The “Know Your Client” (KYC) concept is at the heart of financial advisors’ suitability obligations, but KYC often is misunderstood. And, given that most client lawsuits against advisors are based on KYC issues, it is important to clarify misunderstandings. This is likely why the Mutual Fund Dealers Association of Canada (MFDA) recently published a discussion paper on the KYC suitability process and the use of risk questionnaires.

The KYC document is nothing more than a summary of what should be a much more thorough discovery and profiling process applied to each new client relationship. In my experience, too many advisors and dealers put too much emphasis on a client’s KYC risk label (e.g., “medium risk”) with far too little attention being paid to what that label really means and how it was determined.

The client-profiling process should follow a well-defined but flexible framework. For clients with significant investible assets, it’s important to understand how they accumulated their current wealth. Maybe this prospective client made a massive bet on a single stock, received an inheritance, built and/or sold a successful business or simply saved diligently. The journey of the person sitting in front of you is likely to have attitudinal and behavioural implications.

Next up should be a conversation about what your clients want their wealth to accomplish – i.e., you need to have a goals-based discussion. Clients usually will start with broad objectives, such as qualitative descriptions of what is to be accomplished. You must work with your clients to translate those objectives into quantifiable goals with associated time frames.

Past investment experiences, knowledge level and attitudes about risk should be woven throughout the above discussions.

Although a framework can guide these discussions, those parts of client profiling are inherently subjective. So, it helps to add a tool to the mix – e.g., a risk-profiling questionnaire – as a way to assess risk more objectively.

As the MFDA paper points out, your questionnaire of choice should have separate questions aimed at each client’s financial capacity to assume risk and their emotional willingness to take investment risk, so that each can be measured. Discussions and your assessment of financial resources should also allow you to judge each client’s need to take risk.

The final step of client profiling is to put all of your information together to highlight any big inconsistencies. It’s common to see clients who, for example, have goals that imply a rate-of-return target that is at odds with their risk profile. Further discussion is required with clients who, for example, need to achieve a 5% return target but can’t tolerate more than 40% in stocks.

Either these clients must dial back their goals, push out their time frames or increase the amount of risk they’re willing to take in order to achieve their stated goals.

I know that most of you are thinking that there is no way that you can implement this kind of detailed process for all of your clients. You can.

For high net-worth clients, it will be worth your time to spend more time on running your clients through this process. For mainstream clients with more modest portfolios, the various steps can be completed very quickly.

Dan Hallett, CFA, CFP, is vice president and principal with Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.

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