Legally speaking: Avoiding liability in uncertain times (Part 2)

Part 2: Letters of engagement and your “get out of liability free” card.

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

Professional financial advisors and planners beware. Clients look to you for advice and rely upon what you recommend. While there are the rare “rogue” clients, most clients turn to professionals because they don’t have the skills to create their own financial plans or the interest to learn how to undertake holistic planning exercises. Most clients are remarkably naive and overly optimistic when evaluating risk and options. They are quick to rely on assumptions of success unless confronted with the unknowns their assumptions are based on and the risks that underlie these assumptions.

See also: Part 1, second opinion seekers.

The trap for financial advisors and planners is that, when expectations are not met, most clients are quick to judge. Most clients who judge, though, judge harshly with the benefit of hindsight.

As lawyers who work with investors, financial advisors and planners, we have observed the effectiveness of some key tools advisors use to avoid negative client conclusions and escalation of complaints.

The most basic tool was learned by most people in high school math classes: show your work. Without written records or a process guarantee to prove how the professional financial advisor or planner came to his or her conclusions or fulfilled his or her obligations, responding to client concerns, let alone to a formal complaint, is difficult.

If a dispute is reduced to weighing what happened in the absence of independent contemporaneous written records, the client is unlikely to be persuaded by the professional’s recounting his or her version of events. So, too, if the matter escalates to a complaint, the regulator, licensing organization or a court will likely rely more heavily on the client’s version of the story.

The first step is keeping a contemporaneous record of all oral and written communications with the client. Where possible, and promptly following meetings or phone calls, confirm your understanding of oral communications in writing and send this to your client. This shows your professionalism and avoids misunderstanding. It also plays an important role in dispute resolution. Years later, the client may have a different recollection, but most are persuaded when shown a letter or e-mail confirming the conversation.

Engagement letters are perhaps the most important tool for avoiding negligence claims. Work with your expert lawyer and your compliance department to draft a template engagement letter for your clients. These should be written contractual exchanges, in which the professional financial advisor or planner and the client confirm they understand the obligations of each party and understand which services and products are excluded or not part of the service relationship — either because the professional does not offer the products or services, or because the client has declined to make use of the services available.

Ideally, an engagement letter is used at the commencement of the advisory or planning relationship and is updated on a regular basis thereafter. Updates need only to confirm the extent to which prior engagement letters are still in effect and any obligation changes or changes to the list of included products or services. Professional advisory and planning relationships evolve; the contractual records related to the relationship should evolve as well.

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.

It is never too late to start using engagement letters in your practice or with a particular client. If you wish to introduce an engagement letter after providing financial advice or planning, a simple explanation is recommended. It is reasonable to expect that, as a professional, you will continue to upgrade your practices and services; in fact, this is a hallmark of professionalism. The trick is to explain to your clients directly the benefit of this improvement in your practice. You are making an opportunity to ensure they know:

• the services and products that you are qualified to offer; • the services and products that you are comfortable offering; • the limitations of your services and products offered; and • your understanding of the services and products that they wish you to consider when providing plans and financial advice.

It is best to make clear which services and products you are not considering or offering when providing your financial advice. Ideally, you should make reference to qualified persons who can offer the excluded products or services or to another place to which the client can get a referral.

A professional is obligated to make his or her limitations clear. Overextending your service offering and promising a process guarantee is highly risky. If you have led a client to believe that you are qualified to provide advice or plan using services and products that are beyond your core competency, you are courting a client complaint. On the other hand, a forthright admission of your limitations bolsters credibility — a case of sales optics directly reflecting the best professional standards.

Letters of engagement also should contain the following information:

• the professional’s process guarantee; • names of the parties; • contact information including phone, e-mail, fax, address, etc; • the services to be provided; • client obligations (for example promptly reporting enumerated KYC information); • advisor obligations and planned activities; • how facts and assumptions will be confirmed; • how recommendations will be developed; • how recommendations will be presented; • how instructions will be provided and confirmed; • how the advisor or planner will be compensated; • how either party can end the contractual relationship; • recommendations for working with relevant professionals; and • privacy information, conflict of interest disclosures (if any) and corporate relationships.

The key to a successful engagement letter is clear communication. Avoid industry jargon. Hint: You’re probably a jargon junkie if you’ve used and abused the Emperor with No Clothes parable to draw comparisons.

In any event, the goal of an engagement letter is to avoid misunderstanding and, in the worst case, to provide unequivocal support for the advisor’s recollection of an event if a dispute arises. To achieve this goal, the engagement letter must be complete and easily understood by the client. The best engagement letters can be understood by a teenager. The worst engagement letters appear to be written by a lawyer or an out-of-control compliance officer.

Thus, when reviewing or creating an engagement:

1. put it in writing; 2. use plain language; 3. keep it simple; 4. make your role clear; and 5. make it clear that the client has a role as well.

A professional financial advisor or planner who is aware, cautious and uses engagement letters is in an excellent position to respond to unreasonable expectations, especially when recollections are enhanced with flawed 20/20 hindsight.

Next week, part 3: Your KYC process and other tools .

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.

(03/31/09)