Think carefully before referring, lawyer warns

(April 21, 2005) Referring clients to third-party products is routine for many advisors. But the controversy surrounding Portus has cast doubt on the practice. Advisors are right to be cautious, says a lawyer who focuses on financial advice.

“If there is an advisory relationship, then any steps that the advisor takes within that relationship has a risk associated with it, if it’s bad advice,” says Harold Geller. “So if you say “Hey, look at this product, I don’t actually sell it, but I think it would be good for you,” that’s an advisory recommendation and as a result the advisor has significant risk.”

In a situation like Portus, where a referral fee is paid, the case becomes even more clear-cut, the Ottawa-based lawyer adds. “There’s a benefit construed on the advisor and there’s an incentive. Doesn’t that simply reinforce the obvious? I think it does.”

Even if the third-party product is dealer-approved, advisors can still be on the hook. “If the dealer recommends the product, it may be a defence between the agent and the dealer — an indemnity issue, meaning who pays. But it is not between the client and the advisor.”

If a client forms a contractual relationship with an advisor, the client doesn’t necessarily know who stands behind the advisor and so relies on the advisor to do his or her job, says Geller. “If the advisor fails in some manner, [the client] can sue the advisor.”

And advisors aren’t the only ones at risk if a referred product turns sour. “Because of the regulatory regime, there are other people I can look to for their responsibility. For example, if a dealer is responsible for compliance, I can look to them for any compliance failure. If the dealer knew of bad practices by the advisor, then I can look to the dealer for failing to inform me of the risk.”

Still, the most important relationship is between the advisor and the client, and that’s been shown to be true in the courts. “It would be unusual for the lead action to be commenced against a dealer or an MGA,” says Geller. “The courts usually look at the advisor’s role. They are usually first to the plate, no question.”

The Peel Institute’s Jim Bullock cites this real-life example: “Recently an advisor was asked if he handled group insurance. He said “No, I don’t know anything about group, but “John Doe” does; he specializes in group. The client used the recommended advisor, he eventually stole the health benefit trust money. The client sued the original advisor who recommended Doe on the grounds that the advisor failed to do his due diligence.”

A safer option for referring advisors is to remove themselves entirely from the decision-making process, Geller says. “If I am referring someone to an accountant, not my area of expertise, I will always say ‘Here are a few accountants to consider, interview them and satisfy yourself that their qualifications are good and that their style is good for you.'”

However, with any recommendation comes risk, Geller cautions. “If I recommend someone to an accountant who had a history of problems, even though I didn’t know about, I directed my client into a problem and I might likely be sued and the court might find that I was negligent.”

In the Portus case, it appears some insurance-only licensed advisors were referring clients to a securities product. That’s also problematic, Geller says. “If you are providing advice on an area that is regulated and you’re not licensed in that area, the licensing body can still go after you. And your errors and omissions insurer might say “We’re not going to cover you for that. We covered you for insurance products, not IDA products, so we are not going to stand up and provide you with defence or indemnity.'”

That illustrates the importance of reading the fine print on an E&O policy, something advisors are often guilty of ignoring. “Almost no-one who has come to me and asked me for legal advice has a clue what their errors and omission insurance is,” Geller points out. “Every professional should know that when they make a statement to a client and it’s a type of advice, they have a risk.”

Harold Geller is a guest speaker at the Peel Institute symposium in Toronto on May 17 and 18. “Myself and Ellen Bessner are going to be talking about the risks financial advisors face and how to minimize those risks,” he says. “I will be using Portus as illustration of risks that could have been avoided.”

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For details on the Peel Institute symposium, please click here..

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com