When financial planner David Spence was shopping for errors and omissions insurance a little over a year ago, he came across an interesting fact: one of the requirements from a potential insurance provider was that his firm regularly provide a letter of engagement to its clients.

Spence, a CFP and elder planning counsellor who has been in the business for 17 years, had understood that various industry associations were encouraging the use of these documents but he hadn’t recognized how essential they had become.
“That reinforced to me that this was important,” he says, from his IPC Investment Corp. office in Mississauga, Ont. Since then, his firm’s standard practice is to provide an LOE to each client.

It’s always helpful to have the details of any business relationship laid out in writing. In the case of a financial advisory relationship, that can mean an LOE, which sets out the general parameters of what the advisor and the client can expect from each other, or an investment policy statement, a more specific document that details the client’s investment goals and a clear strategy for attaining them.
Which document is used — or whether both are used — depends on the client, the advisory services offered and the nature of the individual advisor/client relationship.

Letter of engagement

An LOE (sometimes called a “letter of understanding”) is a document that establishes the rules and outlines the expectations of the advisor/client relationship. The obligations of both parties are clearly outlined, including the implementation process, compensation, any conflicts of interest and a clear exit strategy for both parties. Although few advisors use LOEs, these letters are becoming more prevalent as the industry moves away from its transaction-driven roots toward professional advice-based services.

“An engagement letter really clarifies the terms and the scope of the engagement,” says Carolyn Fallis, director of professional and student affairs at the Financial Planners Standards Council in Toronto. By providing LOEs to clients, advisors can prevent misunderstandings and even possible litigation, while also emphasizing the value of their professional services, she says:
“This is a clear step in the right direction toward the evolution of a profession.”

Although the FPSC code of ethics has always stressed that advisors have the obligation to share certain information with their clients, its new financial planning practice standards, finalized this spring, insist that CFP-designated planners issue written disclosure covering these areas.

“This is not really a new ethical obligation,” Fallis points out. “We are just trying to put a little form around it so that we have a benchmark against which financial planners and their activities can be assessed.” CFPs have until April 2006 to comply.

To encourage planners to get the process underway well before the deadline, the association has launched a resource that will walk them through the development of their own letters. Because of the many possible variations when it comes to LOEs — this is an industry, after all, in which every relationship is different — the resource allows for flexibility and customization.

“There is no one-size-fits-all,” says Fallis.
Rather than provide a traditional template, the resource presents a number of suggested phrases that can be incorporated into the letter, depending on the circumstances and needs of a particular client and the qualifications and product loyalties of the advisor. Scenarios include comprehensive financial planning engagements, along with services that don’t fit under the financial planning mandate per se but may be offered by the advisor, such as the sale of insurance.

A straight transaction is a good example of when it makes sense to have an LOE clarifying exactly what the engagement involves, according to Fallis. “An uninformed consumer might presume that this person is making the best decision on behalf of his or her entire financial situation,” she says.

Clarifying expectations is the whole point of LOEs, according to Rick Johnson, director of practice advisory services for Advocis, which recommends the entire industry adopt the LOE process. The association offers an LOE template online through its Best Practices Manual (free to members; non-members must pay a fee but the price is equal to a membership).

Why, then, are the majority of planners not taking what appears to be a sensible and simple step forward? Johnson says most advisors are either unaware of the benefits of these documents or are simply unwilling to embark on what they think might be a complicated business shift. Yet, it’s just the opposite, he says: “A letter of engagement could simplify their lives rather than complicate it.”

@page_break@For example, a typical scenario might have an advisor looking at a client’s finances and coming up with a plan to cover three possibilities: early death, disability and a longer than expected lifespan. Then, a few years later, the client becomes ill with a condition that might have been covered by critical illness insurance — and the client is no longer qualified to purchase CI insurance. An LOE that specified that the advisor was addressing the three possibilities individually and not offering a comprehensive plan can protect the advisor from accusations of neglect.

Another LOE payoff: the often messy ordeal of dropping clients is cleaned up with an LOE that outlines a very specific exit strategy.

News coverage of corporate governance scandals and dissatisfied investors should be enough to convince any advisor that LOEs make sense, says Jim Rogers, chairman of The Rogers Group Financial Advisors Ltd. in Vancouver. “We don’t want to be the object of any litigation,” he says. “It’s the prudent thing to do.”

Rogers says that although his firm has, for some time, offered clients disclosure documents — which lay out the advisor’s services, qualifications, potential conflicts of interest and payment structure — it now follows that up with an LOE based on Advocis’s Best Practices Manual and other sources. “There’s lots of material available,” he says.

And, he says, the time invested in developing a letter is well worth it, if only as a value-added service: “It’s an astute marketing move.”

Yet Rogers believes misconceptions are keeping many advisors from using the letters. “They’re taking the incorrect position that the client doesn’t want it,” he says. “The advisor’s attitude might be: ‘Until they ask for it, why provide it?’”

Another hurdle may be a fear of disclosing compensation. Advisors worry that once the client figures out how much money they make, the knowledge will work against them. But this is backward thinking, Rogers maintains: “The more transparent or open you are about the relationship, the more they’re going to come to trust you because you appear to have nothing to hide.”

His recommendation? Turn the concern around. “Rather than try to hide what you make, wouldn’t it be better to provide the service that justifies your salary?” he asks.

Sylvain Morin, financial consultant with Investors Group Inc. in Halifax, is a big believer in the LOE as a marketing tool. He says that these letters, which he has been providing clients for more than a year now, have earned him additional respect from clients. “They say, ‘I didn’t know you were that much of a comprehensive financial planner.’ And I tell them: ‘That is how planners should be’,” he says. “You basically set yourself apart.”

Not all Investors Group consultants provide LOEs to their clients, but the Winnipeg-based company is hoping that will change. In anticipation of the FPSC’s spring deadline, the firm is developing its own internal LOE template, according to executive vice president Mark Kinzel.

The company has long supported
disclosure with a “welcome” package, which includes LOE elements, he says. “We are very comfortable that this, by itself, provides a high level of information to clients [regarding] what they can expect from us,” says Kinzel. Slightly more than 40% of the firm’s 3,509 consultants hold the CFP designation or, in Quebec, the F. Pl. While LOEs are mandatory for Quebec planners, only some of the firm’s CFPs have built their own LOE with the help of existing resources.

Once the template is launched, it will be blended into the personal financial planning software online. That should be well before the April deadline, says Kinzel. The company plans to encourage all consultants to use it to develop their own LOE templates, he adds.

Getting up to speed and adding a new business practice can take time. Terry Gibson, vice president of EES Financial Services Ltd. in Markham, Ont., says his firm has been using LOEs in various forms for the past 15 to 20 years, although not consistently.

“I wouldn’t say it’s necessarily done every time,” he admits. “But most of the time, it’s done.” For example, files from veteran clients might not have an LOE or, if they do, the letters are not updated to reflect the current relationship. But the goal is to present all new clients with an LOE, even if it takes six months to get one done, he says.

It’s particularly critical for a fee-only firm to embrace this business practice, he adds, because some clients may not understand exactly what degree of service they are paying for. LOEs can protect an advisor from over-the-top client expectations without making things personal. “If you’re looking at fees and the time you’re spending with a client and you have no up-front amount, the client will invariably think the sky’s the limit,” Gibson says.

To ensure that the business stays on track, EES Financial cross-references LOEs with client time sheets, he says, and will contact a client if an advisor starts exceeding his or her commitment under the LOE.

As for IPC’s Spence, he’s happy he was pushed to offer LOEs in his quest for E&O insurance. “Clients like it, especially brand new clients,” he says. “It sets the stage for the relationship.”


Investment Policy
Statements

“Know Your Client on steroids:” that’s how Advocis’s Johnson describes investment policy statements. While a KYC form, required by provincial securities commissions, outlines a client’s assets, level of investment knowledge and risk tolerance, an IPS digs deeper into the nuts and bolts of the client’s feelings and goals, risk tolerance and portfolio considerations.

There’s no doubt that IPSes are useful documents for advisors and investors. They provide a solid investment foundation, manage expectations and help clients stay focused. But they’re not always necessary, Johnson points out. For example, if a client wants to put a lump sum of money into a GIC in order to generate interest, providing a 10- to 14-page plan might be overkill, he says: “It would be like having a detailed map to go to the corner store.”

But, if a client is planning on taking a fairly long financial journey, an IPS can effectively outline the parameters of investing and keep both parties on track, he adds.

Helping investors understand and stick to a plan may well be one of the motivations behind the growing popularity of IPSes, but there is a more pragmatic reason for the development of these documents, says Dwayne Dreger, vice president of corporate affairs at AIM Funds Management Inc. in Toronto. “By doing this deeper
methodological document, it allows [advisors] to manage their business risk,” he says.

There’s a growing body of evidence that suggests IPSes are instrumental in preventing advisor/client conflicts and misunderstandings, he says. For example, while a financial advisor might not have discretionary trading authority on a client’s account, a client might assume that this is the case and then become upset when the advisor fails to make a certain lucrative trade. “There’s a huge opportunity for miscommunication and misunderstanding that the IPS serves to correct,” he says.

Last summer, AIM blended the creation of IPS plans into its existing In Sync financial planning software and its Portfolio Sense portfolio software, allowing advisors to create either a simple or detailed IPS. The detailed IPS has advisors check appropriate boxes and fill in fields to reflect the plan.
Then it’s simply a matter of printing out the document.

The creation of an IPS is one component of the two programs, both available online.
(There are also In Sync workbooks available.) Dreger says that the use of these documents is indeed growing. It’s difficult to track their precise popularity, but the company says that of its 18,127 registered online users, more than 3,500 have created at least one IPS.

The time commitment for creating an IPS is on par with a KYC document and not at all onerous, says Dreger: “Because the information drills down more deeply, it serves as an adjunct to — and not a replacement for — a KYC.”

IPSes may offer no guarantee against future conflict, but they do, by their very detailed nature, generate more protection for an advisor, he says: “If there’s ever a source of conflict, the IPS is an awfully good document to fall back on.”

It’s also effective as a marketing tool, he adds, because it moves the value proposition away from more nebulous promises such as “better returns.” Offering a more holistic approach — digging deeper into a client’s individual situation and building a financial program that is consistent with his or her specific objectives — is a great way to set one’s business apart, he says.

Investors Group also offers a strategic investment planning program called Symphony, which creates an IPS-style document, according to Kinzel. The document, called the “investment strategy report,” is a little less technical and more client-friendly than the traditional, institutionally rooted IPS, he says: “It’s our version of it.”

The company encourages consultants to use the tool. “It absolutely helps with the relationship with the client because the client is more knowledgeable,” he says, adding that it also prevents certain challenges as the relationship grows.

For example, the report helps alleviate one of the headaches for the typical advisor — getting the client to stay on track with a plan — because it provides “big picture” perspective to the client, he says: “That’s a big plus.”

Although the FPSC is mandating the use of LOEs for its CFP advisors, there is some debate as to whether IPSes will ever become mandatory. Dreger’s attitude is:
never say never. “There is clearly a movement underway to document more rather than less,” he says.

But Advocis’s Johnson believes that, although IPSes are great planning and communication tools, they’re not for every relationship. Advisors need what Johnson calls “a certain power of discretion,” so they can make judgment calls based on individual situations. In the case of transactions that have little to do with comprehensive financial planning, an IPS might only confuse clients, he says.

IPC’s Spence has been offering IPSes for about two years. However, the search to find one that worked with his business wasn’t easy. At first, he used an internal program offered by his firm, but found it too long for his needs as it delved into the educational side of portfolio creation. “It was a whole presentation,” he says.

Although the company now offers a condensed version, Spence says, he prefers to stick with AIM’s In Sync.

“It flows very well,” he says. Portfolio Sense is also helpful as it allows comparisons between portfolios, including AIM competitors. “It’s totally open,” he says.

The only price paid for its ease of use, he says, is that the final portfolio review document is text-based, with no visual component. “There’s no opportunity for graphs or educational pieces,” he says.
However, he adds, the simplicity means that he’s now able to use IPSes on a more regular basis: “I’m really ramping it up.”
IE