Loss Prevention for Financial Advisors

Transcription

1 Loss Prevention for Financial Advisors Markel Cambridge Alliance Topics for Discussion 1. FINRA Arbitration Statistics 2. Loss Prevention 3. Investment Selection 4. Questions 2 1

2 Finra arbitration statistics Historical market performance 160.0% S&P 500 Indexed Dow performance 30 since Nasdaq 3/ % 0% 120.0% 100.0% 80.0% 60.0% 40.0% 20.0% 3/00 3/01 3/02 3/03 3/04 3/05 3/06 3/07 3/08 3/09 3/10 3/11 3/12 3/13 4 2

3 Finra arbitration stats FINRA Arbitration Cases Filed 10,000 7,500 5,000 8,945 8,201 6, ,704 7,137 6,074 5,608 5,558 4,982 4,614 3,238 5,680 4,729 4,299 2, Finra Arbitration Stats Security Types Involved in FINRA Cases % 21.3% 20.0% 16.9% 15.0% 14.2% 10.0% 7.2% 5.0% 4.8% 0.0% Common & Preferred Stock Mutual Funds Options, Derivatives & Alternatives Annuities Fixed Income 6 3

4 Finra Arbitration Stats Allegations in FINRA Cases % 55.9% 50.0% 44.3% 44.3% 40.0% 30.0% 36.4% 31.9% 32.1% 20.0% 10.0% 0.0% Breach of Misrepresentation Negligence Failure to fiduciary duty supervise Omission of Facts Unsuitability 7 Finra Arbitration Stats % of Cases with Damages Awarded 50.0% 45.0% 40.0% 35.0% 45.0% 47.0% 43.0% 44.0% 45.0% 42.0% 42.0% 37.0% 30.0% 25.0% 20.0% 15.0% 10.0% 0% 5.0% 0.0%

5 Loss Prevention Loss Prevention We will touch on the three critical areas of loss prevention Execution errors Client Selection (& de-selection) Documentation 10 5

6 Execution Errors Easiest losses to avoid, and the most common Trade was forwarded by fax to Andrews Air Force Base, failure to trade remained undetected for two months; loss of $70,000 Verbal order to buy was executed in shares, not dollars, as securities title contained the word shares ; trade was outstanding for 7 minutes, resulting in $20,000 loss 11 Execution Errors Match every order against the return confirmation, and promptly resolve discrepancies Your only goal is to make the client whole Keep a log of erroneous trades, look for patterns and address them Maintain discretionary funds to quickly address an erroneous trade before it gets worse 12 6

7 Client Selection Some clients would be better served by your friendly competitor down the street Chronic overspenders Won t take your advice Risk tolerance and life circumstances are inconsistent Unethical or immoral Partners in conflict High maintenance, low return 13 Client Selection If you knew then what you know now, would you still take on the client? 14 7

8 Documentation In a claim situation, proper documentation can be of huge benefit This just in: Clients are not always truthful Remember: you don t have to be negligent to be accused of negligence! 15 Investment Policy Statement (IPS) Multiple investment policy statement models: Simple model CFA model 16 Life circumstances Risk tolerance Risk Tolerance Return objectives Investment objectives Taxes Investment Style Time horizon Legal g / regulatory Liquidity Unique circumstances Regardless of model chosen, updates should be at least annual. More frequently if circumstances dictate. 8

9 Ongoing documentation Brief file notes should be kept on every interaction with the client. Small matters can become very large ones Complete documentation of any changes in objectives Advice given, but not heeded Quarterly summary of activity or discussion which is signed by client acknowledging understanding 17 Disclosures Registration shift from SEC to state regulators has probably affected you update and comply Identify and discuss ALL potential conflicts of interest Including WHY it could be a conflict Compliance with the 1940 act is mandatory you could be fined or penalized 18 9

10 Market Loss Claim Inflated damages measured by peak to trough (not accounting for withdrawals) Punitive damages sought, but rarely awarded Client s sophistication is nearly always understated, and: Client s role is unstated Client will forget conversations you had, letters you sent them 19 Diversification claims 20 Large area of claim activity comes from clients with concentrated positions May ypre-date the advisor relationships Inheritance, tax consequences No matter what you have expressed to your client, a concentrated position that goes south will suddenly be your fault Make sure you document! Carve out concentrated positions from the advisory agreement 10

11 Negligence and Damages The Negligence Case Distribution of Damages Prove standard which advisor should have met Advisor failed to meet the standard Failure to meet the standard is the cause of client loss Damages are measureable Market decline Client contributory negligence Advisor negligence 21 Investment Selection 11

12 Alternative Investments Return only comes with risk It is not possible to consistently generate above market returns without assuming above market levels of risk 23 Risk Framework Risk has traditionally been defined as price volatility The more of the element below, the greater the potential for loss. Minimal Regulatory Oversight/Control Leverage Lack of liquidity Unclear valuation methodologies Investor expectations for high returns Complex manager compensation 24 Large minimum investment Lockup periods 12

13 Alternative investments In a claim situation the question will not be if you understood the investment, but if your client understood the risks. Were there other similar investments available that carried less risk? Did you conduct and document thorough due diligence of the alternative investments you recommended to a client? 25 Conclusion 13

14 Summary Institute trade confirmation practices Carefully review problematical clients Put the files in order and institute rigorous client documentation procedures Carefully review adequacy and completeness of disclosures Think of alternative investments in the context of Risk vs. Reward Insurance is business asset and a risk management tool 27 Questions? 14