August 1, 2012 by Brynna Leslie
Three years ago, Judith Cane, owner of Antara Financial in Ottawa, watched from the sidelines as a colleague faced a lawsuit from a client. The claim was that he had not done his due diligence as a financial advisor, and the client had lost money as a result.
“When you’ve been in the business for this long, you kind of always expect that something may rear its ugly head,” says Cane, now a financial planner, and an advisor for more than 20 years. “Anytime there’s a huge crash or any kind of jarring motion in the market, people are likely to come and say ‘I didn’t tell you I wanted to invest in that.’ Everyone’s risk tolerance becomes much more balanced when they’re losing money. And they’re looking for someone to blame.”
Across the country, financial advisors and their dealers deal with disgruntled investors almost weekly. The Investment Industry Regulation Organization of Canada (IIROC)—the regulatory body for investment dealers—generally receives between 1200 and 1300 complaints per year. In 2008, following the market crash, that number shot up to 1,532, a near 30-per cent increase over the year before. Reasons cited for complaints included unauthorized and discretionary trading, unsuitable investments, misrepresentation, and service issues.
“I think a lot of it comes down to desperation,” says Ian Gold of legal firm Thomas Gold Pettingill in Toronto, which specializes in insurance litigation. “People who had any sort of investment and were expecting returns of 10%, which at one point they could count on, were now finding themselves in a position where they could not retire and were not financially set-up. They felt they had no choice but to seek legal redress.”
This puts financial advisors, dealers and investments at a much higher risk for being sued for errors and omissions. “When there’s a lawsuit, everybody gets named,” explains Gold. “Generally it starts with the advisor being accused of giving a client bad advice on a project, and if the advisor works for a company, the company also gets sued. And in cases where an investment simply hasn’t performed as projected, the client, or even the financial advisor will turn around and sue the investment.”
As the industry has become more professionalized in the last ten years, regulatory bodies, such as IIROC and the Mutual Fund Dealers Association of Canada (MFDA), require their members to be well-insured against claims of errors and omissions (E&O).
E&O coverage itself is relatively straight-forward and uptake has been good. Most independent advisors in Canada require between $1 million and $5 million in coverage, which they can obtain for anywhere from $650 to $1,500 per year in annual premiums.
But things can get murky when it comes to claims, says Joe Fidilio, senior counsel for underwriting and claims at Liberty International Underwriters.
“As soon as there’s any sort of allegation or hint that an advisor has done something wrong, our philosophy is that they should be reporting it to us, the insurer,” says Fidilio.
Fidilio says the problems come when advisors fail to notify their internal compliance departments and insurers of criticisms or negative comments from clients, instead attempting to smooth things over on their own.
“Advisors are in the business of helping people, and often times the advisor will out of goodwill respond to a complaint by saying, ‘yes, I will fix this,’” explains Fidilio. “By doing this, they are taking on responsibility and assuming liability or potentially admitting guilt. These things have a tendency to blow up later on, but if they’ve already admitted responsibility, they may have also prejudiced their insurance policy in the process.
“The sooner we’re involved, the sooner we’re able to ensure a couple of things: 1) they’re not going to do anything to prejudice their E&O policy; and 2) we can do a lot to make the process run smoothly,” Fidilio says.
Both IIROC and the MFDA now require members to report and investigate verbal complaints in the same way they would written complaints. Fidilio says every accusation—even if it’s not in writing—should trigger a phone call to the insurer.
“If something transpires or develops two or three years down the line, anything that flows from that initial notice is more likely to be locked into the period in which they reported it to us,” says Fidilio. “More often than not, these accusations don’t come to anything. If there’s ever any doubt, advisors should call us or their brokers directly to report allegations.”
Disgruntled clients have the option to make a formal complaint to one of the regulatory bodies in the industry, seek arbitration, file a notice with the Ombudsman for Banking Services and Investments, or take legal action. The majority of claims are resolved without going to trial—and often without any kind of financial compensation. Out of the more than 1,000 claims made each year, IIROC has only had to take disciplinary action against an advisor or dealer between six and 18 times per year.
Regardless of the method or the outcome, however, insurers say financial industry professionals could be doing better to mitigate claims frequency.
“For this type of insurance product, frequency is usually the main concern,” explains George Georgiadis, underwriting manager of professional lines for AXIS Reinsurance Company’s Canadian branch. “There have been some high profile cases involving leverage investment strategies that have the potential for multi-million dollar damage rewards.”
Georgiadis points out that any time a claim has been made against an advisor, regardless of the settlement, it has to be disclosed in future applications for insurance.
“The advisor’s past history, the seriousness of the claim that was made and the final outcome of the claim would all be taken into consideration,” says Georgiadis. “Circumstances leading to the claim are all taken into account when determining an advisor’s insurability.”
And a high level of claims activity is always a red flag for insurers.
“Question marks can arise when an individual has a track record of claims activity or complaints against them,” says Garth Pepper, senior vice-president of specialty casualty at Liberty International Underwriters. “It might suggest that perhaps the advisor has not been following protocol, not doing things the way they should be done or not doing them very well. I wouldn’t say it automatically makes them uninsurable, but it may be a situation where their premium goes up or they become subject to more restrictive terms.”
The Broker’s Role
Brokers can play a key role as risk managers for their financial advisor clients, helping them to understand how to avoid E&O liability claims.
“We highly recommend advisors have tested and proven standard procedural practices for dealing with their clients that is followed in every case,” says Roberta Tasson, vice-president of corporate risk at The Magnes Group Inc. “Claims often emerge months, if not years, after the transaction in question.”
Encouraging advisors to communicate clearly with clients—diligently filling out the know-your-client (KYC) forms, understanding and updating their risk tolerance, and ensuring they understand instructions, advice and limitations on advice provided—could become essential in a claim situation.
“Inevitably what we see in these cases is a dispute between the advisor saying ‘this person called and said they wanted to get into something with higher returns,’ and the client saying the opposite,” says Gold. “It’s a question of proof. The best proof is having things in writing. It’s not a guarantee that the court will find in favour of the advisor, but it carries a lot of weight.”
Advisors not only need to diligently document client conversations and exchanges in a standardized way, says Tasson at Magnes, but they need to retain the documents as well.
“It is often heard after a claim is made that the advisor had notes, but they were destroyed, shredded, lost, etc.,” says Tasson. “A document that can’t be found does not exist.”
And while many advisors access group insurance through a dealer or an industry association, there are many independent financial professionals out there who wouldn’t mind being taken by the hand when it comes to insuring themselves appropriately.
“These days pretty much everyone in the industry has E&O insurance; you can’t have your life license or investment license without it. But you can control the amount of insurance you have,” says Cane at Antara Financial. “Where the insurance broker can really add a lot of value is by sitting down with me and figuring out exactly how much money I’m managing, how much risk I face, and how much coverage I need. Just as my clients may have the tendency to undervalue their homes when accessing fire insurance or their lives when accessing life insurance and get their brokers to help them assess that, I may need an outside opinion to help me put the true value on my own practice.”
Help clients avoid making classic mistakes
1) Be sure clients understand there is no penalty for reporting an allegation of wrongdoing to the insurer, especially one that has the potential to lead to an E&O liability claim. Walk clients through the process of registering and dealing with both verbal and written complaints. If they are members of a dealer, be sure they are also following the internal compliance processes. If an allegation becomes a claim, policy coverage kicks in from the date the allegation was first registered.
2) Don’t be afraid to talk clients out of pursuing legal action. More often than not, claims do not go beyond internal compliance departments, let alone to trial. Very few complaints lead to financial settlements. “A lot of the time a potential client will come to see us because they believe that they have been treated unfairly,” says lawyer Ian Gold. “A large part of our job is talking people off the ledge, explaining that it’s usually not worth going to court strictly over a matter of principle. Having your day in court and a piece of paper saying you’re right is often not as fulfilling as people think it is. Just because you have a judgment on paper does not mean that you can necessarily collect on that judgment. Brokers can do well to explain this to their clients up front.”
3) Encourage documentation and communication. The best thing financial advisors can do to avoid E&O claims is to document everything, file everything systematically, and put the necessary checks and balances in place to make sure they are acting in the best interest of their clients. Financial advisor Judith Cane likes to get on the phone with clients the second the market dives to remind them of their plan, reiterate past communications between advisor and client, and reassure them that everything is on track. “The best insurance broker is going to have a good understanding of how I’m approaching my clients and my business to make sure I’m doing what I can to manage risk,” says Cane. “And if there’s something I can be doing better to avoid getting sued, then tell me.”
Copyright 2012 Rogers Publishing Ltd. This article first appeared in the May 2012 edition of Canadian Insurance Top Broker magazine.
This story was originally published by Canadian Insurance Top Broker.