The client’s income question on the know-your-client (KYC) form seems simple to answer until you are exposed to regulatory inquiries and legal challenges. So, why has this become so complicated? The reason is that there are several issues that arise from the source and reliability as well as the definition of the income and consistency of reporting. If clients deny the accuracy on the KYC form, then advisors need to be able to prove the accuracy of the number inserted or range of income ticked off on the form.
First, let’s address the importance of the source of the income:
- Is it from employment, a trust fund, government benefits, a pension, investments or a court order (in the form of spousal support)?
- Is the source reliable? For example, if it is employment income, is there a bonus or commissions structure?
- Is the income based on several years of employment and an indication of future income, or has it fluctuated over the past few years and is therefore precarious?
- Is the employment from which the income is derived in a growing or shrinking company or industry?
- If the income is from a trust fund or pension plan, what are the terms? Does the trust continue for the client’s entire life or does it end at some point?
- What about income from investments? What type of investments? Are these investments likely to fluctuate — i.e., speculative stocks or high-risk mutual funds — or are they low risk with a guaranteed income and/or return of capital? And is the income return of capital or return on capital, as this distinction may impact a client’s assets.
Both the source and reliability of the income impact clients’ ability to assume risk in regard to the financial products they purchase, whether they’re investments such as securities or insurance products. Furthermore, the source and reliability may impact clients’ time horizons, as they may need the investments to remain liquid if their income suddenly takes a nosedive.
The problems that advisors can run into arise from the many different definitions of income: estimated, actual, gross, net, before taxes, after taxes, income for tax-related purposes, etc. There is great confusion surrounding which definition to use for the KYC form and no guidance from the regulators on this issue. Advisors can be faced with documentation from clients, such as income tax returns, letters from employers prepared at the client’s request, contracts of employment, or T4 slips, challenging the accuracy on the KYC form if the KYC form is inconsistent with the documentation clients produce to support a claim against the advisor.
Advisors are required to know their clients at every stage of their relationship and, therefore, being able to prove the income — along with the other items on the KYC form — is crucial to avoid accusations that they failed to fulfil this regulatory and legal requirement. Furthermore, if there is a leveraged loan that is at issue and there is inconsistency among the documentation, such that the income is higher on the loan application than what is on the KYC form, tax return or other documentation, then an advisor and his or her dealer may be accused of inflating a client’s income to pass internal compliance reviews and be approved by the lender, even if this was the furthest thing from the advisor’s mind.
So, don’t simply ask your clients, “What is your annual income?” and insert the answer blindly on the form, as you will not be in a position down the road to prove the accuracy of that number when challenged by a client at the regulator or in court. Questions on the KYC form are there for a reason, if not to test advisor’s attention to detail and understanding of how it might impact their clients.