From the June 2009 issue of Investment Advisor • Subscribe!

June 1, 2009

Formulas for Success: Clients Have Rights, But Also Responsibilities

Advisors and their clients must alter their approach to future relationships

Okay, I know it's not cool to blame the victim. But honestly, don't you find it a bit exasperating that so many people have been clipped by so many fraudsters? Don't you just cringe when clients and prospects imply with their questions that you may not be trustworthy because others in the industry have cast a shadow over your profession?

Haven't you caught yourself muttering, "I feel sorry for some of those people who got taken, but how did they not get suspicious about the outsized returns and the lack of clarity around the investment process?" Don't you get angry when you hear how feeder firms either failed to perform proper due diligence or overlooked the obvious and now claim to be victims themselves?

The canvas of this landscape, of course, is painted with multiple shades of gray. Clients hire advisors to guide them through complex financial decisions. Boards of non-profits outsource to investment consultants. Widows who have never balanced a checkbook seek handholding and direction from trusted financial professionals. Artists and actors delegate financial decisions to people who perform the role of business guru so that they can concentrate on their crafts. The whole point of hiring an advisor is to engage an intermediary, a guide, to do what a layperson doesn't or can't do well.

But does this mean the client should abdicate all responsibility? Wouldn't they take action to understand nutrition and exercise if their doctor said they were morbidly obese? Wouldn't they try to understand their child's learning disability if he fell behind in school? People must frequently make decisions and take action on things they know nothing about. Why is understanding where their money is going and what their advisor is saying any different?

It is true that we seem to be living in a world where the obvious somehow becomes fodder for litigation and blame throwing. I came across a blog about frivolous law suits that have resulted in ridiculous warning labels like:

o "Remove child before folding," on a baby stroller.

o "Harmful if swallowed," on a brass fishing lure with a three-pronged hook.

o "Never iron clothes while they are being worn," on a household iron.

o "Shin pads cannot protect any part of the body they do not cover," on shin guards.

I can only imagine what advisors will now have to print on their ADV and application forms to alert clients to the obvious.

All of this raises the question: What is the client's responsibility to minimize the risk of fraud or failure in the management of their account? The Madoff affair has elevated the question of whether the markets are fixed to work against ordinary folks. Multiple other incidents continue to reinforce the impression that the financial services industry is out of control. It's maddening that while you're keeping your nose clean, others are sullying your reputation by association.

Blame and Responsibility

This tension around whom to blame got me thinking about advisors helping clients to understand their rights and responsibilities in the management of their money. Yet how can this discussion occur at a time when clients are wounded and wary without the advisor coming off as trying to shift accountability?

Recently, I was asked to talk about this subject for the PBS television show "Consuelo Mack WealthTrack." With the help of readers of the newsletter Inside Information, and input from members of the elite cadre of advisors in the Alpha Group, I pulled together some ideas that advisors might consider in communicating with their clients. One of those ideas is to provide clients with a "Bill of Rights and Responsibilities" as part of your engagement process. This document would outline responsibilities and expectations for both parties.

Clients' Rights

Here's how a Client Bill of Rights might read:

As someone seeking advice from a financial planning and investment professional, you have the following rights:

o To know the credentials and relevant experience of your advisor and her team.

o To know the compliance and disciplinary history of your advisor and his associates, including relevant problems in their past such as: personal bankruptcy, poor health that may impair their work on your behalf, business history, and financial strength.

o To know your advisor's processes and protocols for developing her recommendations and executing their strategies on your behalf.

o To understand your advisor's investment philosophy and to expect that he can communicate it in a way that you can comprehend and even recite back to them.

o To understand all the fees, charges, and expenses charged by your advisor, by the funds she uses, and the cost of execution.

o To know whether your advisor uses an independent clearing firm if affiliated with a broker/dealer, or an independent custodian if a registered investment advisor (RIA).

o To receive printed or electronic confirmations from the independent custodian of every transaction of money or assets into and out of your account, and to receive statements summarizing activity in your account at least quarterly.

o To know if your advisor is receiving extra fees or compensation from her custodian including 12b-1 fee rebates, or "soft dollar" payments for doing business with them; or in the case of broker/dealer affiliated advisors, to know whether the registered representative (broker) has received a signing or retention bonus to affiliate with a particular firm. To have these terms explained to you in the context of how they could influence the advisor's work with you as his client.

o To receive regular communication from your advisor on the status of your account, status of activities that your advisor is committed to, and other relevant developments.

o To be provided with the contact information of other clients as references.

Clients' Responsibilities

The counterpart to having rights is having responsibilities, too. Here's how a Bill of Responsibilities could read:

It is my responsibility as your advisor to be completely transparent about how I do business with you. I will develop and implement recommendations and follow the protocols that we have described to you, and will charge appropriately for my services. I am here to guide you based on my professional experience and education, but ultimately you must be both comfortable and clear about what I am doing on your behalf.

The following is a Statement of Personal Responsibility. It is your responsibility:

o To ask for explanations on any recommendations that you do not understand.

o To not authorize execution of the recommendation if you do not understand how it works, how it will benefit you, or what the risks are.

o To look at every "confirm" and statement you receive from the broker/dealer or custodian and to reconcile those statements with any performance reports that your advisor provides to you independently. You may choose to engage a CPA, bookkeeper, or trusted person separate from your advisor to perform this reconciliation.

o To understand and agree with your advisor's investment philosophy or to seek another advisor if you do not agree or understand.

o To not allow investment of all your assets with a single money manager or fund.

o To evaluate your advisor not just on performance but on his ability to listen, communicate, and respond to your concerns, and to change the relationship if it is no longer acceptable.

o To understand your tolerance for risk and your own relationship with money.

o To question why returns are much greater than the market averages as vigorously as you might question why your returns are below a reasonable expectation.

o To challenge fees that were not agreed to in advance and to evaluate whether you believe you are receiving value for what you are paying.

o To not give full discretion for the management of assets, or to give a Power of Attorney over the assets, to the same person who is responsible for executing the transactions.

This is not a complete list of items to include in your Bill of Rights and Responsibilities for clients, but an example of how to help clients assume control of their financial lives.

Though it is likely we will see changes in regulation that will attempt to shore up weaknesses in our system and better protect clients, it will be impossible to totally prevent investment abuse without better vigilance by investors and their other advisors including accountants and lawyers. Clients should always know their rights, but they should also understand their responsibilities as well.

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