2. FORUM 9
Game
A sharp rise in investor lawsuits is expected
within the coming months. Much of these will likely be
attributable to selective memory — clients who have sud-
denly forgotten the nature of equity markets and why they
were in those investments in the first place.
How can advisors protect themselves against such
charges and allegations from angry clients? At times like
these, advisors need their firm and, more precisely, their
compliance department, on their side.
THE GOLDEN RULE:
KNOW YOUR CLIENT
This is where it all starts. Does the advisor truly know
the client? Know Your Client (KYC) forms (also known
as New Client Application (NCA), New Account
Application Form (NAAF) or some other variation)
exist to help advisors gather necessary information,
thereby satisfying the professional obligation to know
their clients. These forms contain some of the basics,
such as a client’s investment experience, financial and
personal situation, investment objectives, marital sta-
tus, net worth and risk tolerance, to help advisors
become familiar with clients.
There are, however, many other relevant factors
required to gain an in-depth understanding of each
client’s unique situation.
“When completing KYC forms,advisors really need to
delve into it and get the information behind the answers.
But this isn’t always easy,” says Ellen Bessner, litigation
partner in Gowlings’Toronto,Ont.office.“Advisors often
have to tackle sensitive issues and there must be a certain
level of comfort in the advisor-client relationship to facil-
itate open and effective communication.”
BlameThe
PHOTO:DAVIDMCGLYNN/GETTY
Compliance is a hot topic these days and will likely continue to
heat up even more. Plummeting equity markets have no doubt
caused many clients to open their account statement,only to dis-
cover they’ve incurred horrific losses.Unfortunately,many of these
disgruntled clients are looking to point a finger of blame and, as
Michael Callahan explains, advisors are often an easy target
3. 10 FORUM MAY 2009
A CONTINUOUS PROCESS
Knowing your client does not begin and end with the comple-
tion of a form. Clients change over time and staying up to date
with these changes is of paramount importance. According to
Bessner, regular contact is critical.
“One of the most effective ways to strengthen an advisor-client
relationship and develop a deeper understanding of a client’s per-
sonal situation is through regular and consistent contact,” she
explains. Clients may get married, have children, get divorced,
lose a job or get a raise, for instance. Any such change needs to
be properly documented so that client’s information is up to date.
In addition, life changes such as these may involve a change
in goals and, therefore, dictate a change in a client’s current
investment strategy. For example, a client previously suited to
an aggressive growth strategy may now be more interested in
protecting principal. Or, as we’ve experienced in the past and
as we’re experiencing again in today’s roller-coaster-like mar-
ket, clients may change their risk tolerance according to cur-
rent market conditions. Risk tolerance, along with most other
information gathered on the KYC form, is subject to constant
change. In order to offer meaningful advice, advisors need to
stay abreast of these changes, as products that were once suit-
able may no longer be appropriate.
BURDEN OF PROOF
It’s one thing to know your client. Being able to demonstrate
this,however,is an entirely different kettle of fish.When it comes
to compliance, simply“knowing your client”just doesn’t cut it.
Advisors have to be able to prove they know the client.
In an advisor-client relationship, the advisor is the profes-
sional and, therefore, assumes an inherent duty of care to the
client. After all, that’s why clients deal with an advisor— they
can’t do it alone. In court, many clients will emphasize this
point: that they lack the necessary sophistication and knowl-
edge and, therefore, yield to their advisor’s recommendations.
Unfortunately, what often accompanies this point is that the
clients did not understand their investments or their associat-
ed risks. The onus is now on the advisor to prove otherwise.
Advisors need to demonstrate not only that they were acting in
their client’s best interest and that the recommended invest-
ments were in line with the client’s goals and risk tolerance, but
that the client was aware of the investment strategy and any
related risks, thereby acknowledging the advisor’s actions.
This is where an advisor’s practice goes under a microscope.
Fortunately, there are several key exercises that can help advi-
sors safeguard against client allegations. Cilia McGee, CFP, CSA,
financial advisor and branch manager of the downtown Ottawa,
Ont. office of Manulife Securities Inc./Valcore Planning
Solutions, discusses her approach.
“My focus, after trade suitability, is accurate and useful doc-
umentation,”she explains.“I encourage advisors to use a note-
book with pre-numbered pages. The notebook would contain
the details of conversations with clients and would include the
date as well as a start and an end time of the conversations. This
COMPLIANCE
COMPLIANCE
CHECKLIST
Documentation: Advisors should document all con-
tact with clients. Face-to-face meetings, conversations
by telephone and email correspondence are all impor-
tant. It’s important to save all client-related email and
take detailed notes during all meetings and telephone
conversations with clients. Be sure to include any
questions asked or comments made by the client.
KYC: Know your clients and know them well.
Advisors can stay up to date with changes in their
clients’ personal situation through regular and con-
sistent contact.
Disclosure: Advisors need to properly notify their
clients,in writing,of any potential conflicts of interest.
Written declarations should be signed and dated by
both the client and the advisor and stored in client files.
Risks: It’s important that advisors outline the poten-
tial risks (such as principal risk, interest rate risk,
longevity risk,etc.) associated with any recommended
investment strategies and investment products.
Product: Before recommending any investment
product, advisors should do their due diligence in
order to gain a solid understanding of the product.
Only then can advisors truly determine if the product
is suitable for clients.
type of documentation will go a long way if an advisor is ever
put in the unfortunate situation of having to defend her
actions. Contact management software [with capabilities for]
emails, letters, tasks, etc., is also an invaluable tool. It’s impor-
tant that sufficient time be taken after every client contact to
document the conversation and subsequent actions to be taken.”
McGee works very closely with the advisors in her branch,
helping them manage their businesses in accordance with the
appropriate compliance procedures and guidelines.“No detail
is too trivial,” she adds.“When I conduct reviews, I am expect-
ing to read a story about the client. If the story is there, then I
feel confident that the advisor really does‘know the client.’”
McGee runs a tight ship and there’s no doubt that follow-
ing this advice can prove invaluable, especially if an advisor’s
actions are called into question.
KNOW YOUR PRODUCT
It seems straightforward that advisors should have a solid
understanding of the products they’re selling. But that’s not
always easy, depending on what types of products an advisor
When working with clients, advisors can take the steps
necessary to ensure compliance for general advice-giving:
4
4
4
4
4
4. uses. “Investment products of today are vastly different than
those of yesteryear,” says Jeff Kehoe, director of enforcement
and litigations for the Investment Industry Regulatory
Organization of Canada (IIROC).
According to Kehoe,the density of structured products today
can cause a great deal of confusion. Investments such as mort-
gage-backed securities, asset-backed commercial paper, hedge
funds, credit default swaps and funds of funds can prove very
confusing for even the most seasoned investor. “Products are
increasingly sophisticated, making it harder for advisors and
clients alike to understand exactly what they’re buying,”he says.
But understand it they must. Kehoe cites this is one of the
most common ways advisors get themselves into trouble — by
selling products they do not understand.
SUITABILITY
Bessner describes a “triangle of suitability,” which starts with
the client, proceeds to the KYC form and finally the product.
Only then can advisors truly determine the appropriate suit-
ability of investments. The trouble begins when advisors jump
to the third step, delving into the product and its merits, and
thereby omitting the client from the process. This is a big no-
no. The basis for an advisor’s recommendation must come from
an intimate knowledge of the client’s personal situation.
Another common pitfall is failing to properly communicate
the associated risks of an investment product or strategy to the
client. Bessner lists several reasons advisors sometimes omit
this explanation:“The client wouldn’t understand even if I did
explain it,”or“The client will buy whatever I tell him to buy, so
why waste everyone’s time?”While that may be true, it’s the kind
of logic that can land advisors in hot water. Bessner offers a sim-
ply eloquent solution: Say to the client,“Please bear with me, I
have an obligation to go through this,” followed by the appro-
priate explanation.Advisors who chose to gloss over such detail
could be heading for trouble.
THE COST OF
NON-COMPLIANCE
The cost of non-compliance can prove quite extreme. Various
fines, a suspended licence or being permanently banned from
the industry are all possible outcomes.When engaging in non-
compliant behaviour, an advisor’s lifeblood is truly at risk:
licence, reputation and income — they’re all on the table.
Consider the cases of Robin Anderson in Edmonton, Alta.
and Robert Ernest Leo Hart in Toronto,Ont.Anderson and Hart
had embezzled hundreds of thousands of dollars from elderly,
unsophisticated clients,depositing the funds into their own per-
sonal accounts. Both advisors were fined and banned from the
industry by the Mutual Fund Dealers Association (MFDA) and
IIROC, formerly the Investment Dealers Association (IDA).
In another case, Sean Shanahan, Stephan Katmarian and
Nicole Brewster participated in trading schemes designed to
MAY 2009 FORUM 11
5. 12 FORUM MAY 2009
COMPLIANCE
benefit one client while damaging another. All were punished
for their actions, including Shanahan, who was permanently
banned from the industry and fined $482,353.58.
While these cases of fraud and embezzlement may seem
extreme, advisors often end up in complicated positions, even
when acting appropriately. Bessner describes one of the most
difficult issues facing advisors today.
“Consider the case of a client who is properly asset allocat-
ed, properly diversified and whose investments are well in line
with goals and risk tolerance. But due to current market con-
ditions and through no fault of the advisor, the client has lost
money. Continued discussions with clients concerning the mar-
ket and its impact on some of the investments, along with a
paper trail to prove that these discussions occurred, will help
support the advisor’s version of events that the client did accept
some risk and understood the investment choices,” she says.
Without appropriate records, advisors leave themselves vul-
nerable to a client who claims that he or she did not understand
the risks associated with their investments.According to Kehoe,
this often results in a “he said, she said”-type scenario, which
is a very unfortunate position to be in. Indeed, the risks an advi-
sor takes by not keeping proper documentation are substan-
tial. On the other hand, advisors who act appropriately and
keep a paper trail are in a better position to defend their actions.
“Take comprehensive notes and document all conversations.
Because in the end, that’s what we [IIROC] want to see,” adds
Kehoe.
A HAPPY ENDING
In a recent article in the Financial Post, Gowlings’ Bessner dis-
cusses a case of particular interest where an advisor who main-
tained a paper trail of communication in which the client is
warned of the risks regarding an investment strategy taken is sued
by the client. The client’s action was dismissed.
In March 2008, Superior Court Justice Thomas Lederer dis-
missed Ron Parent’s claim when he sought to have his financial
advisor, Leach, and investment dealer, Merrill Lynch, reimburse
him for losses incurred in a risky investment strategy. It’s the
classic case of an aggressive client who wanted to take high risks
in order to enjoy high returns, but pointed a finger of blame at
the advisor when the strategy didn’t pan out.
Leach kept a good paper trail. He had warned Parent of the
associated risks on several occasions and there was ample doc-
umentation to support his testimony. Leach had letters deliv-
ered, one of which was received with Parent’s signature and
returned to Merrill Lynch. Parent argued that Leach told him
the letter was unimportant and that he should disregard the
content but sign and return it as required.
Judge Lederer didn’t buy it. Parent denied regular contact
with Leach, but Leach had notes of discussions with Parent over
decisions made regarding accounts and specific trades. For
example, The Option Account Agreement, signed by Parent,
was accepted as evidence of what was told to Parent. Attached
to that agreement was a list of the risks associated with option
trading and, ultimately, Leach’s evidence was preferred over
Parent’s. Judge Lederer concluded that Parent’s allegations were
unsubstantiated. Parent could not blame his losses on Leach
or Merrill Lynch, as there “were too many warnings and too
many opportunities to make the necessary changes.”
While it’s clear that the advisor had acted appropriately in
this case, it’s the sound documentation that helped prove it —
the advisor had the records necessary to defend his actions.
To help advisors,Bessner has recently published a book titled
Advisor at Risk: A Roadmap to Protecting Your Business (avail-
able at Chapters-Indigo). Intended as a guide for advisors, deal-
ers and insurance agents, it is designed to equip advisors with
the tools necessary to reduce the risk of client complaints.
In the end, advisors must protect themselves.
MICHAEL CALLAHAN can be reached at callahan_michael@yahoo.com.
The risks an advisor takes by not
keeping proper documentation
are substantial. On the other hand,
advisors who act appropriately and
keep a paper trail are in a better
position to defend their actions.
