Suitability: Tailoring your advice to your client

The issue has been called “intangible,” “nebulous” and “a grey area” by many people in the financial services industry. Regulators and lawyers say it is crucial that you ask questions, listen to your clients and document all client/advisor communications – both to provide suitable products for your clients and as a basis upon which to defend your recommendations should you end up in front of a regulatory panel or a court’s judge.

“Suitability is usually the foundation of any litigation or complaint,” says Ellen Bessner, a litigation partner with Cassels Brock & Blackwell LLP in Toronto. “The difficulty is that suitability is partially an art and partially a science.”

Still, regulators in the three main financial advisory channels acknowledge the significance of suitability issues in client complaints:

– In the 2012-13 fiscal year, the Investment Industry Regulatory Organization of Canada reported that more than 45% of all complaint case-assessment files dealt with suitability complaints.

– The Mutual Fund Dealers Association of Canada (MFDA) stated in its 2012 report that individual complaints about suitability remain a priority and noted that the MFDA still is dealing with grievances from 2008 or earlier.

– Although complaints about suitability in the life insurance industry are relatively low, the Financial Services Commission of Ontario is embarking on a review of the way life insurance advisors make product recommendations to prospective policyholders.

Bessner, author of Advisor at Risk: A Road Map to Protecting Your Business, says that this means that you need a consistent process to substantiate the recommendations you make to your clients regarding products and strategy. Bessner has developed a “triangle of suitability” method aimed at collecting adequate information – before filling in any “know your client” (KYC) information and prior to making a recommendation.

The three sides of Bessner’s triangle are:

– The initial talk with prospects and new clients. This step is a “getting to know you” meeting. Simple questions covering topics such as what the prospect does for a living, his or her marital status and whether the client has children often open the door to more revealing topics, such as financial objectives and personal goals.

Although this meeting might seem easy enough to an outsider, you probably know that problems begin when more personal, prodding financial questions are asked.

“It’s human nature that most people aren’t sharers,” says Heather Freed, an independent advisor who holds both the certified financial planner and chartered life underwriter designations. “If you’re talking to them about investments, they’re not going to tell you about what insurance they have, and vice versa. So, the first part of the challenge is getting clients to be forthright so that you can give them proper advice. And that can take time and further probing.”

The difficulty in uncovering answers may stem from the fact that the financial literacy level of the average client isn’t what it should be, says Stephanie Holmes-Winton, president and CEO of The Money Finder in Halifax.

Rather than asking clients how much debt they have, Holmes-Winton says, perhaps it’s better to ask what year they anticipate becoming debt-free. “Technically, they are the same question,” she says. “But one is paralyzing the client with fear to answer; whereas, the other one will just make the client feel that they simply don’t know the answer.”

An advisor with good interviewing skills should be able to get to what makes the client tick, although it may take more than one visit.

– Filling out the paperwork. The KYC rule applies to all advisors as the cornerstone for suitability, whether or not prescribed KYC forms are required. If there is a KYC form, include information in addition to what’s required on the form to show that you have listened. Also, ensure consistency in your client’s answers and double-check that the client signs all necessary material.

With or without KYC forms, many advisors also use a “needs assessment” or a “risk tolerance” questionnaire. Some good questionnaires can be found on the websites of mutual fund dealers and on Morningstar Canada’s website.

Holmes-Winton says the data you have about clients’ net worth and cash flow should be as accurate as possible – especially if you don’t provide debt and cash-flow management as part of your service.

“If your client’s cash-flow and debt-management information is inaccurate,” Holmes-Winton says, “you could be – without intending to – giving advice to a client that in the long term might come back to [haunt you].”

Holmes-Winton says cash flow and debt, in addition to net worth, show risk capacity (the amount of risk the client must take in order to reach his or her goals) and not just risk tolerance.

It’s also important to set expectations through a service agreement, says George Hartman, co-founder and managing partner with Accretive Advisor Inc. in Toronto.

You can’t guarantee investment returns, but you can put in writing that you will attempt to contact clients every quarter, semi-annually, annually or when markets are volatile. Include an agenda at every client meeting that contains specifics, Hartman says, and re-evaluate risk every two or three years or if there are serious market changes.

Your clients should have written obligations as well, says Hartman: “This includes: ‘Do not make any rash investment decisions without consulting me; advise me of changes in your attitude as well as your assets; and participate in regular reviews with me’.”

And while you will be searching for a suitable product, says Aaron Keogh, president of Greendoor Financial Inc. in Windsor, Ont., the client will be looking for an advisor who is on his or her wavelength.

“It is important,” says Keogh, who also is president of the Windsor chapter of Advocis, “because it’s a relationship in which you are working together, with the common goal of meeting the client’s needs.”

When it comes to insurance, there are no regulatory requirements to complete prescribed forms, says Grant Spears, assistant vice president, individual compliance, with Sun Life Financial Inc. in Toronto. (Exceptions include the replacement of an insurance policy, and policy sales in Quebec, where a specific needs-analysis document is required.)

However, a few years ago, the Canadian Life and Health Insurance Association Inc., along with Advocis, the Canadian Association of Independent Life Brokerage Agencies and the Independent Financial Brokers of Canada co-created The Approach, a guide that lays out key elements that insurance advisors should use in a sale.

This guide’s process includes disclosure to the client, the services the client can expect of the advisor, a needs assessment, fact-finding about the client’s objectives and making a recommendation.

The Approach points out repeatedly that you must keep adequate documentation of client meetings. And, even if you are selling only an insurance product, you should take a big-picture approach in meeting a client’s needs.

“That makes it easier to make sure from a strategy perspective that we’re doing the right thing for the client,” Spears says. “It’s very much about ensuring that our advisors take a needs-based selling approach because that aligns very well with making sure the sale is suitable. If you’re satisfying a need, that’s going to lead to something the client is going to be happy with.”

As well, Advocis’s Best Practices Manual (a.k.a. the BPM) advises that a needs assessment be flexible and reflect factors such as underlying risk, the client’s objectives and the complexity of the product being sold. The BPM also says that advisors should act in the client’s best interests. You should recommend only products you and your client fully understand, and consider the benefits and risks, given your client’s level of financial literacy.

– Making a recommendation. Keogh always provides his clients with a short list of products, outlining the positives and negatives of each. Keogh attaches his recommendation and the reasons why he chose a particular product, then has a discussion with the client. Afterward, Keogh contacts the client regularly to make sure that the advice still holds true.

In some instances, your client might initiate the product selection, coming to you with a product already in mind – perhaps recommended by a friend or a relative.

At first blush, you might think this recommendation is pretty good, too. But it’s part of your responsibility, says Sandra Kegie, executive director of both the Federation of Mutual Fund Dealers and the Association of Canadian Compliance Professionals, to dig a little deeper to check out issues such as the history of the portfolio manager and the fees.

“Let’s say you have two funds pretty much the same and one has a higher fee than the other,” Kegie says. “If there is a client complaint about suitability, the regulators could say you put the client in a fund with a higher fee, which benefited you and not the client. At the same time, the cheapest is not always best.”

If the mantra in real estate is “location, location, location,” its counterpart in financial services might well be “document, document, document.” That is because, in the end, it’s what’s in your notes that might make all the difference if you get wrapped up in a regulatory or legal issue.

Most clients don’t take any notes, Bessner says. But if you can produce a raft of communications sent to the client, it will support your assertion that both the investments and the strategy were suitable.

“Advisors have become more cognizant of note-taking and documentation,” Bessner says. “As a result, more cases are being won in favour of the advisor, as opposed to the client.”

Bessner suggests you look into client relationship management software that can track discussions that you and any member of your team holds with each client.

Suitability isn’t always about a product, Freed says. Sometimes, it’s about not buying a product.

“If a client has to make the decision between paying off credit card debt at 19% and putting $3,000 into his or her RRSP,” Freed says, “paying off the credit card debt makes a lot more sense because you can’t find many investments that return 19%.”

The last time Freed made a similar suggestion to a client, she obtained two referrals as a result. “[But] that’s not really why you do it,” she says. “You do it because it’s the right thing to do.”

Issues of suitability have figured prominently in complaints from clients received by regulators in all three major financial advisory categories:

IIROC

Suitability complaints ranked No. 1 among all complaints received by the Investment Industry Regulatory Organization of Canada (IIROC) in 2012 and for the first seven months of 2013. In 2012, there were 224 complaints about unsuitable investments, followed by 87 complaints of unauthorized and discretionary trading, and 54 complaints about misrepresentation. As of July 31, in the current year, 131 complaints regarded unsuitable investments, 53 regarded unauthorized and discretionary trading, and 13 regarded misrepresentation. Suitability assessment standards are one of the issues being assessed through IIROC’s client relationship model amendments.

MFDA

The Mutual Fund Dealers Association of Canada’s (MFDA) 2012 Enforcement Department Annual Report notes there were 60 complaints dealing with leveraging suitability, or 13% of the total cases opened, and 47 complaints regarding product suitability, representing 10% of cases.

The MFDA’s case assessment group opens cases in which there is the possibility of a violation of MFDA requirements. In one such case, an advisor was permanently prohibited from acting as an advisor and fined $500,000.

Insurance regulators

The Canadian Council of Insurance Regulators has recommended that provincial regulators hold reviews to ensure consumers receive proper information to ensure they make informed decisions and are sold suitable products. The Financial Services Commission of Ontario (FSCO) is conducting such a review with advisors under its purview. Over the past two years, FSCO has received 90 complaints related to the suitability of life insurance advisors’ licenses and 13 complaints regarding product suitability.

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