Financial advisors should ensure that they’re thoroughly familiar with all the details of the products they’re selling, and that the products fit the specific needs of the clients they’re selling to, in order to minimize the risk of legal action, according to Eric Dolden, founding partner with Dolden Wallace Folick LLP.
Speaking at the Independent Financial Brokers (IFB) Spring Summit in Toronto on Tuesday, Dolden highlighted a variety of recent legal cases involving the financial services industry, and discussed the implications for advisors. He said 90% of legal cases against financial advisors involve breaches of the Know Your Client (KYC) and Know Your Product (KYP) rules.
With respect to KYP, Dolden said recent cases have revealed the detailed extent to which judges expect that advisors are familiar with the products they’re selling.
In one case, a client successfully sued an advisor after losing a substantial proportion of her original investment, when the product she purchased was liquidated by the product manufacturer following the financial crisis. Although the prospectus had outlined the possibility that this could happen in the occurrence an “adverse financial event”, the judge found that the advisor who sold the product had failed to warn the client about this risk.
“It underscores the obligations you have,” Dolden said. He said advisors are expected to have read all of the disclosure information, and relayed any relevant risks to their clients.
“The expectation of the judge is that you’ve read all 105 pages of the prospectus,” Dolden said, “that you know it, and that you’ve warned the client about those types of risks.”
Don’t wait for clients to ask about specific risks, Dolden added. Rather, he said advisors are expected to volunteer information about any relevant product risks. Even the possibility of another significant market downturn is a risk that clients should be made aware of, he said.
“Judges across Canada adopt the view that the prospect of a financial downturn is reasonably foreseeable,” he said. “You’ve got to manage client expectations around that.”
Advisors should take into consideration the level of investment knowledge that clients have when determining the level of detail they need to share, Dolden said.
“The less experience the client has, the more you have to be very explicit in what you tell them about the product, and the risks inherent in the product,” he said.
It’s important for advisors to be able to prove that they’re meeting their KYP obligations in the event that a legal case arises, Dolden said. Even if you verbally disclosed all of the risks associated with a product, he suggests sending clients a follow-up email outlining the details of the products discussed, and the risks involved.
With respect to KYC obligations, Dolden said a common pitfall among advisors is failure to review and update the client’s information periodically. Even if you collected all of the necessary KYC information at the beginning of the relationship, clients’ circumstances often change over time, which can impact their risk tolerance and product suitability.
Dolden recommends re-evaluating each client’s financial situation at least every two to three years, and particularly when clients are experiencing significant life changes, such as entering retirement.
“The client’s needs and risk appetite can change as they transform into retirement, or semi-retirement,” he said.