In today’s litigious landscape, knowing how to run an efficient business without crossing the compliance line is a necessity. Unfortunately, this line is far from clear or straight. It bends in some areas and in others remains rigid. This is the commercial (and legal) reality with which all practices should come to terms, without fear.
“Doing the right thing” is the essence of compliance and it is usually understood that client servicing revolves around doing the right thing proactively and efficiently. However, can doing the right thing get you in trouble? It all depends on whether you, as the adviser, have a clear and ongoing understanding of what your client requires.
Understand, then recommend
Knowing the client and setting specific and measurable goals allows you to demonstrate that your advice is appropriate and in the client’s best interests. “Knowing the client” does not merely include having a comprehensive understanding of the client’s personal circumstances, risk tolerance and existing products at the time of the advice. There are two additional elements to this concept that are usually forgotten:
- whether the inherent risk of the recommendation was correctly explained and understood by the client; and
- whether the adviser has an ongoing understanding of the client’s circumstances and risk tolerance throughout the service relationship.
When drawing a line between compliance and efficiency, these elements must be considered.
The relationship between these two concepts was recently addressed in a Financial Ombudsman Service (FOS) determination, where advice provided to a client with a “balanced” portfolio was deemed inappropriate (see note 1). The adviser had made a recommendation which included 70 per cent of the client’s investment held in income generating assets (with 26 per cent in growth and 4 per cent cash). The client was a widow, and even though she was in great need of income, she was a moderate risk taker with little financial experience. Nine out of the ten recommended investments were capital volatile, meaning that what the adviser considered to be “income assets” were not “defensive” but rather “growth” assets.
The adviser most certainly was addressing the client’s income generating goal, but neither the client understood the inherent risk of the recommendation nor the adviser understood the client’s overall situation.
The issue with over-delivering
It is usually said that when servicing clients, it is best to under-promise and over-deliver. It shows proactivity and efficiency. While this is generally true, when it comes to financial services, it is important to understand that over-delivering can easily leave an adviser on the wrong side of the compliance line, if not done correctly.
Many advisers perceive their first meeting with a client as the first and only opportunity to demonstrate their abilities and knowledge – and there is nothing wrong with this. The problem arises when, in the course of trying to demonstrate their skills, advisers steer their clients away from their original reasons for seeking advice.
An example is the client who goes to a meeting with the intention of getting an insurance plan and a vague idea around their retirement, but walks away with: a full suite of insurances, a self-managed super fund and an investment property under a limited recourse loan structure.
From the adviser’s point of view, the most likely reason for this advice is “the client wanted to have control over their financial future and retire comfortably while protecting their investments”. But does this actually address the specific needs of the individual? Without proactively understanding the client’s goals, risk tolerance and financial experience, it is hard to tell. After all, who does not want to have control over their financial future, and retire comfortably while protecting their investments?
Advisers should also be careful of relying too literally on risk profile questionnaire responses, particularly if they are worded in a way which may elicit a particular response from a client. For instance, most clients would want to increase wealth or ensure all their debts are discharged in the event of sickness or death. However, the client may not be prepared to shoulder the risk or pay the premiums associated with such a response.
Financial advice should only be provided to the extent of the client’s capacity and understanding. Just because a client has the monetary means to embark on a more complex strategy does not mean that it should be recommended. Educating the client to understand the advice provided while building a solid relationship should be the long term strategy of any financial business.
Proactivity and efficiency should not result in over-delivering services that the client did not have any intentions to receive in the first place. This can easily result in a claim if the client is ultimately left in an onerous financial position they do not fully understand.
An ever-changing landscape
Another side of knowing the client is having an ongoing understanding of the client’s changing circumstances and risk tolerance. The ever-changing nature of this concept requires proactivity in understanding (and documenting) any changes in the client’s circumstances and risk tolerance, while confirming the client’s ongoing understanding of the recommended strategies and products.
In order to comply with this requirement, advisers are required to have up-to-date fact finders, risk-profiling tools and any other documentation that can demonstrate the ongoing basis for their advice.
Another FOS determination (see note 2) considered whether the adviser had a clear ongoing understanding of the client’s needs and circumstances after he had expressed his concerns regarding the falling value of his listed property portfolio.
During a telephone conversation the adviser explained that market fluctuations were part of the client’s long-term investment strategy. A very familiar explanation. Inexperienced investors are quick to panic and that alone is rarely a sufficient reason to warrant a change of strategy. However, the real issue was whether the adviser had an adequate basis to dismiss his client’s concerns.
The lack of up-to-date risk profile and data forms was enough to conclude that the adviser did not have enough evidence to demonstrate that he knew his client at the time of advice. Was the adviser looking after his clients? Yes, but despite his willingness to service his clients, the adviser failed to demonstrate that his original advice was still relevant and in the best interests of the client.
Doing the right thing, right
A key takeaway is that knowing the client forms the basis for any financial advice. Proactivity and efficiency are not isolated concepts that only become relevant when delivering advice. They are also means for the adviser to have a clear understanding of the client’s needs and circumstances throughout the relationship.
Doing the right thing does not mean doing more for the client. It means doing what is required by the client, and doing it right.
NOTES:
1. FOS Determination – Case number 314583, 24 June 2014
2. FOS Determination – Case number 329444, 20 August 2014