Avoiding Customer Complaints
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Transcript of Avoiding Customer Complaints
Copyright 2009 Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C. Chicago, IL All rights reserved.
Avoiding Customer Complaints
PRESENTED BY:
James J. Eccleston, J.D.
April 30, 2009
FPA New York Spring Forum
New York, NY
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I. FINRA Arbitration
Filings are increasing• In 2008, 54% increase (4,982 vs. 3,238 claims)• Through mid-March 2009, claims filed = 1,475• “Win” rate for customers rebounded, from low of
37% in 2007 to 42% in 2008• “Failure to supervise” claims up 24%• “Omissions of fact” up 337% • “Misrepresentation” up 171%
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• “Omissions of fact” and “misrepresentation” account for more than 40% of disputes of the 10 listed security types– Reflect explosion of “Derivative Securities” disputes and “Auction Rate
Securities” disputes – with chief allegations relating to what investors were told and not told
• Traditional security types also visible in customer disputes– Mutual funds (171%)– Corporate bonds (130%)– Certificates of Deposit (98%)– Common stock disputes declined in number
FINRA Arbitration
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Unsuitable investments• An issue in many, if not most, customer arbitrations and claims
against financial advisors
NASD Conduct Rule 2310:• Requires broker/advisor to have reasonable grounds for believing
that recommendation is suitable based on the facts, if any, disclosed by the customer as to his or her other security holdings, financial situation, and financial needs
• Advisor must determine if the recommendation is suitable for anyinvestor, regardless of the investor’s wealth, willingness to bear risk, age or other individual characteristics (so-called “reasonable basis” suitability)
FINRA Arbitration
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Unsuitability – Typical Scenario• Retiree (or person approaching retirement)• Sold investment (e.g., stock, bond or mutual fund) or product
(e.g., deferred annuity) that is too risky or volatile in view of the customer’s objectives and needs
• Account is too heavily concentrated in one asset class (e.g., stocks/equities) or sector (e.g., financials, technology, etc.)
• Investment risks are not adequately disclosed and/or misrepresentations are made
FINRA Arbitration
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II. Critical Functions(NYSE Series 7 Examination Content Outline, 1995)
3-5) Considers the tax implications for a customer of particular investments
4-9) If there is to be any power of attorney over the account, obtains the necessary documents and approvals
7-1) Routinely reviews the customer’s account to ensure that investments continue to be suitable
7-2) Suggests to the customer which securities to acquire, liquidate, hold or hedge
7-3) Explains how news about an issuer’s financial outlook may affect the performance of that issuer’s securities
7-4) Keeps the customer informed about the customer’s investments
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Monitoring
Common Problems• Asset class, sector or stock becomes
over-weighted/over-concentrated• Client changes his/her situation
– New questionnaire– Objectives
Critical Functions
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VARIATION ON UNSUITABILITYPortfolio Mismanagement by an Investment Fiduciary• Registered Investment Adviser and its representatives have fiduciary
duty to clients• Modern Portfolio Theory (MPT) and Prudent Investor Rule define
standard of care• Financial planning “negligence” – failure to anticipate client’s income
needs, inflated projections based on unrealistic returns, etc.
III. Implications For Investment Advisers
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MODERN PORTFOLIO THEORYAsset Allocation and Diversification• Fundamental concepts that sometimes are disregarded by advisors
Asset Allocation:• Practice of combining non-correlated asset classes (e.g., stocks, bonds,
cash, REITs, hedge funds)• Significantly reduces risk (i.e., volatility) in portfolio• Does not significantly reduce investment returns
Diversification:• Means not having all of your eggs in one basket (i.e., sector)
Implications for Investment Advisers
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PRUDENT PRACTICES FOR FIDUCIARY ADVISERSby Financial Planning Association (and Donald Trone)
• Outlines prudent practices for Fiduciary Advisers as defined in the Pension Protection Act of 2006
• FPA states the handbook “represents a standard of excellence for fiduciary advisers”
• Includes a four-step investment management process:1. Organize2. Formalize3. Implement4. Monitor
Implications for Investment Advisers
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Let’s look at the second step, FORMALIZE:• Practice A-2.1
– Fiduciary adviser will analyze investment options and review them with the client
• Practice A-2.2– Fiduciary adviser should identify and document the investment time horizon for the
client
• Practice A-2.3– Identifying and discussing the client’s risk tolerance
• Practice A-2.4– Identifying, discussing and documenting the client’s expected investment return
necessary to meet the client’s investment objective
• Practice A-2.5– Suggests the procedure by which advisers should recommend particular asset classes
for the client
• Practice A-2.6– “Preparation and maintenance of a client’s investment policy statement (IPS) is one
of the most critical functions performed by the fiduciary adviser, even if it is not stipulated by law or regulation.”
FPA Handbook
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Let’s look at the fourth step, MONITOR:• Practice A-4.1
– Obligates fiduciary advisers to provide periodic reports to clients which compare investment performance against an appropriate index or peer group and against the objectives of the IPS
– A “watch-list” of underperforming investments is encouraged, and the fiduciary adviser should advise the client how to periodically rebalance investments in the portfolio
• Practice A-4.2– Recommends that the fiduciary adviser periodically evaluate the qualitative and/or
organizations changes of investment managers or other investment decision-makers which may affect the investment offerings within the plan, including corporate stock of the plan sponsor
– Fiduciary advisers are expected to notify the client in writing of any unsatisfactory news regarding a material holding in the client’s portfolio
FPA Handbook
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IV. Themes of Mistakes
INCLUDE:• Failure to document• Failure to control• Digging the hole deeper
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Failure To Document
• Define the scope of the engagement– What part of the whole are you responsible for giving advice
about?
• Not obtaining complete financial picture from client• Have clients fill out applications and questionnaires in
their own writing
Themes of Mistakes
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Failure To Document
• Allowing parts of questionnaire to go unanswered• Not documenting what the objectives are for the
funds you manage• Not obtaining all information from client before giving
advice
Themes of Mistakes
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Investment Policy Statements
Themes of Mistakes
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Failure To Control
Letting the client control the advice you give
Example: Clients who want to retire young, but have not yet saved enough
Your choices:• Tell clients what they want to hear• Deliver bad news
Themes of Mistakes
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Typical example:Someone who is 55 and married just retired from his job and took a lump sum distribution:
• Recommend an aggressive asset allocation to get the numbers to “work”
• Tell client “to go back to work and earn some more money”
Themes of Mistakes
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Avoiding This Problem• Have a research-backed, consistent
methodology• Follow it with each client, even when it means
saying: “You may want to retire, but you can’t.”
Themes of Mistakes
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Handling The Spendthrift Client
Identifying potential spendthrift clients• Retirees with lump sum distribution• Clients with limited earning potential• Heirs and trust beneficiaries
Themes of Mistakes
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Handling The Spendthrift Client
Signs of problems• Living expenses beyond reasonable levels• Unwilling to limit expenses or change
lifestyle
Themes of Mistakes
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Handling The Spendthrift Client
Solving problems• Communication with customer regarding
expenses• Avoiding growth investing for income model• Reevaluating client goals and expectations• Documenting problems and solutions offered
Themes of Mistakes
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Digging the Hole Deeper
“No good deed goes unpunished.”
• Admitting that a past strategy was not a good idea• Offering to waive fees or give a discount for poor
performance• When a client does not have the stomach to take
losses, don’t fight him• Sell a position that is going down and revise the
questionnaire to reflect that the client “can’t sleep” with certain investments
Themes of Mistakes
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• If you and a client no longer have the same ideas about investing, end the relationship
• Document any time that a client took an action against your advice
• Never admit that an investment was a bad idea or a mistake
• Never give a refund/discount for services due to investments performing poorly
Themes of Mistakes
Avoiding Digging the Hole Deeper
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Dealing With a Customer Complaint
• DO NOT meet with the customer or communicate with the customer
• Notify compliance
Themes of Mistakes
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V. Senior Issues
FINRA NTM 07-43:• “To urge firms to review and, when appropriate,
enhance their policies and procedures for complying with FINRA sales practice rules, as well as other applicable laws, regulations and ethical principles, in light of the special issues that are common to many senior investors”
• Defined as those “at or nearing retirement”
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No “special rules,” but:• “Age and life stage (whether pre-retired, semi-retired
or retired) can be important factors, and firms should make sure that the procedures they have in place take these considerations into account where appropriate”
• Suitability of recommendations and communications aimed at older investors are “of particular concern”
• Refrain from making an unsuitable recommendation
Senior Issues
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Note:“A customer’s net worth alone is not determinative of whether a particular product is suitable for that investor, even when the investor qualifies as an accredited investor.”
– FINRA states that over-reliance on net worth is “particularly problematic” where the investor has met the accredited investor standard based largely on the value of his or her home, “which may represent the largest asset of many senior investors.”
Senior Issues
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Suitability• Age and life stage
– “As investors age, their investment time horizons, goals, risk tolerance and tax status may change.”
– “Liquidity often takes on added importance. And, depending on their particular circumstances, seniors and retirees may have less tolerance for certain types of risk than other investors.”
– “Retirees living solely on fixed incomes may be more vulnerable to inflation risk than those who are still in the workforce, depending on the number of years those retirees are likely to rely on fixed incomes.”
– “Investors whose investment time horizons afford less time to or opportunity to recover investment losses may be disproportionately affected by market fluctuations.”
Senior Issues
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Suitability• Liquidity needs, consider
– Customer’s primary expenses (Mortgage?)– Sources of income (Fixed?)– Amount of retirement savings (How invested?)– Health insurance coverage (Relying on assets to pay for health
costs?)
Senior Issues
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Risk• Caution: older investors may “reach for yield to
maximize retirement income without the appreciation of the concomitant risk”
• Must present a “fair and balanced picture of the risks, costs and benefits”
Senior Issues
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Particular concerns• Deferred variable annuities, equity indexed annuities
and some real estate investments and limited partnerships– “Have withdrawal penalties or otherwise lack liquidity”
• Using home equity to make investments• Using retirement savings (including IRA withdrawals)
to invest in high risk investments
Senior Issues
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FINRA Report: “Protecting Senior Investors: Compliance, Supervisory and Other Practices used by Financial Services Firms in Serving Senior Investors”
1. Senior investor not defined by age, but “to include investors who have retired or are nearing retirement”– Age, life stage & “diminished mental capacity” are critical
components– Diminished mental capacity may be more prevalent among older
investors, who may also be more frequent targets for financial abuse
Senior Issues
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2. Firms are communicating effectively with seniors– Firms increased frequency of contact so they remain informed
about changes in the investor’s financial needs, employment status, health and other life events
– Firms adopted practices to encourage their financial advisers to avoid financial jargon & to document conversations with investors, including by sending follow-up letters
– Firms have drafted written materials, in larger-font versions, aimed at educating senior investors
Senior Issues
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3. Some firms consider training on how to identify diminished capacity a critical program for employees, especially identifying “red flags”:– Of diminished capacity, including the inability to process simple
concepts, memory loss, difficulty in speaking or communicating, disorientation and erratic behavior
– In financial matters, including refusing to follow appropriate investment advice, making investment decisions inconsistent with long term goals, concern or confusion about missing funds, being unaware or not understanding recently completed financial transactions
Senior Issues
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4. Practices regarding specific products– Limiting or prohibiting purchases of certain investment
products, such as “structured products” based on life stage and risk profile
– Prohibiting purchases of certain variable life insurance products by investors over a certain age
– Requiring a heightened review of annuity applications for investors over a certain age in a low tax bracket or with low liquid net worth
Senior Issues
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CONCLUSION
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James J. [email protected]
312.621.4400
Questions?
Thank you!
For more information on the securities practice group at SNSFE, or if you have aquestion about this presentation, please contact:
Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C.
20 N. Wacker Drive, Suite 2900Chicago, IL 60606-9719
312.621.4400 (T)312.621.0268 (F)
www.SNSFE-law.com www.FinancialCounsel.com