Are your clients as wealthy as they claim?

Your client may claim to be an accredited investor.

But don’t take her word for it. Verify she meets the requirements for the Accredited Investor (AI) exemption.

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Typically, a client qualifies in one of these ways:

• She owns, alone or with a spouse, financial assets worth more than $1 million before taxes but net of related liabilities, or net assets of at least $5,000,000.
• She has net income before taxes exceeding $200,000 in both of the last two years and expects to maintain at least the same level of income in the current year; or the client has net income before taxes, combined with that of a spouse, exceeding $300,000 in both of the last two years and expects to maintain at least the same level of income in the current year.

Sounds simple enough, but industry experts warn some advisors tend to make unwarranted assumptions about clients’ financial circumstances.

“The client base, more often than you think, is in the borderline of the accredited investor [category], and that’s usually because a lot of segments of the market have attracted an older client base,” Geoffrey Ritchie, CCO at BMO Harris Private Banking, said at a Private Capital Markets Association of Canada event in Toronto.

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“As wealth moves into a later generation, it’s very easy for relationship managers to make assumptions about the status of their clients.”

Ritchie says there’s no substitute for caution.

“Sometimes you can find out their income levels are significantly lower than you thought. Contrast that with the fact that a lot of high-net-worth clients do everything they can to structure it so their income is quite low. So you actually can inadvertently trip up on the accredited investor piece.

“You need to be able to demonstrate clearly as to how you’re making that determination about the qualifications for the exemption. High-level information is simply not enough.”

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In April, Philippe Tardif, a partner at Borden Ladner Gervais in Toronto, told Advisor’s Edge Report that advisors should keep records of how they determine clients meet the requirements. “If the investor has $1 million with the advisor, there’s no need to look further.” But if there’s even the slightest doubt a client qualifies, the advisor should require him or her to provide income and other records.

“That will reduce the risk,” says Tardif, “of a regulatory complaint or of a claim by the client in the event the investment is not successful.”

The American AI definition is the same as ours, notes David Gilkes, president of North Star Compliance & Regulatory Solutions in Toronto. “And what [the SEC has said] is that we recognize that sometimes investors embellish what they have.” He adds when someone wants to become an accredited investor, she may say she has more income; but every time the tax man comes, she says she has less.

SEC focuses on the processes firms use to determine whether a client meets AI criteria, Gilkes explains. “They say if you have a reasonable process [and] it turns out […] that person isn’t an accredited investor, we’re not going to take action against you.”

Also read:

Compliance roundup – April 2014

How to become an EMD