According to John P. Huggard, CFP, CLU, too often, advisors take their eye off the ball in regards to compliance issues.
Not that they’re necessarily doing the wrong thing with malicious intent, but that they don’t know all of the available compliance issues.
As Huggard sees it, advisors do a a good job of building their business and increasing their income. However, not keeping up with niggling compliance issues can cripple a financial practice.
With that in mind, Huggard has identified the compliance issues that federal regulators are most concerned with for 2014.
1. Mental Capacity of Clients
One of the major issues facing financial advisors today is selling financial products to older clients who may have reduced mental capacity that is not recognizable. Almost every advisor is aware of the Glenn Neasham case in which Mr. Neasham, a financial advisor, sold a variable annuity to an older client.
The variable annuity was a suitable financial product for this person and, indeed, actually increased in value. A family member complained that the variable annuity should not have been sold to the client because the client had reduced mental capacity. Over the course of a few years, Mr. Neasham essentially lost everything he owned and was eventually convicted of larceny involving the transaction. His conviction went to the appellate courts in California and recently was reversed.
However, it is important to understand that financial advisors must still be vigilant when dealing with older clients or any client that might have reduced mental capacity.
The best way to handle the issue of reduced mental capacity with older clients is to determine whether or not they have been involved in other transactions that would require mental capacity. 2. Failure to Supervise
Some financial advisors are placed in supervisory positions (OSJ, office supervisor). One of the major issues in nearly every FINRA case filed today against a registered representative is the issue of whether or not the employing broker-dealer, through its supervisors, properly supervised the financial advisor.
If it can be shown that proper supervision did not occur, it will expose the brokerdealer and its supervisors to a potential adverse judgment before a FINRA panel. One of the easiest ways to ensure that financial advisors are not involved in activities that will result in regulatory complaints is to contact clients on a regular basis (not less than twice a year) and ask those clients if their financial advisor has been involved in any prohibited activities.
Such a request can easily be sent out by mail or email or be enclosed in statements sent to the clients. In most cases, the clients will indicate that none of the activities listed have taken place and they need not respond.
However, should a client discover that her or his financial advisor is involved in any of the activities listed, it will enable the broker-dealer to immediately look into the matter. Such a form will also provide the broker-dealer with the ability to show that it is attempting to supervise the individuals it hires. 3. Outside Business Activity
Anything that generates income or remuneration, however small, is considered an outside business activity. Problem areas include:
Honorariums. For example, a financial advisor who agrees to give a short talk to a civic group without compensation can be held to have been involved in an outside business activity if an honorarium is later provided.
Discounts. Outside business activities that are conducted on a voluntary basis for no compensation can become outside business activity if it is determined that the financial advisor involved later received any financial benefit.
Gifts. A financial advisor who provides any type of service on a non-compensated basis can still be held to have been involved in an outside business activity should he receive a gift from those persons receiving his uncompensated services.
The best rule to follow is that any activity, compensated or not, should be reported to one’s broker-dealer so this entry can be placed on the financial advisor’s record (U-4). 4. Exotic Investments
One of the most common areas for disciplinary action by federal regulators such as FINRA involves financial advisors who sell exotic or nontraditional investments. Investments such as stocks, bonds, ETFs, mutual funds, and variable annuities are common investments sold by financial advisors.
However, almost every year a new exotic investment comes on the scene that is touted as a great investment for the public. These exotic investments almost always have two characteristics:
1) They are incredibly complex to understand; and
2) They usually pay high commissions.
The financial advisors who sell these exotic investments often do not understand them, which poses problems when they are requested to explain to regulators why such a product was sold to their clients.
In the past few years, exotic investments including strangerowned life insurance (SOLI), promissory notes (medical capital), private placements (Provident Royalties), non-traded REITs, and similar products have been sold with devastating results both to the broker-dealers and to the financial advisors who have sold these products as well as to their clients.
Financial advisors who are approached to sell investments they have never heard of, especially if they are complex and offer enticingly high commissions, should be very careful about getting involved in the sale of these products. 5. Failure to Document All Transactions
Nearly every securities attorney that does defense work will tell financial advisors that the most important thing they can do to protect themselves against claims from their clients is to document every aspect of any financial transaction they recommend to a client.
A good financial advisor can make a list of those items that are most often alleged by a disgruntled financialclient and, from that list, create disclosure documents that will address those issues with clients.
By doing so, this will reduce the potential for litigation or claims in the future should suchlitigation or claims be filed.
This documentation will help a financial advisor prevail in a regulatory case.