Client’s inbox likely full of ‘hot stocks’

Investment advice can come in many forms — from an advisor, an article, a stock-savvy friend — but one place where seemingly hot stock tips are popping up is in your client’s e-mail inbox.

North Americans get over 100 million investment-related spam e-mails a week, and according to a document put out by the Canadian government’s Task Force on Spam in 2005, 80% of all e-mail is junk. While investors should be knowledgeable enough to know that most unsolicited stock tips are pump-and-dump schemes, not everyone can decipher a good tip from a bad one.

“We have received calls from investors who have fallen prey to this,” says Patricia Trott, manager of investment communications for the Ontario Securities Commission. “We know it’s a problem for people.”

Alex Popovic, vice-president of enforcement at the Investment Dealers Association, says out of 300 suitability complaints a year, about 10% are related to e-mail investments. “People call, usually after they’ve lost their money,” he says.

Although only a handful of investors have been deceived by dubious stock information, advisors still need to be aware of spurious securities and misguided clients. That’s why the OSC, the IDA and many brokerage firms have set up education programs for clients and advisors. Geoff Whitlam, president of Toronto-based brokerage company Research Capital, says his firm has sent “various cautions” internally to let their brokers know about stock spam, while the OSC has presentations, public service announcements and even a toll-free line where people can find out more about an unsolicited stock.

While education will help the discerning advisor, one of the most important tools someone can use in dealing with a risk-taking investor is due diligence. “As with any investment, an advisor needs to do their research,” says Trott. Simple steps like Googling the company or checking if they have any regulatory filings are good places to start, but many of these questionable e-mails have the same red flags that should tip off advisors.

“They’ll often promise high returns at very low risks,” says Trott. “They’ll have very high-pressure sales tactics, like ‘This is a really hot one, get on board now.'”

Despite the red flags, some investors still might take their chances on a dubious penny stock, so advisors have to determine if buying this equity will damage their client’s portfolio. “An advisor has a duty to take a look at the individual’s profile and determine if this is within their objectives and risks, and advise them against doing it if that is the advice,” says Popovic.

If a client has cash to spare, then this might not be a huge problem. “If the client has the financial wherewithal and the particular investment in total isn’t going to make a material difference, then you might say, ‘Look, I don’t advise that you buy this, but if you’re telling me that you want to execute the trade, I’ll mark it down as an unsolicited trade,” says Whitlam. However, an advisor who thinks the investment will harm a client is well within his or her rights to refuse the trade.

Whatever an advisor does, Popovic stresses that every action needs to be documented. “If a client insists on buying it, they can take the order, but the advisor should note that he has advised against it.” If an advisor fails to keep proper records of interactions with a client, he or she could be sued.

Popovic says that some of the people who get burned by these schemes blame their advisors for giving bad advice. If the IDA receives a complaint against an advisor, it will collect all the information an advisor has to see if he or she was at fault. “We would review it for such things as seeing if the ticket was marked ‘solicited’ or ‘unsolicited’ and if there was documentation in the advisor’s books to show that he provided the advice or that the client came on their own volition and placed the order.”

But what if an investor bypasses the advisor and trades directly on the web? Whitlam suspects that many of these e-mails target investors who use discount brokerages. “There are many investors who trade online, and I suspect those are the principal targets for these e-mails. They’ll go in and make a trade online, and the online broker doesn’t have the ability to pause and query the client on why they want to make the trade.”

Popovic says that while online brokerage firms need to follow “know your client” rules, their processes are not nearly as thorough as the forms the average advisor needs to fill out.

“The firms are responsible to ensure the accounts aren’t being used for abusive purposes such as market manipulation or money laundering,” he says. “But they’re not paying for any advisory service whatsoever, so if you want to blow away your hard earnings, you’re free to do so.”

TD Waterhouse Discount Brokerage, one of Canada’s biggest discount brokers, does have advisors on hand if clients have questions, but it’s up to the investor to make the trade. If someone wants to buy a questionable stock then “that’s their prerogative,” says Marvin Daley, associate vice-president, TD Waterhouse. “All we can do is ask appropriate questions and help give them guidance. The direction they take is up to them.”

When an advisor isn’t there to second-guess a client’s trade, disaster can strike. Several years ago, when Popovic was working at the RCMP, he came across a case where a CEO lost $12 million after investing in a company he heard about via his e-mail.

“There was no advisor,” he says. “He did it on his own volition.” Popovic says that in most cases — including this one — these companies aren’t regulated and therefore outside of the IDA’s jurisdiction. “Many of the spam e-mails you see are usually linked to some sort of boiler room operation,” he says. “They’re completely outside the regulated industry.”

Because it’s difficult to regulate these companies, there’s nothing stopping them from sending out mass e-mails propping up a stock. “You have to be registered to give advice or sell securities,” says Trott. “But there’s nothing illegal about sending out an e-mail.”

If any unsolicited e-mail guarantees returns or trades stocks that aren’t registered, the OSC is supposed to prosecute, but, Whitlam says, this doesn’t happen often enough. “The focus needs to be more on the authorities and the regulators to enforce the rules. There doesn’t seem to be a willingness on the part of the authorities to go after the people who send out this information.”

Popovic adds that a lot of these unregistered companies fall under the watch of the police, not necessarily the security commissions. “If they were registered, this would be illegal. A lot of these people fall under the criminal authorities for fraud or theft or forgery.”

In the end, no matter how tough the OSC and RCMP get, pump-and-dump operations, boiler rooms and get-rich-quick schemes will always be around. But, says TD’s Daley, it’s not time to panic yet — the masses aren’t perusing their junk mail boxes for hot stock tips. “Naturally, you’ll see more and more of this, but it’s not something that’s overtaking the industry.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(04/23/07)

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.