Got Unhappy Clients?

As to errors and omissions coverage, advisors should make sure they know whether or not they are covered. When was the last time you reviewed your errors and omissions policy? Are you sure that you E&O policy provides coverage for all of your advisory operations? Have you reviewed the “Exclusions” section of the policy? Have you continued to increase the amount of coverage as your practice has grown?

An advisor should substantively review policy coverages and exclusions at least annually. Most policies now exclude coverage relative to the purchase of private investment funds. The private investment fund offering memorandum and subscription documents serve to protect the fund sponsor, not the investment advisor who is recommending the purchase to its clients or reviewing the prospective investment at the request of the client. As a result, we are now strongly recommending that an advisory firm have its clients execute a Private Investment Acknowledgment, pursuant to which the client acknowledges the risks associated with such an investment, including principal risks and liquidity constraints.

Is E&O necessary? No, if you are sure that you will never face an adverse claim. However, as indicated above, regardless of the merits of a claim (or more important, the lack thereof), there is no guarantee, nor can there be, that a client will not become adversarial. No matter how careful and proactive an advisor is, there can never be any such assurance. Just make sure that you are paying for the coverage that you need for your operations (see sidebar Raise the Deductible).

The Advertising Issue

Based upon recent experience, no column on how to avoid client complaints would be complete without a corresponding discussion of advisor advertising practices which, in my opinion, have become a great potential source of advisory firm liability. I am constantly amazed by the number of advisors who pay large sums to marketing consultants and advertising agencies to prepare marketing materials such as brochures, Web sites, and media advertisements, who know very little about the advisory industry (or are not sensitive to the unique relationship that an investment advisor shares with its clients). Too many marketing consultants, talented as they may be, are focused on making the sale and speak and write in superlatives. Investment advisors do not sell widgets, and their services should not be marketed as such. When a product does not perform as advertised, consumers will generally not purchase that product again. However, when an advisor’s services do not conform to its advertisements, it may not be that simple: the adverse outcome to the consumer (the client) is usually much more severe, and could lead to (or at least help support) client-initiated litigation or arbitration proceedings.

Advisors must be extremely careful not to engage in the unnecessary use of “puffery” or superlatives, or include phrases in their marketing materials that could be construed as an indirect guarantee or assurance of profits, future wealth, or against losses. These types of phrases or superlatives (e.g., “superior,” “best of breed,” “world class,” “time-tested,” “Nobel prize winning,” “comprehensive,” “outstanding,” “We treat you like family,” “Our services are unique,” to name just a few popular phrases) could be used against the advisor in an arbitration or litigation proceeding.

Unless an advisor is clairvoyant or perfect, these types of phrases or words too often set the bar way too high, and are destined to be questioned at some point in an advisory relationship or by crafty plaintff’s attorneys. I am not saying not to engage marketing consultants. Let them be as creative as they would like. But when you receive proposed content, remove (or modify) the suspect phrases and superlatives and see if the same message comes across. Chances are, it will. Clients generally engage advisors based upon recommendations–most often from happy existing clients–and meetings with the advisor, not marketing content. My intention here is not to minimize the importance of good marketing, just to point out that you can have good marketing without potentially exposing the firm to adverse client claims. The above advertising/marketing discussion does not even begin to address the coordination of advertising practices with regulatory requirements and prohibitions, which will be the subject of an entire future column.

There can be no guarantee that a client will not become adversarial. However, with ongoing prudent action and procedures, an advisor can minimize adverse clams and increase its probability of success in the event of a claim. As we well know from experience, “an ounce of prevention . . .”

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York, and Philadelphia that represents investment advisors, financial planners, broker/dealers, CPA firms, registered reps, and investment companies. He can be reached at [email protected].