Legally speaking: Avoiding liability in uncertain times (Part 1)

Part 1: Second opinion seekers.

This three-part series, advice that reflects lessons learned during past economic downturns, is written to help advisors avoid risk during these turbulent times.

Jim Bullock of the Peel Institute for Applied Finance is a well-known industry expert. He says complaints and lawsuits are inevitable because every human needs three things: food, water and someone to blame. This is surely an illustrative simplification, but it is worth thinking about when dealing with “victims” of the recent downturn.

Next week, part 2: Letters of engagement and your "get out of liability free" card.

From our present perspective, it seems likely that for decades to come investors and talking heads will refer to 2008 as the most significant financial crisis since 1929. The number crunchers and academics who supported the creation and sale of convoluted and esoteric financial products got it wrong — it is easy to see this in hindsight. The basic economic fundamentals we all studied in university economics classes were disregarded.

The cult of diversification, meanwhile, also proved to be false. It turns out the global economy and financial systems are highly interconnected and, as a result, highly correlated in times of financial stress.

The mantra of global equity diversification became a planning “must,” despite evidence of oversimplification. Diversification mantras were repeatedly slogged and strategies were implemented, despite how obviously inappropriate these strategies are for people in retirement and the later stages of wealth accumulation.

Dealers, insurers, their representatives and agents also disregarded the planning basics that they learned in the Canadian Securities Course or the LLQP course. Many agents and representatives assumed that conservative financial planning principles and processes could be set aside during an economic boom. Many licensed individuals with superior credentials (CLUs, CFPs, RFPs, Ch.F.C.s, etc.) failed to adhere to mandatory planning processes.

Many professional financial advisors and planners failed to plan for the bust that inevitably follows the boom — knowing full well that the 2003–2008 period was undeniably a boom.

Now what? Financial advisors and planners are witnessing retail fallout from the downdraft. The tsunami’s inundation is receding, so to speak, leaving wreckage and loss behind. Many retail investors are still in shock. Anger is undeniable in many cases as well, but many are still turning to those they relied on in the past. Some retail investors panicked and sold when reporters and talking heads repeatedly issued dire warnings; the lucky ones went against their professional financial advisor’s or planner’s advice and sold early. Some listened to their advisors and waited. How long will they wait?

Many financial advisors and planners are engaging experts to help repair frayed client relationships; others are rolling out marketing campaigns to target the newly identified risk averse.

Based on the calls we have already received and based upon our experience defending advisors in regulatory and licensing hearings, along with our experience suing and defending them in the courts during the last two financial downturns, we believe that financial advisors and planners cannot expect a repeat of past delays, where clients waited 9–18 months to investigate and change advisors. The signs suggest there will be a much faster transition this time.

Historically, client moves (followed by client complaints) are preceded by soft complaints to their current advisors, soft enquiries to new potential advisors or both. Clients seek explanations for what occurred. How did their conservative and secure financial plans end in disarray? They seek to understand why their plans were not written with objectives and exit strategies. They seek to come to terms with the sense of abandonment that follows when advisors and planners remain silent after their financial security was decimated.

Sometimes clients demand an explanation of why the financial advisor and planners urged them to buy in the face of declining markets that appeared to have no bottom. Where was the plan? Why were they exposed to so much risk? Why weren’t there systematic strategies in place for profit taking? What now?

Related articles:

• Part 1: Second opinion seekers • Part 2: Letters of engagement and your get out of liability free card • Part 3: Your KYC process and other tools

From the series: Avoiding liability in uncertain times, by Harold Geller.

If you receive these calls and e-mails, take heed. Hopefully you obtained and maintained your independent errors and omissions coverage. Hopefully you chose coverage that includes a regulatory defence budget. In any event, hire an independent lawyer who is an expert in advising financial intermediaries to advise you about repair strategies, dispute resolution and business process remedies.

If you receive a second-opinion request from investors complaining about their financial advisors’ and planners’ having failed them, you have been handed a golden opportunity, but handle it with care.

The business opportunity is obvious. A potential client is ready to make a move, and you simply need to do what you do best. Given the lessons of 2008, it is more likely that new clients will truly appreciate terms such as “risk” and “volatility.” So, it is also likely they will appreciate that a “return of capital” trumps a “return on capital.”

See also: Revisiting risk.

New clients today are much more likely to appreciate that you cannot provide price or product guarantees. They may understand and appreciate the value of a detailed engagement process. They are likely more willing to engage in a thorough KYC process and will likely appreciate the value of written financial plans, investment policy statements and other planning documents.

Instead of offering price guarantees or crystal ball promises about the markets, you can impress upon potential clients your professional objectives and provide a process guarantee — that is, if the client is willing to fully engage in a detailed planning process. You can match their KYC attributes using your suitability processes and regularly review all of this planning, along with any related assumptions.

During this process, plan for the extremes — they do occur. Recommend maintaining cash or near-cash reserves (they are always prudent). For all but the true gambler, recommend avoiding moderate-high- to high-risk investments. Make sure that your client works with you to understand specific meanings for industry jargon and subjective terms. Most don’t know what words like “balanced” or “moderate” mean when discussing specific funds or an individual’s risk tolerance.

If clients want to gamble, they can gamble. Just deliver on your process guarantee, explain the assumptions you are using, along with the facts, investigations and your recommendations, in plain English (or French as appropriate) and get clients to sign off. A client has the right to gamble, but you shouldn’t become the insurer of that gamble by failing to deliver on your process guarantee.

A second opinion is a great opportunity. The best professionals, those who adhere to the highest professional standards, have shone during the financial eclipse of 2008. A vast number of opportunities are beginning to show up, and more will soon follow.

A few final thoughts:

1. Don’t slag your predecessor. A professional does not belittle a prior financial advisor or planner. Point out what should have been done by making good your process guarantee. Commit to a reasonable timeline for rolling out your process guarantee if a client chooses you.

2. Document your work. A client once stung is likely to be somewhat jittery. If you confirm your process, advice and instructions in writing, clients can review your work at their leisure. This builds confidence and lessens the chance of misunderstandings.

3. Refer clients with legitimate complaints to a lawyer who specializes in this type of dispute. Let the lawyer provide the hard news, and separate yourself from the inevitable stress that comes with an investigation or claim of negligent advice against a former advisor. Just make sure such clients know they have two years to sue and that the clock may be ticking.

We are experiencing and witnessing a flight to quality. With hard work, and the luck that comes with hard work, a financial advisor who adheres to the highest standards of professionalism stands to profit from this once-in-a-lifetime opportunity. Good luck.

Next week, part 2: Letters of engagement and your "get out of liability free" card.

Harold Geller is an expert on legal issues affecting financial intermediaries. Harold assists and represents dealers, MGAs, branch managers, compliance officers and advisors dealing with their compliance, regulatory and negligence issues. Harold also helps financial intermediaries with internal business and their clients’ legal issues. Harold is a well-known industry commentator, a CE provider and administrator with foradvisorsonly.com. Harold’s law firm, Doucet McBride LLP, also provides advice on tax issues, Succession Planning, Retirement Planning, Estate Planning and buying and selling books of business. Harold can be reached at hgeller@doucetmcbride.com.

(03/24/09)