The battles over account decisions gone wrong are heating up.
Here are some common-sense rules to keep you out of Dodge.
Reprinted by permission from Financial Planning magazine, July 2003
Financial planners may have to defend themselves against a whole range of client claims. However, all disputes originate from one or more of five key failings: failure to know and understand the client, failure to make full and timely disclosure of material information, failure to make a contemporaneous record of events, failure to supervise staff adequately, and failure to anticipate problems. Advisers who grasp these implications will spend more time working with satisfied clients and less time involved in expensive arbitration proceedings.
Know and understand the client. The NASD's rules impose clear suitability requirements for making investment recommendations. While it is debatable whether federal securities laws impose suitability requirements, 20 years of arbitration proceedings have made it clear that arbitrators consider absence of investment suitability as grounds for action.
Although accurate statistics are hard to obtain, "unsuitability" is probably the most frequently voiced investor complaint. Consequently, this complaint creates the largest number of client grievances and arbitration claims against advisers. According to the NASD, the number of unsuitability claims filed for arbitration increased by 22% over the past year alone.
To determine suitability, financial professionals must know and understand a client's investment objectives and risk tolerance. "Know Your Customer" is sage advice for muffler shops and corner grocery stores, but it is especially good advice for financial planners who are entrusted with the responsibility of making prudent investment decisions--or recommendations--for their clients.
Equally important to suitability is other information about the client that is often ignored in the rush to open an account or make a sale. First, make sure you know why a new client chose you in the first place. The seeds of dispute often are planted when you fail to screen new clients. For example, if a client is moving his or her business from another firm, it is important to find out why. This is not always easy to discern, but if you ask enough questions and listen carefully over time, you will pick up a few clues. Let manners and tact be your guide.
When time and circumstances allow, ask clients about their prior investment experience. Some will criticize previous financial advisers. If the advisers' actions make sense to you, the clients may have unrealistic expectations.
Others will reveal unrealistic expectations other ways. Beware of clients who say they are leaving a competing firm because it was unable to deliver 40% to 50% annual returns with low risk. A few will reveal that they have made claims against prior financial advisers. One prior claim may not be a red flag, but clients with multiple prior claims present multiple red flags. Avoid litigious clients.
A second piece of information is the client's prior investing experience. Many clients arenot candid about this. They may be embarrassed by earlier failures. Or they may be in denial about the fact that their own decisions contributed to their disappointments. Whatever the reason, it is important that you determine this in as diplomatic and ethical a manner as possible. As time progresses in your relationship, develop opportunities to learn more about your client's investment experience. Clients will throw out clues; you need to listen and observe carefully.
To confirm your understanding of new clients, resist the urge to fill out new account forms for them. Instead, have the clients complete new account forms in their own handwriting. Disgruntled clients frequently argue that the information reflected on new account forms is inaccurate, bolstering this argument by pointing out that the information is not in their handwriting. Whatever your current practice, never sign clients' new account agreements; it is imperative that clients sign their own names. Forged signatures can vitiate the arbitration clause and subject you and your firm to serious regulatory and potentially criminal charges.
Fully disclose material information. A financial adviser's duty to disclose material information is at the heart of federal and state securities laws. Without timely and full disclosure, the investor's confidence vanishes, and serious regulatory and criminal charges are sure to follow. What information do financial professionals often fail to disclose in a timely matter? Three important categories include other business relationships between themselves or their firm and issuers of securities being recommended to clients; a fair comparison of proprietary and non-proprietary financial products; and personal compensation arrangements.
Every honest and ethical financial adviser recognizes the obligations of full disclosure under the securities laws. But information that a panel of arbitrators finds "material" may be different from what a financial adviser may believe to be material.
Remember, your client's lawyer in an arbitration proceeding will diligently search for items that you may not have disclosed. The non-disclosure itself is often an element of a fraud claim against the financial professional and the firm. A non-disclosure is, simply, just another form of a lie.
All trial lawyers want to erode the credibility of the witnesses testifying against their clients. The best way to do this is to identify a misrepresentation made by the witness. The lawyer argues that if the witness misrepresented one thing, he or she probably misrepresented others as well.
This approach is particularly common in arbitration proceedings, where rules of evidence--which might preclude a jury from hearing harmful evidence of a lie on a side issue--do not apply. It is human nature not to ignore what has been seen or heard. Once an audience hears evidence of one misrepresentation, it is more difficult to persuade those individuals to ignore it.
Make a contemporaneous record of events. It is impossible to overemphasize the importance of documenting in a timely manner the investment advice you provide to clients and the investment decisions clients make. Keeping a record is important for several reasons.
First, in the event of a dispute with a client, the contemporaneous entry in the firm's business records--what you did, when you did it, why you did it--will help defend your conduct. All too often, a disgruntled client asserts a claim after the financial adviser has resigned from the firm. Without those records, it will be hard for the firm to defend it's former employee's actions.
Second, records made at or near the time of the event can refresh your recollection. You may not remember why you advised a client to buy particular securities years ago. But if you made and kept notes describing the reasons for the advice, you may later use the notes to refresh your recollection and then testify about why the advice was given and made good sense for the client at the time. If you keep these kinds of notes in the regular course of you or your firm's business, they may be offered as defense evidence.
Third, when you testify as a witness, your contemporaneous records will help you withstand cross-examination. A good lawyer will attempt to test your recollection. It is much more difficult for a lawyer to assail your recollection of what happened when you can point back to contemporaneous records.
Supervise your staff. If you supervise others involved in the sale of securities in your firm, it is important to have and maintain a system and procedures to prevent or detect any securities law violations committed by subordinates. Federal securities laws and many state securities laws impose liability on supervisors and managers who fail to maintain such a system and procedures.
It is beyond the scope of this article to detail the provisions of securities laws that impose supervisory duties. Supervisory advisers will want to tailor procedures to the circumstances of each supervised individual, however. Common procedures include:
- Monitoring client transactions to ensure they match current investment objectives and are consistent with up-to-date investment objectives;
- Periodically visiting with clients to confirm that sales practices conform to high standards and meet client investment objectives;
- Ensuring that certain changes in client investment objectives are documented when they occur; and
- Periodically reviewing in detail selected client accounts to make sure there are no recurring patterns of inappropriate conduct.
Anticipate problems. Regular two-way communication between financial professionals and clients is essential. Regular periodic written reports are important, but there is no substitute for personal meetings where clients can tell you what they are thinking. These meetings give financial professionals the opportunity to listen actively to what clients are saying.
Again, listen for clues. If there are problems, now is the time to address them and head them off before they become arbitration claims. This is easy for clients who trade frequently, since the chance to communicate presents itself often. For clients who want only financial planning advice, schedule regular meetings that are consistent with their investment objectives. These face-to-face meetings should take place at least annually, if not more frequently. If clients have shorter-term objectives, more frequent meetings are essential.
Of course, these activities are not free. They require additional efforts. If a client looks troublesome, you may have to turn away business and occasionally end a relationship. But the rewards of these practices are worth the effort. Every avoided claim reduces legal costs, minimizes staff distraction, and saves tremendous emotional costs. Good practices in forming, supervising, documenting, and maintaining relationships with clients may not eliminate all arbitration claims, but they can reduce their number and severity.
Controversies and Security Types Involved in Arbitration Cases, 1999-2002
