|
|
|
|
Guarding Against the Spendthrift Customer
onsider the all - too familiar scenario in which the fully invested customer repeatedly spends money, requiring you to liquidate and possibly modify your investment strategies for the account.
I recently had the pleasure of defending an investment advisor in a mock securities arbitration, before approximately 50 investment advisors who were concerned about their exposure. As the consensus of the attendees indicated that the experience was worthwhile, I will share it with you.
Briefly, here are the facts. The mock arbitration involved a widow who opened an account with the adviser in the early 1990s. At the time, she was 62 years old and had no direct experience with investments, as her recently deceased husband had handled all of those affairs. Her primary investment objective was to preserve her assets, with modest growth to offset the effects of inflation, to ensure a comfortable retirement. She considered herself to be "conservative".
Nonetheless, the investor was overly - confident regarding her wealth, which led her to increase her spending dramatically. Her requests for money initially had only one consequence; ill-timed sales of securities. However, in the mid 1990s, her spending increased to the point of jeopardizing her ultimate goal of being able to retire comfortably.
For a moment, stop here and consider what you would advise this investor. Now, consider what this adviser did. First, this adviser maintained copious notes of each conversation (and there were many) regarding the requests for withdrawals, as well as his cautionary remarks against doing so. Second, at the point when this adviser clearly was exasperated by his customer's frustrating his investment planning for her, he sent a letter bluntly warning her that if her withdrawals continued at their rapid pace, the adviser would have to invest her money in securities with "more risk" (for possible greater return). Additional notes demonstrated that he gave this warning several more times.
Despite the warnings, the withdrawals continued unabated. The adviser thus invested in more risky securities - technology, for the most part, and engaged in some active trading to capture short - term gains. Of course, the timing could not have been worse. The account value increased as it rode the technology wave for a short time, before plummeting to a "peak to trough" loss of nearly $1 million.
The mock arbitration claim alleged that the technology investments and the short - term trading were unsuitable and that the adviser failed to fully inform the customer of the risks associated with these recommendations. On the other hand, the adviser defended his recommendations by pointing out that he had done all that he could do by way of warning the investor that unless she changed her spendthrift ways, she would have to assume more risks.
Who should win - customer or adviser? Although the mock arbitrator ruled in favor of the adviser, brokers reading this column should be concerned with their exposure. Brokers should note the following.
First, regardless of a customer's uncontrollable spending habits, brokers cannot recommend securities that are unsuitable. One feels sorry for the broker and the dilemma presented. However, the prudent course of action would have been to fire the customer.
Second, a broker cannot "cure" an otherwise unsuitable recommendation by explaining its risks. That is, although it is important for a broker to educate customers about the risks associated with a particular recommendation, the law is clear that the suitability rule requires more than mere risk disclosure. This is true even if the customer understands the risks involved.
Third, even if the customer has changed her investment objectives (say, from conservative growth to aggressive growth, whether or not recorded in account documentation), that is no defense to an unsuitability claim. The law is clear that a customer's investment objective is but one factor to consider in determining whether a broker's recommendation was suitable.
Many brokers may be faced with similar situations. Do more than make your own paper trail. In addition, seek counsel, and do so early, from your branch manager, compliance department and legal department. There simply is no defense that the "customer made me do it"!
|
About Us
|
News
|
Alerts
|
Articles
|
SNSFE News
|
Calendar
|
Contact
|
Search
Register
|
Free Opinion
Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment advisor when building and protecting your wealth.
All content Copyright © 2008 Advocate Capital Management, Inc. except where noted. All rights reserved.
20 North Wacker Drive, Suite 2900, Chicago, Illinois 60606
Telephone: 312-621-4400 | Fax: 312-621-0268
|
|
|
|
|
