Risk management: Best practices for advisors

By Heidi Staseson | October 19, 2005 | Last updated on October 19, 2005
3 min read

(October 2005) Advisors need to think more about potential risks in their practice, according to one expert, who argues that managing risk is one of the keys to long-term success.

"We have the ability to anticipate risk and learn to mitigate and manage those risks. And importantly we can start to incorporate consistent routines into our behaviour," said Karen Smiley, AIM Trimark’s vice president of practice management, at a recent advisor conference.

For those who think risk management isn’t an issue, Smiley pointed to the IDA’s 2004 annual report, which listed more than 200 complaints by investors over unsuitable investments and more than 300 complaints regarding authorized discretionary trading. Of the cases that actually made it to arbitration, 25% of were about negligence while 42% highlighted unsuitable investments.

Time and experience ultimately will change definitions and understanding of risk among advisors, she noted, and scenarios once perceived as normal practices can suddenly be deemed risky business when new policies and procedures, rules and regulatory changes come into play.

For example, she told the story of an advisor who recommended a client — an accountant — redeem a certain fund and purchase a different fund the advisor felt was better suited to the client’s risk tolerance. During the transaction, the advisor engaged in appropriate know-your-client (KYC) and due diligence practices.

A week later, the client called the advisor to back out on the investment after his accounting firm told him they worked with that particular mutual fund manufacturer. Investing in the new fund was therefore a conflict of interest for the client.

Smiley said the example demonstrates how businesses change, and as a result, levels of potential risk follow suit.

The story wasn’t over though. After the advisor put the redemption order through, his compliance officer called him, questioning the advisor’s actions, which he considered to be short-term trading. The advisor then had to go back to the client, get a letter of indemnity and an explanation from the investor’s company. Smiley calls this a clear example of how new regulations and procedures, notwithstanding perception and interpretation of risk, can come into play at any given moment in an advisor’s practice.

"Was [the advisor] really doing what was right for the client? Absolutely he was," she said. "But the interpretation can be about conflict or compliance."

"It’s really about making sure that we know all of the pieces of the puzzle, and that we’re putting all of the component pieces together to get an accurate understanding of what’s really happening in that particular story," she added.

Based on her seminar, Smiley mentioned the following business-risk safety precautions (in no particular order) advisors might consider implementing:

  • Backup client files on a hand-held PDA device or computer.
  • Assign an individual in the office as risk management monitor.
  • Use an external facility as disaster recovery.
  • Work more closely with head office to understand their dealership’s disaster recovery program.
  • Keep updated copies of all KYC forms, not just for one investor but for every single client.
  • Keep a detailed journal, recording all client conversations and interactions.
  • Make sure those pages are dated and numbered (to prove they haven’t been tampered with.)
  • Keep letters of engagement that outline advisor services, accountability and investment policy statements

"Clients feel comfortable when they know exactly what they’re going to get … You feel comfortable when you know exactly what process you’re going to follow," Smiley said. "This is not about programming people. It’s about making sure that we’re planned — planned in our interactions with clients and in our experiences."

Over time, such routines can become healthy habits. "If it’s a habit that you want to have happen once a week, it still might take about 12 weeks to build. "That’s 12 weeks of diligence for a lifetime of reward — a pretty small price to pay in the big picture."

Lastly, she cautioned advisors not to take the attitude that being sued by a disgruntled investor or being perceived by clients as inconsistent and incompetent could never happen to them. "It can happen to anyone, no matter how good you are," she warned. "No matter how great your relationships are we are all vulnerable. Business is business and money always matters. Patterns of diligence are put in place to help protect us and the clients."

Filed by Heidi Staseson, Advisor’s Edge, heidi.staseson@advisor.rogers.com


Heidi Staseson