Keeping abreast of a client’s needs is always part of your job, but it’s particularly important in a downturn, when financial losses can motivate clients to seek compensation through the courts.
“There’s no doubt we’re going to see an increase in litigation claims,” says Tom Newnham, a partner at Dolden Wallace Folick in Vancouver. “That’s something we’ve seen in previous recessions.”
Clients often pay more attention to their portfolios when markets are volatile, which puts advisors at a higher risk of litigation and regulatory scrutiny, says Maureen Doherty, a partner at Borden Ladner Gervais in Toronto.
As clients suffer through volatile markets, job losses and damaged businesses from the economic shutdown, dissatisfied investors may confront advisors.
“People are going to be asking questions about the planning — or lack of planning — if that’s the issue,” Newnham says.
Did you plan for foreseeable risk?
Planning gaps will likely be evident to clients with inappropriate exposures or insufficient cash reserves.
Advisors could be found negligent if they didn’t help clients establish plans that accounted for income losses, and balanced needs with risk, says Harold Geller, an associate at MBC Law Professional Corporation in Ottawa.
Terri Williams, a financial literacy advocate in Lakefield, Ont., says she’s aware of recent retirees who have no cash wedge. “Those are the situations where they should be going back to their financial advisor” to discuss planning, she says.
Advisors often talk about how they add value by keeping panicked clients from selling. However, “if you haven’t planned for [having] no income […], then you can talk that language all you like but it’s meaningless,” Geller says.
Clients need a cash wedge to avoid the “foreseeable risk” of being forced to sell at market lows, he says.
Case law has confirmed that market downturns, while not predictable, are foreseeable.
Did you document your duties?
Advisors also have a duty to warn clients about downside risks, because clients can give informed consent only if they’ve been advised of the benefits, risks and alternatives, Geller says.
These warnings must be clearly documented; risk can’t be relegated to “the fine print in faded writing on the back of a dealer’s new client application form,” he says.
Documentation of instructions and risks is often lacking in litigation cases, Geller says, putting the advisor at a disadvantage that could have been avoided.
While clients tend to remember details, advisors — who may have hundreds of clients — won’t. Newnham suggests advisors send and save emails, document detailed client discussions about volatility and risk tolerance, and note when the client is shown illustrative figures, for example.
Advisors who typically speak with clients by phone should write detailed notes or send follow-up emails after phone discussions, he says. In cases where a client writes a lengthy, emotional email, the advisor may want to write an initial response by email before phoning, addressing each point raised by the client, Newnham says.
Another issue in court is inaccurate or out-of-date know your client (KYC) information. Courts look at KYC forms “so closely that it places a considerable amount of scrutiny on advisors,” Newnham says.
KYC issues include completing the form to put clients into a particular product, he says. And a recurring fact pattern in claims is the less sophisticated investor in a sophisticated product or leveraged investment.
What can you do now?
Doherty says the pandemic will likely result in material changes for many clients, such as having adult children move home and becoming financially dependent again. These changes require proactive contact.
If an advisor has dropped the ball on client contact, now’s the time to pick it up. The right attitude is important, Geller says.
“This is not the time to be defensive or justifying one’s actions. This is the time to be listening, trying to understand,” he says, and showing the client how the plan accounted for volatility.
Part of the discussion can be about establishing a cash wedge, if that was lacking, Newnham says.
If a client has to sell investments to meet cash-flow needs, document why and when the client is selling in case they experience regret and ask questions later, Doherty says.
Less sophisticated clients may require extra attention during a crisis.
“They’re often the ones that are more likely to panic [and] bring claims if they suffer losses,” Newham says. “The time that advisors put in to listen to those clients’ concerns, and provide the best advice and comfort that they can, is time well spent.”
The pandemic provides an education opportunity, as clients typically seek advice after a life event, and advisors may get more candid answers to difficult questions.
“The awareness of risk and the impacts are more real,” Geller says.
Developments in the statute of limitations
Litigation associated with the current downturn could take time to emerge. Gillian Dingle, a partner at Torys in Toronto, says cases could surface in about six months as investors figure out what their new normal looks like.
Cases of financial loss arising from the pandemic will likely be dealt with more quickly compared to those after the 2008 financial crisis (at least one such case was still being heard in a Canadian court last year).
Harmonized limitation legislation enacted since then gives clients a two-year basic limitation period to sue for negligence and contract claims, and breach of fiduciary duty.
“It gives more of a measure of certainty to advisors,” Newnham says.
That doesn’t mean, however, that clients have two years from the time the pandemic started to bring forth a claim. The clock starts to run from when the client knows they suffered a loss because of the advice they received, Newnham says.
Limitation legislation is based on discoverability, which will be specific to each client and case, he says. “The question becomes: ‘Would a reasonable person have known that they had sustained a loss due to a wrong committed by their advisor?’”
There’s another reason why claims could be resolved more quickly — and at less cost — this time around: a greater focus on having cases resolved without a full trial. This development is an access-to-justice issue, Newnham says.
To resolve a dispute without going to trial requires that a case can be decided based on, among other things, written arguments, highlighting the importance of advisor documentation.
When an advisor is a defendant, the first thing a lawyer will look at is whether the case has an arguable limitation defence that’s viable, Newnham says.
His research on limitations and advisor cases found that most were settled without a full trial: of 12 summary judgments between 2012 and 2020, the claim was dismissed because the statute of limitations had expired in eight cases.