In a recent article, Shail Singh, lead ombudsman, and Alex Sidoti, senior ombudsman, investments and advice for the Australian Financial Complaints Authority, said the calculations the regulator uses to determine direct financial loss arising from a breach can be complex, and often different methodologies are needed to assess the direct loss depending on the circumstances of the complaint.
The ”but for” test is one of the key methods the regulator uses and looks at what should have happened if the advice had not resulted in the complaint.
“In some cases, AFCA applies a ‘no-transaction’ counterfactual. This assumes that, had the client received appropriate advice, they would have taken no action at all,” Singh and Sidoti said.
They added that this method is particularly relevant when the original investment was in a stable, regulated product, the advice to sell the original investment was clearly unsuitable, or the advice to invest elsewhere led to significant losses.
They gave an example of a client who was advised to switch from an APRA-regulated fund to an SMSF with most of the assets placed in a high-risk product.
“Having found the advice to be inappropriate, under the counterfactual scenario AFCA would compare the performance of the original APRA fund to the actual performance of the SMSF investment to calculate the loss,” they said.
A second calculation method used by AFCA is the counterfactual or “estimate” used in situations where a no-transaction approach doesn’t make sense.
These cases can often involve long-term financial advice relationships and in this method AFCA considers the client’s risk profile and an appropriate market benchmark.
To illustrate this method, they gave an example of an SMSF client who had for many years had actively managed investments.
“AFCA would evaluate the client’s risk profile and use a market benchmark – for example, the Vanguard Fund, a passively managed portfolio – to estimate the returns the client should have reasonably achieved with that level of market exposure,” they said.
They added that using a benchmark like the Vanguard Fund ensures compensation reflects not just potential rewards but also market risks.
Furthermore, they said the counterfactual approaches prevent over-compensation or under-compensation based on short-term market fluctuations.
“Taking a counterfactual approach is consistent with relevant case law and it doesn’t ask advisers to ‘underwrite’ the market, with compensation based on likely market exposure – whether that realises risk or return,” they said.
“By focusing on counterfactual scenarios and market-based benchmarks, AFCA aims to provide fair, consistent and legally sound compensation outcomes.”
