When it comes to handling disputes with investors, financial advisors are in a much better position to mount a defence if they have made detailed notes on the rationale behind a trade or strategy. That was a key message Laura Paglia, a partner at Toronto-based Torys LLP law firm, offered in her presentation at the Federation of Mutual Fund Dealers conference yesterday.
“Unless advisors can show a paper trail,” Paglia said, “they’re in for an uphill battle.”
Issues related to suitability of investments constitute the lion’s share of investor complaints investigated by the Ombudsman for Banking Services and Investments, Paglia said, citing 2011 statistics that show 224 of 453 complaints were about suitability issues. Investors who have lost money on a trade will often claim that it failed to match their investment profile or goals, and will seek restitution for losses claiming that the security or mutual fund was inappropriate. The vast majority of complaints to the OBSI concern securities and mutual funds, but also cover segregated funds, principal protected notes and scholarship trusts, she said.
Most advisors rely on the Know Your Client (KYC) form to record important information about their clients relating to suitability but, Paglia said, the KYC form alone is inadequate.
“The industry has been overly reliant on the KYC and has elevated its importance to biblical proportions,” Paglia said. “But it’s only a guide. If there are extra notes in the file, it’s like finding a pink diamond when defending against a complaint.”
It’s important that a trade be compatible with the goals and risk tolerance described in the KYC form, but also that the form accurately reflect the client’s true nature, Paglia said. More than facts are required; good judgment and interpretation on the part of advisors are also essential.
Determining the extent of client losses is a tricky exercise when it comes to redress. Decisions must be made as to whether to assess the entire portfolio or simply the losing transactions, and whether to measure losses based on the purchase price or the subsequent high-water mark of a security.
Paglia said a “suitability assessment” should be made promptly any time a new security is purchased or transferred; if a new advisor takes over the account; or if any change is made to the KYC form. She also said that describing a client as “sophisticated” on the KYC form does not protect the advisor.
“I would take the word ‘sophisticated’ off the KYC,” Paglia said. “The only person who is sophisticated is a pro. Clients are not.”