Gone are the days when you, as advisors, could sell any dealer-approved product simply by relying on marketing materials and issuer roadshow presentations. A product manufacturer’s marketing presentations and marketing materials generally highlight and briefly summarize the benefits of the product. That would be the full extent to which the advisor was obligated to know the product.
Recently, however, advisors who are hauled in for interviews with the various Canadian regulators are asked: “Did you read the prospectus or the offering memorandum (OM) associated with the product before you sold it?” Of course, answering honestly, they admit they did not, and yes, that is evidence that regulators use against advisors for failing to know their products at the time of sale. In fact, this is now treated as a regulatory offence that can be subject to penalty. (And it’s worse to lie about it as this is another infraction that will lead to an additional penalty and maybe much worse.)
So, what do you, as an advisor, need to know about the products you sell? Well, like most useless lawyer answers, it depends. on the following:
- Is the product complex? (The more complex the more you need to study it.)
- Is the product similar to one you have in-depth knowledge of?
- Is the product unique?
- Is the complexity and risk of the product high?
- Are there embedded costs with the product? (These need to be understood.)
- Is the product so complex that even you are unable to understand it? (You cannot sell it if you don’t understand it. Why? If you do not understand it, you cannot explain it to the client and you also cannot determine for whom the product would be suitable.)
- Is the product illiquid? (You need to understand why and in what circumstances clients can get their money back.)
- Does the product have embedded leverage? (This is more risky and, therefore, you need to understand when leverage is used, how much [the ratio] and its impact on risk.)
- Are “anticipated returns” suggested by the issuer realistic? (If you think these are high, why is your view different?)
- Is a portion, or the entire amount, of returns a return of capital? If so, what is the benefit to the client? What are tax implications, if any? Are these tax implications being oversold?
The obligation to know your product is beyond just a regulatory requirement; it’s necessary to understand the product before you sell it to gain an appreciation of the risks to ensure it’s suitable for your clients.
I prepared a regulatory “cheat sheet” to help advisors understand the product which can be found at http://www.babinbessnerspry.com/kyp.pdf.
So, why on earth do you have to read the prospectus or OM when most of these documents are filled with gobbledygook written by lawyers? Some of those sections are not about the actual product — and you could skim these — but the portions that drill down on the elements of the product, the risks, who should buy the product and how it’s affected by market fluctuations, are key elements.
Sorry for this bad news, but I want to ensure my message is clear about what you as advisors need to do and how to do it to ensure you protect yourselves. So, please don’t shoot the messenger.