Most advisors acquire books of business from other advisors without having had the opportunity to review the quality and the risks arising out of the book. So, what should you do, and in what order, to minimize those risks?
Here are four steps you should follow:
> Step 1
Assess the type of investments in the book. Are the investments in client accounts, whether securities or segregated funds, generally in moderate, medium, high or speculative risk? If the investments are mostly in moderate to medium-risk investments, move on to Step 2. If they’re in higher-risk investments, you need to focus on the largest and most risky accounts first to determine your exposure. It’s your responsibility to rebalance anything unsuitable, but you do have a few months to figure this out. Of course, if there are investments in the book that are outside of the parameters of your licence — for example, options, assuming you do not have that licence, you will need to flag that for compliance to ensure the account is moved to someone else at your firm.
> Step 2
Are there any clients borrowing to invest or using margin or leverage? If yes, see whether:
(i) there are detailed notes in the file that confirm explanations of additional risk;
(ii) there is evidence that those clients are sophisticated; and
(iii) the clients can afford to take on the additional risk.
If there is any doubt on any of these three criterion, then discuss this risk when you meet with clients to collect the “know your client” (KYC) information and determine whether they have both the appetite and pocketbook to absorb losses, if they were to occur. Note that there’s a general propensity in the investment industry to assume that clients can afford to lose money if they are sophisticated. Although a judge would likely rule in your favour if a client is sophisticated, those sophisticated clients tend to not shy away from launching a lawsuit.
> Step 3
Do a deep dive into KYCs. You need to redo all the KYC forms; don’t just take the old ones, copy them into the new ones and send them out to clients for their signature. You have never met these clients, so you need to start from scratch. Thus, you need to get to know these clients just as you would with new clients who have no previous KYC on file.
You need to assess these clients’ risk tolerance and objectives independently. Don’t take the previous advisor’s word for it as he or she could have been wrong, or clients’ circumstances may have changed since the previous KYC was signed. Ask your compliance department to give you several months to get this done, depending on how active your clients are in the market and, of course, how many clients there are. Set a loose deadline with your compliance department and set a schedule to meet that deadline.
For example, if there are 100 clients and you have six months to get this done, focus on the higher-risk clients first, then get 16 or 17 clients done each month and try and get ahead of it if you can. This is a difficult task as it means you need to see one client every day each month (not including weekends); if you have an active practice, this might be impossible. In these cases you will need to get compliance to agree that a deadline of a year to meet with all your newly acquired clients is reasonable. Regardless of the deadline, don’t procrastinate. Remember: these clients are on your advisor code, so you’re the one at risk if any of the accounts are offside.
> Step 4
Weed out the clients you don’t want. After doing a deep dive into the KYCs and having met the acquired clients, there may be some that don’t fit into your business model. This could be because of the type of investing they do, the clients’ age, the size of their accounts, or just that your personalities don’t mesh. Develop a plan to offload those clients — even if you paid for them. If the end result is that keeping the problematic account will lose you money, offload it to another advisor who might want the client, or send the client away. Don’t allow a few clients to bog your business down.
If any of this is problematic, and you’re not getting the support of your compliance department, you will need to consult a lawyer to help you navigate the more challenging issues. Of course, do the math first as you don’t want to spend the money on legal advice if the account is small.
Although it’s always better to kick the tires before acquiring a book of business, these four steps will help you reduce the risks if you didn’t have that luxury.