files. Most of its authorized representatives were not adequately trained or competent to provide financial services. When Morgan tried to complain, it was discovered that the licensee did not have a dispute resolution system in place and did not maintain organizational competence or the resources required to provide the financial services covered by its license. Rick failed to keep adequate records and gave Morgan non-compliant Statement of Advice by not including information about the basis of his advice.
• Wealth Pty Ltd admits that it made false or misleading representations to clients that it had systems and processes in place that were adequate to provide appropriate advice. Wealth Pty Ltd created the impression that the products they sell were similar to low risk products. The promotional materials did not refer to the differences between the different types of financial products.

Additional details:

- Use the IRAC

- Mainly about Investing in Financial Products, Common Law Framework, Regulation of Financial Services Industry, Conduct and Disclosure in the Investment Advisory Process, Consumer Protection (Chapter 7 of the Corporations Act)

QUESTION: Advise Morgan and the ASIC about legal actions that can be brought against Rick and the licensee. Discuss all relevant legal issues raised in this question. Refer to relevant Australian laws.