Why do clients sue? They’ve usually lost money and they’re looking to the portfolio manager, advisor, dealer, or insurance company to recover it. Some might observe that there are a disproportionate number of reported cases against portfolio managers–why is that? Clients who hire portfolio managers tend to have larger portfolios and also may have a team of other types of advisors, which include lawyers and accountants, to whom they can turn when they feel something has gone amiss. With larger portfolios, and therefore more significant losses, the economics of suing makes more sense. In this market downturn, portfolio managers must be on high alert to ensure they steer clients away from a state of fear.

Clients do not have a basis upon which to sue unless the portfolio manager breached his/her duty or contractual obligations to the client. If this can be proven, the additional risk a portfolio manager has is that the client does not have to prove that they were in a fiduciary relationship. This is inferred because the portfolio manager has discretion over the trading in the account. Accordingly, there is no opportunity, like in a non-fiduciary relationship, to assert that the client contributed to losses in the account, for example by neglecting to open his/her mail.

“When the market turns and the client complains, the client’s memory may paint a picture completely different than what the portfolio manager remembers.”

Too often, clients refuse to spend enough time with their portfolio managers or to disclose their personal information, which is required before opening accounts. Portfolio managers must ensure that they collect detailed information and probe the client to ensure sufficient information is provided to enable them to choose suitable investments for each client.

Certain clients have unreasonable expectations of returns on investments, expecting every investment to yield positive returns. That is why the investment policy statement is so important. It should contain detailed information that reflects the client’s risk tolerance and precisely how much capital he/she has the capacity to lose, if any. In a downward market, portfolio managers, as well as all investment advisors, must keep their eyes on the sum their clients can tolerate losing and call each client as the losses approach that amount, to warn the client and obtain instructions. Of course, clients need to be reassured that markets go up and markets go down. If the investments were suitable for the client at the time they were made, and seem to be those that will and should hold their value in the long term, and if the client has a long time horizon, then your advice may be to hold. If the time horizon is shorter or if the risk of the investment no longer seems suitable, then a rebalancing will likely be in order.

Faced with client complaints, many portfolio managers reflect on their meetings with clients and recall that the clients were sufficiently knowledgeable, able to understand the types of products, and accepted the stated risks set out in the investment policy statement. They recall that the explanation of the product risks seemed clear to the client. The question is whether the portfolio manager captured notes reflecting the discussions.

When the market turns and the client complains, the client’s memory may paint a picture completely different than what the portfolio manager remembers. A client may assert that the portfolio manager, having discretion to trade the account without client contact, traded in a manner that was not in keeping with the client’s (perhaps changed) risk tolerance and personal needs for liquidity. The portfolio manager is accused of losing touch with the client. At this juncture, portfolio managers worry because their integrity, reputation and license are on the line. It is ultimately the portfolio manager’s word against the client’s, but with a paper trail, portfolio managers, advisors, and dealers can prove that they fulfilled their obligations–legal and regulatory.

The market downturn has caused portfolio managers to worry about complaints from clients–no matter how groundless they may seem. I have been asked, “What if my client wants to move his/her account entirely into cash?” Assuming the investments in the account are sound and those you expect will hold their value, I suggest the following:

• Advise the client upfront that it is entirely their right to liquidate their accounts at any time–it is their money.
• Advise the client if there would be any charges (deferred sales charge, etc.) associated with the liquidation of any of their investments. You will need to put this in writing to the client so that they don’t later accuse you of not providing them with this information.
• Advise the client that by selling they will crystallize their losses, and if the investments are in good products that will likely rebound, they will not have the opportunity to allow their investments to bounce back. Remind them of any conversations you had with them when the investments were chosen. Pull your notes, investment policy statements, or other documentation and take the client through the logic.
• Do not, under any circumstances, make any comments that could be construed as a guarantee to the client. This is an unusual downturn and the market might not recover for some time.
• Remind the client that you don’t have a crystal ball so you cannot know if this is the bottom of the market or not.
• After you provide these warnings, remind them again that it is their money and their choice whether to liquidate their account.

Remember, risk tolerance does not positively correlate with the market. In other words, as the market goes up or down, I don’t believe the client’s risk tolerance truly changes. Generally, it is clients’ fear and greed that moves with the market–as the market tumbles, clients fear they will lose money and this motivates them to sell, and as the market improves, clients can be motivated by greed to assume risk. Keep this concept clearly in their minds, and protect your business by calling clients and managing their fear in this tough market. These are tough times but we have been here before and we will be here again.

The key is to ensure that as the market does improve, and history shows it always does, that we not forget these dreadful times and not permit clients to allow their fear and greed to rule the day.

See also Jonathan Chevreau’s interview of Ellen Bessner in a video posted at www.wealthyboomer.ca.