2011 was a year investment advisors will remember for a long time. Volatility in the stock market undoubtedly caused many sleepless nights for IARs. Aside from huge swings in stock prices from day to day, IARs may have had to deal with unusually high numbers of unhappy clients who blame their investment advisors for losses in their portfolios.
Regardless of how compliant an RIA is or how hard the firm works to manage the client’s money, the advisor may still face customer complaints. If not handled properly, a complaint might result in the loss of a valued client. Furthermore, because RIAs rely on favorable references, a complaint means the firm might lose opportunities to attract new customers. Instead of touting the RIA’s expertise to others, an unsatisfied client might make negative comments about the firm to friends, relatives, and business associates.
Worse yet, clients may not be just complaining to the RIA, but to securities regulators as well. Complaints to the SEC can trigger a visit from the Commission for an examination. Even when the SEC is coming for a routine examination, the Commission’s examination information request list will ask for a copy of all client complaints. Examiners will also ask the RIA to provide information regarding the process used for monitoring client correspondence and/or complaints.
The SEC’s most recent list requests information relating to any threatened, pending, and settled litigation or arbitration involving the RIA or any supervised person. A supervised person is any partner, officer, director (or person occupying a similar status or performing similar functions), or employee of the RIA, as well as any other person providing investment advice on behalf of the firm and subject to its supervision and control.
What is a Complaint?
Distinguishing complaints from a client’s frustration with the market is not always easy. Suppose an IAR receives a hostile phone call from an agitated client after the Dow recently dropped over six hundred points following Standard and Poor’s downgrade of United States debt. During the phone call, the angry client yells that the representative told him not to worry and the IAR should have taken action before the bottom fell out of the market. It is hard to discern whether or not this situation falls within the definition of a complaint.
Looking at state securities regulations to better understand the meaning of “complaint” is often helpful. Wisconsin’s Department of Financial Institutions defines complaint, for recordkeeping purposes, as “any written or oral statement of a customer or any person acting on behalf of a customer alleging a grievance involving the activities of persons under the control of the investment adviser in connection with providing investment advice or placing orders on behalf of customers” (§ DFI-Sec 5.03(1)(h), Wis. Adm. Code).
In other states, an RIA might only be required to retain written customer or client complaints. In those jurisdictions, the phone call from an agitated customer would not fall within the definition of “complaint.”
Policies and Procedures Relating to Complaints
A firm’s policies and procedures should define what a complaint is. In one manual, a complaint is defined as:
“Any statement (whether delivered in writing, orally or electronically) of a customer, or any person acting on behalf of a customer, alleging a grievance involving the activities of those persons under the control of the Company in connection with the solicitation or execution of any transaction or the disposition of securities or funds of that customer.”
A different compliance manual states that a complaint is:
an expression by, or on behalf of a client, of dissatisfaction with service provided by the employer or any of its employees, or with the conduct of the firm or any of its employees.
In some compliance manuals, there is no complaint unless the client makes an expressed or implied demand for payment or reimbursement or demands that the RIA take some specific action.
In a typical compliance manual, the firm’s CCO is responsible for ensuring that all customer complaints are handled in accordance with all applicable laws, rules and regulations. CCOs are also responsible for making certain that there is full compliance with the adviser’s policies and procedures. Suppose a client, a school teacher, emails the IAR handling her account complaining that her portfolio contains too many equity investments, and she lost money during the latest market downturn. The client’s primary assertion is that the IAR’s investment strategy was unsuitable in view of her age, risk tolerance, and financial objectives.
At many firms, IARs must notify the CCO immediately upon learning of the existence of a customer complaint, and provide the CCO with all information and documentation in their possession relating to the complaint. IARs must cooperate fully with the firm’s CCO, as well as with regulatory authorities who may be investigating the customer’s complaint. Policies and procedures should address the disciplinary action that will be imposed upon an IAR or other employee who fails to report a client complaint to the firm’s CCO.
Policies and procedures should demonstrate that the advisor takes all client complaints seriously. A firm’s compliance manual will normally require the CCO to review the facts surrounding any written, oral or electronic complaint that is received.
Policies and procedures should clearly define an RIA’s record-keeping obligations relating to complaints. The advisor must maintain a separate file for all customer complaints in its primary office, and should include the following information:
- Who filed the complaint
- When the complaint was received
- The name of each IAR involved in the complaint
- A general description of the issues that led to the complaint
- Copies of all correspondence pertaining to the complaint
- A written report describing the action taken in response to the complaint and the rationale for the decision
It should be obvious that ignoring customer complaints is not an option.
Best Practices for Handling Complaints
All RIAs should adopt policies and procedures designed to ensure a prompt and equitable resolution of complaints against the advisor. Employees and associated persons must be familiar with the firm’s policies and procedures for handling complaints. It is imperative that IARs should not act unilaterally in resolving a grievance. The RIA’s principals and compliance officer need to be involved in bringing closure to the complaint.
Investment advisors must exercise care in defining complaints in their policies and procedures. If an RIA is state registered, the definition should be consistent with that state’s securities laws. A state may not even define the term, therefore putting the ball back in the RIA’s court.
A firm’s CCO and principals should agree upon a definition which makes sense according to the firm’s business model. An overly-narrow definition of a complaint might keep potential problems under the radar, and the firm’s CCO might never learn about the problem. If a complaint is broadly defined, an RIA creates problems for the firm where none exist. For example, treating every unpleasant phone call from an upset client as a complaint might create compliance problems for the RIA. Conversely, a Pennsylvania compliance examiner advised conference attendees that RIAs should treat a client’s grievance as a complaint, even if there is room for doubt that it rises to that level.
At a minimum, RIAs should take the following steps:
- Establish a procedure to track complaints
- Implement a policy requiring prompt reporting of complaints by IARs and associated persons
- Investigate all written and oral complaints
- Notify the person making the complaint of the progress of the investigation
- Consult with counsel and the RIA’s E&O carrier before negotiating a settlement
- Contact the person making the complaint regarding the RIA’s decision and proposed course of action
- Maintain originals of communications sent or received relating to the complaint
When an RIA receives a complaint, the firm’s CCO should examine the cause. Quality improvement gurus sometimes refer to this process as root cause analysis. At a minimum, the RIA should improve its policies and procedures governing the conduct or circumstances that led to the complaint. To prevent complaints similar to the aforementioned school teacher’s, the RIA should enhance its policies and procedures relating to analyzing suitability. Policies and procedures might be revised requiring IARs to regularly confirm in writing the client’s goals, liquidity needs, and risk parameters.
The Big Picture
The SEC has not provided specific guidance on how client complaints should be handled. Nevertheless, a firm’s policies and procedures should provide clear direction regarding how to address complaints from clients. Neglecting complaints can exacerbate a bad situation.
RIAs should check with their attorney before attempting to settle a client complaint. A good will gesture might be viewed as an admission of liability, and it might be necessary for the client to sign a release.
Creative resolutions to complaints may create compliance problems. For example, one RIA wanted to rebate fees paid by a client to head off a formal complaint. Securities regulators may take issue with an advisor making selective payments to some clients and not others. The Investment Advisers Act imposes a fiduciary duty upon RIAs to treat their clients impartially and not favor one over the other. In addition, without a release signed by the client, there is no guarantee that a rebate or some other accommodation will resolve the complaint. An unhappy client might still pursue the complaint against the RIA either by hiring an attorney or contacting securities regulators.
Do-it-yourself complaint resolution may also trigger problems with an RIA’s errors and omissions carrier. An E&O policy, as it is commonly called, is professional liability insurance that protects firms and individuals against claims and lawsuits. These policies also pay legal expenses and court costs, which can rapidly escalate. An RIA’s clumsy attempts at resolving a complaint issue might undermine the insurance company’s defense of a claim. Furthermore, failing to report a claim may lead to a denial of coverage. An RIA’s E&O policy may require a policyholder to report written demands for damages, as well as incidents reasonably expected to give rise to a claim at a later date.
Unlike some insurance policies, there is no regulatory requirement that RIAs carry errors and omissions coverage. In the August, 2011 issue of Investment Advisor, attorney Thomas D. Giachetti urged RIAs to purchase an errors and omissions policy. According to Giachetti, legal defense costs can be substantial, even if the claim is without merit.
Ultimately, a firm’s CCO should decide if a call or letter rises to the level of a complaint. When in doubt, an RIA should retain documentation regarding any oral or written client grievance, even if it does not necessarily rise to the level of a complaint.
Every complaint should prompt an RIA to review and possibly revise the firm’s policies and procedures. Well-drafted policies and procedures often serve the purpose of preventing complaints from occurring. Being proactive in handling complaints can help RIAs avoid potential lawsuits and problems with securities regulators.
RIAs can also take steps to prevent complaints from happening in the first place. The key to avoiding this is to maintain communication with clients during good times and bad. During the narrowly-avoided government shutdown in the Summer of 2011 and after Standard and Poor’s downgrading of United States debt, many RIAs called and wrote to clients more frequently, helping to ease their concerns. A reassuring phone call or email can help negate the possibility of a client filing a complaint arising from frustration or fear.