The Value of Hindsight – 3 Steps to Help Financial Advisors Avoid Client Claims and Complaints

Hindsight is 20/20. Lawyers can’t always predict the outcome of a legal claim. But when a dispute between an investment client and her financial advisor actually reaches a court or a regulatory hearing, the client usually wins and the financial advisor usually loses – unless there’s a good paper trail of what the advisor said or did. Based on these odds, it’s in a financial advisor’s best interests to avoid a legal claim or a complaint altogether, or to deal with it quickly if one comes up.

There are some clients who, when meeting their financial advisor, do their best to come across as investment savvy. But if things go sideways, almost every client portrays herself as an unsophisticated investor who relied completely on the advisor – and claims the advisor breached one of the legal duties she owed her client: to follow the client’s instructions; to ensure she has the client’s authority to trade; to ensure her recommendations are suitable for that client; and to be loyal, act in good faith and disclose any conflicts of interest.

The most common complaints clients make against their advisors are:

• the advisor made unsuitable, unauthorized or excessive trades;
• the advisor didn’t explain the risks (margins, options, selling short, etc.) to the client; and
• the advisor said it was a “guaranteed sure winner”, or “guaranteed we will never lose money”, but didn’t deliver.

Here are three steps to help financial advisors meet their legal obligations – and avoid successful client claims and complaints.

1. Know Your Client – well and often. Advisors must carefully and continuously study the client’s business and personal affairs; in other words, an advisor has to get to know her client well in the first place. Simply filling out the Know Your Client (KYC) form isn’t enough; at a minimum, the advisor must meet the intent of the KYC rule by knowing: the client’s age; her investment objectives and risk tolerance; her investment knowledge; and her net worth and earnings.This requires the advisor to ask her client questions –probing to get full and complete answers – and document her answers. And knowing the client isn’t a one-shot deal; an advisor needs to stay in touch with her clients regularly to make sure her client file – and her advice – stay current:
   • the advisor must decide how often she needs to meet with her client to discuss her client’s personal financial position and investment objectives, and to review and update the KYC and account forms; and
   • implement a follow- up system to make sure those regular meetings and discussions happen, and document what she and her client discussed and when.
2. Give cautious, timely advice. The advisor needs to make sure her advice is appropriate for her client, and take the time to explain it to her client and be assured her client understands and agrees to it – and if she doesn’t, to explain it again. And again, this isn’t a one-shot deal; what amounts to “timely” advice will change as the client’s circumstances change. So in the initial meeting and regularly thereafter, the advisor must:
   • review and explain the KYC and account forms, including all material risks; failing to update a KYC is a classic mistake of an  advisor, so if it’s a follow-up meeting, decide if anything needs to be changed or updated, and involve the client and explain the need and reason for any changes.
   • review and explain the investment strategy she’s developed for her client, and regularly review it with the client or make any necessary strategic changes – always making sure her client understands and agrees to it.
   • when making trades, confirm the trade is consistent with the client’s objectives and risk tolerance and confirm the client’s instruction and discussions, including discussions of risks.What the advisor doesn’t do is just as important as what she does:
   • don’t have financial dealings with the client: that means no borrowings from the client, no lending money to the client and no private deals with the client 
   • don’t bend any rules for the client 
   • don’t have a conflict of interest with the client: full disclosure 
   • don’t promise the client that the advisor will “fix her problems”, or make any “guarantees”
     
3. Document, Document, Document. Finally, the advisor should document – everything, including: 
   • that she explained the KYC and account forms to the client, including all materials risks, and that the client agreed;
   • that she explained the investment strategy to the client and the client understood them and agreed; and
   • the client’s acknowledgement by signing copies of all forms and documents (and the advisor should provide the client with copies).There are lots of options for the advisor to document her relationship with her client: using a client contact log; keeping a daily diary of all of her phone calls, meetings, etc.; making notes for her client file; maintaining computer records; letters to her client.

     Hindsight illustrates the importance of documentation: the first thing, the advisor and her manager usually do after a client makes a claim or a complaint is look back at the documentation that the advisor produced during her relationship with the client – basically all written evidence of the advisor’s knowledge of the client’s affairs, financial circumstances, objectives and risk tolerances, advice she gave the client, and instructions the client gave her. They’re  essentially looking for evidence to confirm: the trades were suitable for the client and consistent with the advisor’s advice to the client and consistent with the (hopefully) up-to-date KYC; the advisor followed the client’s instructions; and the advisor made the required disclosures, discussed the risks and fees, and provided the required documents to the client.

     If the manager and the advisor find full and proper documentation in the advisor’s files, it’s very possible the potential or actual claim or complaint will just go away. But if not – either there’s no documentation, or it’s outdated or incomplete – bad things will probably happen. The claim or the complaint will become a “the client said v. the advisor said” situation. And when that happens, if it’s a lawsuit the lawyers might forge ahead with the legal claim; if it’s a complaint, the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association of Canada might decide to proceed with the complaint, and let their discipline committee hear the evidence and decide who’s telling the truth.

And remember: if it gets to that point the client usually wins and the advisor usually loses – unless there’s proper documentation.

Please contact your McInnes Cooper lawyer or any member of our McInnes Cooper Banking & Financial Services Team to discuss this topic or any other legal issue.

McInnes Cooper has prepared this document for information only; it is not intended to be legal advice.  You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.

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