In my duties as a legal counsel who represents advisors, I often get asked by these very advisors why I suggest that the client signatures on the know-your-client (KYC) forms they’ve completed were not enough to prove the veracity of the information on the forms. This question is usually in the context of a client complaint that needs to be defended either in front of the regulator or in litigation and indicates the advisor doesn’t have a clear understanding of the purpose of the KYC form.
As all advisors know, there is a regulatory and legal obligation to know each client at every stage of the client/advisor relationship. (Note: With the new client relationship management rules, there’s a mandated review of suitability at specified events, but they are not the subject of this article.) Although this is separate and distinct from the KYC form, advisors confuse this duty with the obligation to fill out the KYC form. The duty to know your client goes far beyond the questions on the KYC form — and if the client signs and later denies the contents on the form, then the advisor is left to prove that what is on the KYC form accurately reflects the information collected from the client.
For example, the KYC form requires you, as the advisor, to indicate the client’s annual income. However, many advisors ask only the following question to obtain what they believe to be the necessary information: “What is your annual income?” Let’s say the client answers $100,000. You then fill in this information on the form and move to the next question. In contrast, I strongly suggest to all advisors that to truly know your clients, it would be better to obtain the following additional information:
- What are the sources of income?
- Is this income gross or net?
- Do clients contribute to a company registered pension or retirement plan?
- What was the client’s income in the past two years?
- Is there a fluctuating bonus structure? Is any bonus discretionary?
- Does the client expect his or her bonus this year to be consistent with that of previous year(s)?
- Is the industry the client works in growing, flat, or shrinking?
- Is the company the client works for firing or hiring employees? Is it growing, flat or shrinking?
- Does the client feel secure in his employment?
All of these questions go far beyond what the KYC form requires, so you will end up with the same answer of $100,000 on the form. However, if you take notes when clients answer the questions above, you will also have information that proves you actually knew your client. These answers will also impact your assessment of the client’s risk tolerance because the security the client has in his or her employment could impact how and whether the investments you recommend for him or her will be lower or higher risk.
Another example is the question on the KYC form that’s one of the most important to judges and regulators: Financial knowledge. From what I’ve seen, it’s also the question that gets the least attention from advisors. That’s because advisors usually show a client the options on the KYC form and ask the client which category he or she falls into. The client makes his or her choice and the advisor indicates the answer with a tick mark. The client signs the KYC form but later, when the client launches a complaint against the advisor, invariably the client asserts that the information on the form is inaccurate and, in particular, the financial knowledge portion is wrong.
So, what is the purpose of the KYC form if not to prove that the advisor actually knew his or her client? In fact, it’s merely a summary of the information obtained that’s necessary for supervision of the account. The signature is what the dealer insists upon, but a signature alone will not satisfy the regulator or judge that indeed the KYC form was accurate without notes (electronic or handwritten), which provides proof of information gathered that led to the conclusions set out on the form.
Here’s a little exercise to see if you have sufficient evidence to prove the contents of the KYC form: Look at the supporting evidence in the form of documents or notes and ask yourself: Without the KYC form, would there be sufficient information to support the conclusions on it? If the answer is no, then you should change your KYC process to ensure it is more robust. Otherwise, you won’t pass a regulatory or legal challenge — with or without a client’s signature.