You are busy enough comforting clients through volatile markets; the last thing you need on your mind is a lawsuit. But this type of market causes client complaints to jump. How can you protect yourself?
Know the archetypes
No surprise, advisors wouldn’t talk on the record about this topic. According to several we spoke with, there are five client archetypes that have the potential to become litigious.
HEADSTRONG HARRY: DANGER LEVEL 7/10
Harry knows exactly what he wants to buy. He’s done tons of research and knows the markets. You can’t pin him down on risk tolerance and objectives because he knows they’ll shift over time. He’s looking in part for an order-taker but also secretly wants an investing partner. He’ll look to buy the hottest products but delegate responsibility for their performance, and if the investments he insists on go south, your phone rings.
Protect yourself: This client needs constant communication and detailed documentation of every transaction. He wants a call the moment the market hiccups. He’s watching you, but can be a great client if you’re on your game.
GIC GLORIA: DANGER LEVEL: 5/10
Gloria’s only investments are GICs. But today’s low rates mean she won’t be retiring at 55. She’s looking for higher yield, so you put her in conservative mutual funds. The first time Gloria’s funds go down, she complains. She’s not comfortable with the way mutual funds follow market trends, and insists on going back to GICs.
Protect yourself: This client is not likely to go to the formal complaint process and it can be a good test of an advisor’s skills at explaining how equity markets work. Or you can simply put Gloria back into GICs and make it clear that her investing time horizon will be long. Explain the concept of risk versus reward, but realize some people just can’t tolerate risk. Delve deep during the KYC process and find out about past investment history. Maybe the client lost a significant sum to a bad investment.
SERIAL SALLY: DANGER LEVEL 8/10
Fresh from leaving her previous advisor, Sally complains to you about how he didn’t listen. Further discussion reveals she’s had four advisors in the last three years. It could be all four were bad fits, but you sense that may not be the case.
Protect yourself: A serial client can be toxic to your business and your sanity.
Advisors can’t warn each other about a Serial Sally without risking a privacy violation, so caveat
emptor when taking on new clients. Ask lots of questions and find out exactly why Sally left her previous advisors.
TOO-SMART TIM: DANGER LEVEL 10/10
Tim targets rookie advisors. He opens a new account, and pre-sents himself as a low- or no-risk client. He’ll behave that way for awhile, then suddenly announce he’s flush with cash and wants to start making very speculative trades.
The sizable commission is tempting, but Tim will tell you he can’t sign off on a risk-profile update because he’s trapped at his cottage. Against your better judgment, you do the trade. Tim loses big, and tells your firm, “I shouldn’t have been allowed to buy that security. My account is coded as low risk. Your advisor should have rejected my trade.”
Tim’s brother, Jim, has even more insidious methods. He’ll open a new account with a bogus certified cheque and do a bunch of aggressive trades right away. The trades lose a ton of money, leaving the firm (and you) holding the bag.
Protect yourself: Reject all trades until risk-tolerance documentation is on target, no matter how appealing the commission. Tim knows how suitability is reported on the new account application form and is ready to game the system. If you meet Jim, make sure his certified cheque actually clears before executing any orders.
INNOCENT IRENE: DANGER LEVEL 3/10
Irene’s a longtime client who’s invested in only preferred shares and Canadian bonds. She tells you today she wants to invest in a junior mining stock.
She insists, even though you bring up her investment history. Further questioning reveals she’s in the process of being swindled by a friend, family member or colleague and is looking for a way to make a lot of money in a hurry.
Protect yourself: If you can spot it, you can stop it. Be aware of your clients’ investing patterns and make sure you ask questions when they change dramatically. Find out why they’re interested in the investment, and how much they expect to make. If they can’t explain it to you, advise against it.
Prevention is the best defence
Any client who loses money will get upset. But some investments are inherently riskier and should be approached with caution, regardless of client temperament.
Leveraged investing, back-end-loaded funds, and aggressive tax shelters all came up as areas of concern. One source described a tax shelter scheme that promised a donation of $5,000 would be leveraged into an amount ten times that. That’s sure to raise the ire of the CRA—and of the client when things don’t work out.
Even buying speculative small- and micro-cap stocks can go badly. If the stock goes south, clients may ask for their money back. If you didn’t document the transaction properly, you open yourself up to complaints.
Which means a high threshold for propriety is the best form of prevention.
“Whenever you’re asked to participate in an investment you think is unsuitable, you’re in a risky position,” says Joseph Groia, a Toronto-based securities lawyer.
You have two choices: tell the client to use a discount brokerage, or make the trade and get signed acknowledgement that you didn’t recommend it. It’s better to reject the business outright because the documentation can hang you. On one hand, you told the client not to do it; on the other, you had a hand in the execution, and the supporting evidence is there in black and white.
Groia’s had a case where an advisor’s compliance department asked an elderly client to sign a letter releasing the firm of any liability for some inappropriate investments. That made it easy for him to argue for the client.
“The house took advantage of her vulnerability twice: by putting her into unsuitable investments and [then] in getting her to sign a release when it should have been protecting her.”
When in doubt, fall back on your fiduciary duty. Tell the client you value his business and for that reason, you simply won’t do the trade.
Steps to take
Integrating a few steps into client appointments can also shield you from future issues.
“Have regular conversations with your clients and start by asking if anything’s new, the same way doctors do,” says Julie-Martine Loranger, a partner in Gowlings’ Montreal office. Always update the investment objectives accordingly, especially before a trade that’s outside the old parameters.
Then, take it a step further: walk the client through the rationale behind both the old and new objectives. And explain the consequences—if a divorced client is moving to a lower risk tolerance, make sure he understands the returns will likely be lower, too.
Clarity is key. “You have to explain risk [in a way] that’s accessible. Don’t say things like, ‘This stock is not very liquid.’ They may not understand what that means,” says Loranger. Stay away from anything outside your wheelhouse, since it’s hard to explain products you don’t fully understand.
And never assume you know what your client’s risk tolerance should be. “Just because your client is a good businesswoman [doesn’t mean] she understands investments,” she adds.
Both Loranger and Groia emphasize the importance of working with branch managers and compliance. These are resources your firm is providing, so take advantage of them.
Ultimately, if the firm puts a product on your shelf, it holds the responsibility for ensuring it’s a proper investment for its advisors to sell, notes Groia. “Why wouldn’t you pass the ball to people who make more than you?” he asks. “The commission dollars are not worth the aggravation.”
What happens when you do everything right and your client still complains?
“Half to three-quarters of the time, we tell clients they don’t have a strong suitability case,” says Groia. “When the last meltdown happened, I had people coming to me because they’d lost 40% of their portfolios, which were all invested in blue-chip stocks. I’m not going to persuade any judge that a portfolio with the Big Five bank stocks in it is an unsuitable investment.”
And, even if a client’s case does have merit, you’re not likely to end up in court. Clients complain to the firm first, and firms don’t want complaints to escalate.
Problem is, though, that after a settlement the advisor has a debt to the firm. They may put up the cash to settle a $30,000 complaint and keep it off the news, but the advisor has to pay the tab. With zero recourse against the firm except quitting, the settlement sum becomes a cost of doing business.
With everything at stake, it pays to keep your antennae tuned for suspicious behaviour. If new clients seem too good to be true, they probably are. And if a trade could be even a bit offside, it’s best not to do it at all, no matter the upside.