Peace Of Mind A Litmus Test Of Fund Suitability

By Marcella De Simone

An advisor who is deciding whether to place a client’s money into a certain mutual fund can follow a simple litmus test: will my client be able to sleep at night.

Thats how Joe Sciabica, CFP, New York, decides whether an investment is suitable.

He defines suitability on a case-by-case basis, but, in general, chooses “an investment program that is consistent with an individuals investing experience, with his investment time frame, with his understanding of what different types of risk are.”

People often mistake risk for volatility, Sciabica says. “Suitability relates to all the different types of risk, not only market risk but also inflation risk, credit risk, interest rate risk.”

The responsibility of explaining all of this to the client is the advisors, Sciabica says, but the responsibility does not end there.

“Its absolutely, positively, unequivocally the individual financial professionals responsibility to know his or her client, to know about his experience, objectives and to understand whats going on in his financial life.”

But, Sciabica concedes that no matter how much an advisor does to ensure the best possible investments are made for his client, he remains exposed to a lawsuit.

“When youre dealing with someones financial life, irrespective of what the security is, youre always open to (a lawsuit) because we live in a litigious society. If people feel they were wronged, its not unlikely they will turn around and sue.

“The agents protection is understanding his client and making sure they understand he knows what he is getting into.”

Sciabica also suggests putting together disclosures for the client to sign confirming that he understands the type of investment and the level of risk, and that the alternatives have been explained to him.

The same standard of suitability applies for life insurance sales, Sciabica says, “because when youre talking about soliciting any financial service, youve got to clearly understand your client and his experience and objectives.”

An advisor who is not apprised of everything a client does regarding his financial plan is at a disadvantage, Sciabica says.

“Purchases a client makes affect other aspects of his finances, and he has to understand what mutual funds will do to his taxes, what owning life insurance is going to do with his estate planning.

“Im a big believer of not making financial decisions in a vacuum.”

Hugh Alexander, a lawyer with Alexander Law Firm, Denver, says that the producer is responsible for determining the suitability of a sale because he can gather information at the point of sale.

If no producer is involved, then responsibility falls to the company to disclose what type of product it is selling and who should or should not buy it.

And yet, “the end result is that its up to the consumers to protect themselves and know what they want,” he says.

Federal standards, which require a producer to “make diligent inquiry as to the investment objectives of the client and what other investment vehicles he has,” are a protection against lawsuits, he says. As long as the sale is made “in a straightforward way, there is no liability” on the part of a producer should he become the target of a lawsuit, he says.

Michael Bonevento, a senior financial advisor who works in the Wall Township, N.J., office of American Express Financial Advisors, says suitability “should be a key focus of any professionals practice.

“There are certain things you should know about your client before you begin, including annual income, net worth, investment objectives, experience.”

In fact, when a potential client would not open his finances to his scrutiny, Bonevento turned him away rather than risk not being compliant.

Many advisors fall short of getting their clients full disclosure because it can be time-consuming and it might sabotage the sale, “but in the long-term it builds a tremendous amount of credibility with you and your client,” he says.

Everyone involved in the sale bears a certain amount of responsibility for its suitability, Bonevento says.

The top responsibility holder is the advisor because “hes on the front line,” he says. The second is the advisors managing principle (MPR), whose responsibility it is to supervise the advisor, and lastly the client himself holds some responsibility, Bonevento adds.

As long as all pertinent information is disclosed to the client before she makes a decision, an advisor should be insulated from a lawsuit, Bonevento says, and the same applies to a life insurance sale.

Life insurance is “probably the most misunderstood vehicle in the entire financial services industry and the sales practices that are used to sell a life contract have long been under scrutiny,” he says.

Another factor in protecting ones practice is contacting ones clients on a regular basis, Bonevento says.

“The client might be in a different tax bracket, gotten married, had children, so you have to ask, is the investment vehicle still right for them,” he says.

Also important is to use only current and approved prospectuses and literature, Bonevento says. A mutual fund that was performing well two years ago might not be doing as well today, he says.

Other trigger points for protecting oneself from lawsuits are continuing ones education and staying within ones area of expertise, Bonevento says.

“Often an advisor will act in the capacity of an accountant or attorney,” he says. “Ill point out (to a client) that he should have a will, power of attorney and trusts, but when it comes down to picking one, at that point I send him to the right person.”

Martin Nilson, an attorney with Edwards & Angell, New York, says that advisors can use suitability questionnaires that help identify what the client wants to achieve.

Questionnaires used for private-placement type securities look into the investment experience of the buyer, their net worth, cash flows and what theyre trying to accomplish. In short, it gives a profile of the buyer that can help an advisor decide whether a particular mutual fund is suitable, Nilson says.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 18, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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