by Ellen Bessner
Originally published in the National Post on November 20, 2008, and based on materials published in Ellen Bessner's book: Advisor at Risk: A Roadmap to Protecting
Your Business
Advisors have to withstand the scrutiny of those judging them: regulators, trial judges, the press and the investing public. Advisors have been the target of client complaints, regulatory investigations, litigation proceedings and damaging press releases.
How can advisors reduce the risk of lawsuits and regulatory complaints, especially in a downturning market? By better appreciating their legal and regulatory obligations and the underlying risks.
Only once these are understood can advisors incorporate ways in which to protect their businesses. They must first understand the standard to which they are held -- that is, to the same standard as other professionals: "financial advisors must be taken to assume duties similar to those of any other professional advisor -- doctor, accountant, engineer, lawyer ... to ensure that customers or clients are aware of available options, and of the main potential benefits and risks associated with them" (see Rhoades v. Prudential
Bache ).
A doctor provides medical advice, a lawyer provides legal advice and advisors in the financial and insurance industry provide investment or insurance advice.
Incorporating those standards includes the advisors' need to know their clients at every stage of their relationships with their clients. This is the cornerstone of this industry because one cannot choose suitable investment or insurance products without fulfilling the "know your client" rule, which includes knowing each client's specific objectives, time horizon and risk tolerance.
Knowing your client is one aspect of meeting your obligation; knowing your product is another. Products have become complex and the list is continually expanding. Advisors must "KYP" -- know your product -- sufficiently to explain the product and product risks to their clients. So, arising from these obligations, what are the main risks advisors face?
Markets rise and fall Market participants are happy in a bull market. Advisors and clients alike are lulled into a false sense of security when the value of their holdings increases.
But we all know that markets rise and fall. Unfortunately, even the most successful advisors, analysts and industry gurus cannot accurately and consistently predict just when these movements might happen.
Advisors need to remind their clients that they do not have a crystal ball. When the market fails to recover promptly and clients realize their losses could be permanent, greed can sometimes turn to fear, and that fear must be managed. How to manage that fear?

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Communicate with your clients, explain their options, remind them that markets go up and markets go down and while we are currently experiencing a huge tumble, advisors need to talk to clients about their options.
If the investments were suitable when purchased but are no longer suitable because the rating has changed or the company or industry is not as solid as it was when the purchase was made, talk to the client about selling the investment that may no longer be suitable for the client. "Buy and hold" might be appropriate for certain investments and not for others.
Risk tolerance in a bull/bear market In a bull market, clients can present themselves as risk-tolerant when they are really only excited about the potential upside. The bull market often creates an unreasonable increase in client expectations, and clients sometimes become greedy, which can be mistaken for an increase in risk tolerance.
In a bull market, clients have been known to refuse to allow their advisors to rebalance their portfolios by selling a portion of their fastest-growing and higher-risk investments.
They may even want to buy more. When markets are strong or a particular investment or sector is hot, clients, sometimes spurred on by the media, may push advisors to purchase unsuitable investments or to over-concentrate their accounts in one sector.
However, when prices fall, those same clients do not hesitate to blow the whistle or complain to regulators that their investments were inappropriate and improperly diversified. Advisors are at risk if they don't recognize that a bull market can sometimes disguise a client's true risk tolerance. Advisors, beware! Failure to manage clients' expectations to avoid the mood swings that come with soaring and dipping markets, advisors must manage their clients' expectations of investment returns over the long term. The market may be up 35% so far in a given year, but the average annual gain is much less than that over several years.
The implication is clear: Sometimes markets fall. If the average annual return for a given investment class is 7% over the past 30 years, and an advisor's clients are pressing him to make 15%, they are expecting a level of performance that their advisor may not be able to deliver consistently, or at all, depending on the risk tolerance of the client.
Failure to manage clients' expectations can lead to surprised and disappointed clients.
This increases the likelihood that the client will sue or complain to the regulator. Of course, no one could have predicted our current market "tsunami." What should advisors do in these circumstances? Call your clients --communicate and document.
Help them address and reduce their fears.
Communication risk Most communication between advisors and clients is oral. The risk with oral communication is that it can be misinterpreted, taken out of context or forgotten. When advisors are optimistic about a particular investment or insurance product, they tend not to focus on the disadvantages, costs or possible risks.

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Similarly, some clients tend to focus on product advantages and hear only what they want to hear, disregarding the advisor's warnings about possible risks. Client complaints commonly arise from lack of communication or a breakdown in communication, particularly in a falling market. Communicate with your clients and document the discussion with notes, letters or e-mails.
This is a tough market, in fact, the toughest ever, for advisors and their clients. If you can see your clients through these tough times, you will strengthen client relations and protect your business over the long term.