Compliance check: Limited trading authorization

(November 2004) Getting a client signature for every trade pursuant to MFDA rules and regulations is time-consuming. It might be more practical just to make a telephone call to get verbal instructions for a purchase or sale of funds. Why does an advisor’s life have to be so complex and bogged down with paperwork? Is the regulator convinced somehow that advisors are paid by the hour?

Clients also probably find it inconvenient to get the paperwork signedsimply to rebalance their portfolios, especially if they don’t live close to their advisor’s office, or don’t have access to a fax machine to receive and return signed documentation before the trade can be completed. This is particularily true for elderly clients.

Some advisors have resorted to breaking the rules by signing each document for the client. This is forgery! Some even have their clients sign blank trading forms to effect a more efficient and expeditious transaction-even in advance of contemplating a purchase or sale, rationalizing that taking such steps are in the client’s best interest.

If the client signs in blank, the information pertinent to any trade can be inserted afterwards with no fuss and no muss. That is unless, of course, the advisor is caught!

How does compliance catch advisors in the act? This can happen if a client issues a complaint with the MFDA, or if the MFDA, in a surprise or scheduled audit, discovers the blank signed forms in the advisor’s files. Even if the client hasn’t lost any money, the advisor will be in breach of the rules and subject to a penalty. Furthermore, the supervisor or branch manager’s direction of the advisor in breach will be under review, and he or she will be penalized for failure to supervise.

In compliance with MFDA regulations, some advisors rely on a Limited Trading Authorization (LTA) to avoid paperwork and inconvenience. However, even after signing an LTA, advisors frequently overlook the obligations that follow. With a signed LTA, clients can give advisors specific instructions regarding details of every trade. These can be received verbally, via fax, by e-mail or in writing.

As part of an efficient trade transaction, the LTA is a potentially wonderful tool; however, it must be used, according to the MFDA rules. Unfortunately, these are often ignored or overlooked.

Some advisors incorrectly believe that once the client signs an LTA the transaction is complete and they now have licence to make purchases and sales without further client contact. Additionally, some advisors think a letter from the client will suffice, providing general trade instructions to be applied annually. Or, that perhaps they can write a letter to all clients describing the purchase sale or switch. These are clear and obvious breaches of the regulations. Instructions must come from the client with details of each trade—even if an LTA has been signed. Anything otherwise is discretionary trading.

The advisor must also keep a record of each specific instruction in the client file. Failing to maintain such a record also constitutes breach and the advisor may be accused of discretionary trading and slapped with a significant penalty.

I am frequently asked how long an advisor should keep the paper created from transactions. Although storage space is at a premium these days, the Guideline for Use of LTA Form for Mutual Fund Investing provides that dealers must maintain clear records of investors’ instructions for a minimum of seven years.

While LTAs can be convenient and efficient, the rules must be followed. In my next article I will describe the steps that must be taken to get the LTA signed by the client.

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Ellen J. Bessner is a lawyer at Gowling, Lafleur, Henderson. She practises in the area of brokers’ liability and offers compliance training to brokerage firms. The above is intended for a general audience and should not be considered legal advice.