An advisor recently asked me the following question: “For unsolicited trades, must the advisor know the product in order to buy it for the client?” The answer for him — and for all of you — is a resounding “yes.” If you buy a security for a client, you need to know the product regardless of who initiated the trade. Let me present three different scenarios that will demystify your obligations in respect of investments that your clients have initiated:

Scenario 1: Mr. U tells his advisor that he wants to buy XYZ, a security the advisor is following and that’s suitable for Mr. U. Of course, the advisor can buy this security as long as it is suitable and fits Mr. U’s portfolio. The advisor must explain any risks or concerns about XYZ, and not assume Mr. U is aware of the risks just because he was the one to suggest the trade.

Despite the fact the trade is marked as “unsolicited” — and indicated as such in the client management system and on client statements — the advisor must continue to follow the product to ascertain if and when it should be sold.

Scenario 2: Mr. U tells the advisor he needs ABC in his account as he believes it to be a “sure winner.” If the advisor does not know about or follow ABC, the correct response is to tell Mr. U to buy this in a discount account as it does not make sense to pay the advisor a commission in respect of a product he is unable to advise on or ascertain its suitability or how it might fit into the client portfolio. If Mr. U insists on buying ABC in his full-service account — and the advisor has no intention of following it — the advisor should confirm with compliance, as the terms and conditions of the account likely permit the advisor to refuse the trade, which is what should be done.

If the advisor agrees to buy ABC for the client, then he or she must learn about the product to ensure not only that it’s suitable for Mr. U, but to ensure Mr. U understands any risks or concerns the advisor might have in respect of the product or issuer. Let’s assume, for this scenario, that the investment is suitable, the advisor can buy it, mark the trade “unsolicited” —but must follow the product to ascertain when to sell. If the advisor concludes ABC is unsuitable, then see Scenario 3.

Scenario 3: The facts here are the same as for scenario 2 (the advisor doesn’t follow product), but the advisor is pretty sure that ABC is unsuitable for Mr. U based on the little he knows about the security. The only compliant option is for the advisor to refuse the trade and suggest that if the client wants to buy it against the advisor’s advice, he should buy it in a discount account.

The terms and conditions of the account likely permit you to refuse the trade outright. If the client is adamant, insisting that he will miss an opportunity and sue you for any profits he missed, then you might want to execute the trade and give him notice that he should find another advisor. This should be confirmed in writing.

Then, what’s the benefit of marking the trade “unsolicited” if the advisor is obliged to know the product and follow it? Although it has little regulatory benefit, it can help in litigation in the following ways: it can be evidence of sophistication if the client has initiated trades; and if the client sues for losses on an unsolicited trade, the damages are more likely to, at least partially, if not entirely, flow to the client (see the Negligence Act, R.S.O. 1990, c. N.1).

To understand your obligations in respect of knowing the products you sell, see my previous article, entitled Don’t shoot the Messenger.

Just remember that when your client has a brilliant idea that he or she believes is a “sure winner,” you are not paid to randomly guess, like picking winning lottery numbers, you are a professional advisor who recommends securities based on research, knowledge and experience.