Avoiding Customer Complaints


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Best practices for financial advisers to avoid client complaints

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Avoiding Customer Complaints

  1. 1. Avoiding Customer Complaints April 30, 2009 FPA New York Spring Forum New York, NY PRESENTED BY: James J. Eccleston, J.D. Copyright 2009 Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C. Chicago, IL All rights reserved.
  2. 2. I. FINRA Arbitration Filings are increasing • In 2008, 54% increase (4,982 vs. 3,238 claims) • Through mid-March 2009, claims filed = 1,475 • “Win” rate for customers rebounded, from low of 37% in 2007 to 42% in 2008 • “Failure to supervise” claims up 24% • “Omissions of fact” up 337% • “Misrepresentation” up 171% 2
  3. 3. FINRA Arbitration • “Omissions of fact” and “misrepresentation” account for more than 40% of disputes of the 10 listed security types – Reflect explosion of “Derivative Securities” disputes and “Auction Rate Securities” disputes – with chief allegations relating to what investors were told and not told • Traditional security types also visible in customer disputes – Mutual funds (171%) – Corporate bonds (130%) – Certificates of Deposit (98%) – Common stock disputes declined in number 3
  4. 4. FINRA Arbitration Unsuitable investments • An issue in many, if not most, customer arbitrations and claims against financial advisors NASD Conduct Rule 2310: • Requires broker/advisor to have reasonable grounds for believing that recommendation is suitable based on the facts, if any, disclosed by the customer as to his or her other security holdings, financial situation, and financial needs • Advisor must determine if the recommendation is suitable for any investor, regardless of the investor’s wealth, willingness to bear risk, age or other individual characteristics (so-called “reasonable basis” suitability) 4
  5. 5. FINRA Arbitration Unsuitability – Typical Scenario • Retiree (or person approaching retirement) • Sold investment (e.g., stock, bond or mutual fund) or product (e.g., deferred annuity) that is too risky or volatile in view of the customer’s objectives and needs • Account is too heavily concentrated in one asset class (e.g., stocks/equities) or sector (e.g., financials, technology, etc.) • Investment risks are not adequately disclosed and/or misrepresentations are made 5
  6. 6. II. Critical Functions (NYSE Series 7 Examination Content Outline, 1995) 3-5) Considers the tax implications for a customer of particular investments 4-9) If there is to be any power of attorney over the account, obtains the necessary documents and approvals 7-1) Routinely reviews the customer’s account to ensure that investments continue to be suitable 7-2) Suggests to the customer which securities to acquire, liquidate, hold or hedge 7-3) Explains how news about an issuer’s financial outlook may affect the performance of that issuer’s securities 7-4) Keeps the customer informed about the customer’s investments 6
  7. 7. Critical Functions Monitoring Common Problems • Asset class, sector or stock becomes over-weighted/over-concentrated • Client changes his/her situation – New questionnaire – Objectives 7
  8. 8. III. Implications For Investment Advisers VARIATION ON UNSUITABILITY Portfolio Mismanagement by an Investment Fiduciary • Registered Investment Adviser and its representatives have fiduciary duty to clients • Modern Portfolio Theory (MPT) and Prudent Investor Rule define standard of care • Financial planning “negligence” – failure to anticipate client’s income needs, inflated projections based on unrealistic returns, etc. 8
  9. 9. Implications for Investment Advisers MODERN PORTFOLIO THEORY Asset Allocation and Diversification • Fundamental concepts that sometimes are disregarded by advisors Asset Allocation: • Practice of combining non-correlated asset classes (e.g., stocks, bonds, cash, REITs, hedge funds) • Significantly reduces risk (i.e., volatility) in portfolio • Does not significantly reduce investment returns Diversification: • Means not having all of your eggs in one basket (i.e., sector) 9
  10. 10. Implications for Investment Advisers PRUDENT PRACTICES FOR FIDUCIARY ADVISERS by Financial Planning Association (and Donald Trone) • Outlines prudent practices for Fiduciary Advisers as defined in the Pension Protection Act of 2006 • FPA states the handbook “represents a standard of excellence for fiduciary advisers” • Includes a four-step investment management process: 1. Organize 2. Formalize 3. Implement 4. Monitor 10
  11. 11. FPA Handbook Let’s look at the second step, FORMALIZE: • Practice A-2.1 – Fiduciary adviser will analyze investment options and review them with the client • Practice A-2.2 – Fiduciary adviser should identify and document the investment time horizon for the client • Practice A-2.3 – Identifying and discussing the client’s risk tolerance • Practice A-2.4 – Identifying, discussing and documenting the client’s expected investment return necessary to meet the client’s investment objective • Practice A-2.5 – Suggests the procedure by which advisers should recommend particular asset classes for the client • Practice A-2.6 – “Preparation and maintenance of a client’s investment policy statement (IPS) is one of the most critical functions performed by the fiduciary adviser, even if it is not stipulated by law or regulation.” 11
  12. 12. FPA Handbook Let’s look at the fourth step, MONITOR: • Practice A-4.1 – Obligates fiduciary advisers to provide periodic reports to clients which compare investment performance against an appropriate index or peer group and against the objectives of the IPS – A “watch-list” of underperforming investments is encouraged, and the fiduciary adviser should advise the client how to periodically rebalance investments in the portfolio • Practice A-4.2 – Recommends that the fiduciary adviser periodically evaluate the qualitative and/or organizations changes of investment managers or other investment decision-makers which may affect the investment offerings within the plan, including corporate stock of the plan sponsor – Fiduciary advisers are expected to notify the client in writing of any unsatisfactory news regarding a material holding in the client’s portfolio 12
  13. 13. IV. Themes of Mistakes INCLUDE: • Failure to document • Failure to control • Digging the hole deeper 13
  14. 14. Themes of Mistakes Failure To Document • Define the scope of the engagement – What part of the whole are you responsible for giving advice about? • Not obtaining complete financial picture from client • Have clients fill out applications and questionnaires in their own writing 14
  15. 15. Themes of Mistakes Failure To Document • Allowing parts of questionnaire to go unanswered • Not documenting what the objectives are for the funds you manage • Not obtaining all information from client before giving advice 15
  16. 16. Themes of Mistakes Investment Policy Statements 16
  17. 17. Themes of Mistakes Failure To Control Letting the client control the advice you give Example: Clients who want to retire young, but have not yet saved enough Your choices: • Tell clients what they want to hear • Deliver bad news 17
  18. 18. Themes of Mistakes Typical example: Someone who is 55 and married just retired from his job and took a lump sum distribution: • Recommend an aggressive asset allocation to get the numbers to “work” • Tell client “to go back to work and earn some more money” 18
  19. 19. Themes of Mistakes Avoiding This Problem • Have a research-backed, consistent methodology • Follow it with each client, even when it means saying: “You may want to retire, but you can’t.” 19
  20. 20. Themes of Mistakes Handling The Spendthrift Client Identifying potential spendthrift clients • Retirees with lump sum distribution • Clients with limited earning potential • Heirs and trust beneficiaries 20
  21. 21. Themes of Mistakes Handling The Spendthrift Client Signs of problems • Living expenses beyond reasonable levels • Unwilling to limit expenses or change lifestyle 21
  22. 22. Themes of Mistakes Handling The Spendthrift Client Solving problems • Communication with customer regarding expenses • Avoiding growth investing for income model • Reevaluating client goals and expectations • Documenting problems and solutions offered 22
  23. 23. Themes of Mistakes Digging the Hole Deeper “No good deed goes unpunished.” • Admitting that a past strategy was not a good idea • Offering to waive fees or give a discount for poor performance • When a client does not have the stomach to take losses, don’t fight him • Sell a position that is going down and revise the questionnaire to reflect that the client “can’t sleep” with certain investments 23
  24. 24. Themes of Mistakes Avoiding Digging the Hole Deeper • If you and a client no longer have the same ideas about investing, end the relationship • Document any time that a client took an action against your advice • Never admit that an investment was a bad idea or a mistake • Never give a refund/discount for services due to investments performing poorly 24
  25. 25. Themes of Mistakes Dealing With a Customer Complaint • DO NOT meet with the customer or communicate with the customer • Notify compliance 25
  26. 26. V. Senior Issues FINRA NTM 07-43: • “To urge firms to review and, when appropriate, enhance their policies and procedures for complying with FINRA sales practice rules, as well as other applicable laws, regulations and ethical principles, in light of the special issues that are common to many senior investors” • Defined as those “at or nearing retirement” 26
  27. 27. Senior Issues No “special rules,” but: • “Age and life stage (whether pre-retired, semi-retired or retired) can be important factors, and firms should make sure that the procedures they have in place take these considerations into account where appropriate” • Suitability of recommendations and communications aimed at older investors are “of particular concern” • Refrain from making an unsuitable recommendation 27
  28. 28. Senior Issues Note: “A customer’s net worth alone is not determinative of whether a particular product is suitable for that investor, even when the investor qualifies as an accredited investor.” – FINRA states that over-reliance on net worth is “particularly problematic” where the investor has met the accredited investor standard based largely on the value of his or her home, “which may represent the largest asset of many senior investors.” 28
  29. 29. Senior Issues Suitability • Age and life stage – “As investors age, their investment time horizons, goals, risk tolerance and tax status may change.” – “Liquidity often takes on added importance. And, depending on their particular circumstances, seniors and retirees may have less tolerance for certain types of risk than other investors.” – “Retirees living solely on fixed incomes may be more vulnerable to inflation risk than those who are still in the workforce, depending on the number of years those retirees are likely to rely on fixed incomes.” – “Investors whose investment time horizons afford less time to or opportunity to recover investment losses may be disproportionately affected by market fluctuations.” 29
  30. 30. Senior Issues Suitability • Liquidity needs, consider – Customer’s primary expenses (Mortgage?) – Sources of income (Fixed?) – Amount of retirement savings (How invested?) – Health insurance coverage (Relying on assets to pay for health costs?) 30
  31. 31. Senior Issues Risk • Caution: older investors may “reach for yield to maximize retirement income without the appreciation of the concomitant risk” • Must present a “fair and balanced picture of the risks, costs and benefits” 31
  32. 32. Senior Issues Particular concerns • Deferred variable annuities, equity indexed annuities and some real estate investments and limited partnerships – “Have withdrawal penalties or otherwise lack liquidity” • Using home equity to make investments • Using retirement savings (including IRA withdrawals) to invest in high risk investments 32
  33. 33. Senior Issues FINRA Report: “Protecting Senior Investors: Compliance, Supervisory and Other Practices used by Financial Services Firms in Serving Senior Investors” 1. Senior investor not defined by age, but “to include investors who have retired or are nearing retirement” – Age, life stage & “diminished mental capacity” are critical components – Diminished mental capacity may be more prevalent among older investors, who may also be more frequent targets for financial abuse 33
  34. 34. Senior Issues 2. Firms are communicating effectively with seniors – Firms increased frequency of contact so they remain informed about changes in the investor’s financial needs, employment status, health and other life events – Firms adopted practices to encourage their financial advisers to avoid financial jargon & to document conversations with investors, including by sending follow-up letters – Firms have drafted written materials, in larger-font versions, aimed at educating senior investors 34
  35. 35. Senior Issues 3. Some firms consider training on how to identify diminished capacity a critical program for employees, especially identifying “red flags”: – Of diminished capacity, including the inability to process simple concepts, memory loss, difficulty in speaking or communicating, disorientation and erratic behavior – In financial matters, including refusing to follow appropriate investment advice, making investment decisions inconsistent with long term goals, concern or confusion about missing funds, being unaware or not understanding recently completed financial transactions 35
  36. 36. Senior Issues 4. Practices regarding specific products – Limiting or prohibiting purchases of certain investment products, such as “structured products” based on life stage and risk profile – Prohibiting purchases of certain variable life insurance products by investors over a certain age – Requiring a heightened review of annuity applications for investors over a certain age in a low tax bracket or with low liquid net worth 36
  37. 37. CONCLUSION 37
  38. 38. Questions? For more information on the securities practice group at SNSFE, or if you have a question about this presentation, please contact: James J. Eccleston JEccleston@snsfe-law.com 312.621.4400 Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C. 20 N. Wacker Drive, Suite 2900 Chicago, IL 60606-9719 312.621.4400 (T) 312.621.0268 (F) www.SNSFE-law.com Thank you! www.FinancialCounsel.com 38