The document discusses avoiding customer complaints in financial services. It summarizes trends in customer disputes seen in FINRA arbitration, such as increases in claims of omissions of fact and misrepresentation. Common causes of disputes are unsuitable investments for clients that do not match their objectives and risk tolerance. The document also outlines best practices for financial advisors, such as properly documenting the scope of work, obtaining complete client information, and monitoring client accounts on an ongoing basis. Specific issues relating to senior investors are also covered.

1. Avoiding Customer Complaints
April 30, 2009
FPA New York Spring Forum
New York, NY
PRESENTED BY:
James J. Eccleston, J.D.
Copyright 2009 Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C. Chicago, IL All rights reserved.

2. I. FINRA Arbitration
Filings are increasing
• In 2008, 54% increase (4,982 vs. 3,238 claims)
• Through mid-March 2009, claims filed = 1,475
• “Win” rate for customers rebounded, from low of
37% in 2007 to 42% in 2008
• “Failure to supervise” claims up 24%
• “Omissions of fact” up 337%
• “Misrepresentation” up 171%
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3. FINRA Arbitration
• “Omissions of fact” and “misrepresentation” account for
more than 40% of disputes of the 10 listed security types
– Reflect explosion of “Derivative Securities” disputes and “Auction Rate
Securities” disputes – with chief allegations relating to what investors were
told and not told
• Traditional security types also visible in customer disputes
– Mutual funds (171%)
– Corporate bonds (130%)
– Certificates of Deposit (98%)
– Common stock disputes declined in number
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4. FINRA Arbitration
Unsuitable investments
• An issue in many, if not most, customer arbitrations and claims
against financial advisors
NASD Conduct Rule 2310:
• Requires broker/advisor to have reasonable grounds for believing
that recommendation is suitable based on the facts, if any, disclosed
by the customer as to his or her other security holdings, financial
situation, and financial needs
• Advisor must determine if the recommendation is suitable for any
investor, regardless of the investor’s wealth, willingness to bear risk,
age or other individual characteristics (so-called “reasonable basis”
suitability)
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5. FINRA Arbitration
Unsuitability – Typical Scenario
• Retiree (or person approaching retirement)
• Sold investment (e.g., stock, bond or mutual fund) or product
(e.g., deferred annuity) that is too risky or volatile in view of
the customer’s objectives and needs
• Account is too heavily concentrated in one asset class (e.g.,
stocks/equities) or sector (e.g., financials, technology, etc.)
• Investment risks are not adequately disclosed and/or
misrepresentations are made
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6. II. Critical Functions
(NYSE Series 7 Examination Content Outline, 1995)
3-5) Considers the tax implications for a customer of
particular investments
4-9) If there is to be any power of attorney over the account,
obtains the necessary documents and approvals
7-1) Routinely reviews the customer’s account to ensure that
investments continue to be suitable
7-2) Suggests to the customer which securities to acquire,
liquidate, hold or hedge
7-3) Explains how news about an issuer’s financial outlook
may affect the performance of that issuer’s securities
7-4) Keeps the customer informed about the customer’s
investments
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7. Critical Functions
Monitoring
Common Problems
• Asset class, sector or stock becomes
over-weighted/over-concentrated
• Client changes his/her situation
– New questionnaire
– Objectives
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8. III. Implications For Investment Advisers
VARIATION ON UNSUITABILITY
Portfolio Mismanagement by an Investment Fiduciary
• Registered Investment Adviser and its representatives have fiduciary
duty to clients
• Modern Portfolio Theory (MPT) and Prudent Investor Rule define
standard of care
• Financial planning “negligence” – failure to anticipate client’s income
needs, inflated projections based on unrealistic returns, etc.
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9. Implications for Investment Advisers
MODERN PORTFOLIO THEORY
Asset Allocation and Diversification
• Fundamental concepts that sometimes are disregarded by advisors
Asset Allocation:
• Practice of combining non-correlated asset classes (e.g., stocks, bonds,
cash, REITs, hedge funds)
• Significantly reduces risk (i.e., volatility) in portfolio
• Does not significantly reduce investment returns
Diversification:
• Means not having all of your eggs in one basket (i.e., sector)
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10. Implications for Investment Advisers
PRUDENT PRACTICES FOR FIDUCIARY ADVISERS
by Financial Planning Association (and Donald Trone)
• Outlines prudent practices for Fiduciary Advisers as defined in the
Pension Protection Act of 2006
• FPA states the handbook “represents a standard of excellence for
fiduciary advisers”
• Includes a four-step investment management process:
1. Organize
2. Formalize
3. Implement
4. Monitor
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11. FPA Handbook
Let’s look at the second step, FORMALIZE:
• Practice A-2.1
– Fiduciary adviser will analyze investment options and review them with the client
• Practice A-2.2
– Fiduciary adviser should identify and document the investment time horizon for the
client
• Practice A-2.3
– Identifying and discussing the client’s risk tolerance
• Practice A-2.4
– Identifying, discussing and documenting the client’s expected investment return
necessary to meet the client’s investment objective
• Practice A-2.5
– Suggests the procedure by which advisers should recommend particular asset classes
for the client
• Practice A-2.6
– “Preparation and maintenance of a client’s investment policy statement (IPS) is one
of the most critical functions performed by the fiduciary adviser, even if it is not
stipulated by law or regulation.”
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12. FPA Handbook
Let’s look at the fourth step, MONITOR:
• Practice A-4.1
– Obligates fiduciary advisers to provide periodic reports to clients which compare
investment performance against an appropriate index or peer group and against the
objectives of the IPS
– A “watch-list” of underperforming investments is encouraged, and the fiduciary
adviser should advise the client how to periodically rebalance investments in the
portfolio
• Practice A-4.2
– Recommends that the fiduciary adviser periodically evaluate the qualitative and/or
organizations changes of investment managers or other investment decision-makers
which may affect the investment offerings within the plan, including corporate stock
of the plan sponsor
– Fiduciary advisers are expected to notify the client in writing of any unsatisfactory
news regarding a material holding in the client’s portfolio
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13. IV. Themes of Mistakes
INCLUDE:
• Failure to document
• Failure to control
• Digging the hole deeper
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14. Themes of Mistakes
Failure To Document
• Define the scope of the engagement
– What part of the whole are you responsible for giving advice
about?
• Not obtaining complete financial picture from client
• Have clients fill out applications and questionnaires in
their own writing
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15. Themes of Mistakes
Failure To Document
• Allowing parts of questionnaire to go unanswered
• Not documenting what the objectives are for the
funds you manage
• Not obtaining all information from client before giving
advice
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16. Themes of Mistakes
Investment Policy Statements
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17. Themes of Mistakes
Failure To Control
Letting the client control the advice you give
Example: Clients who want to retire young, but
have not yet saved enough
Your choices:
• Tell clients what they want to hear
• Deliver bad news
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18. Themes of Mistakes
Typical example:
Someone who is 55 and married just retired
from his job and took a lump sum distribution:
• Recommend an aggressive asset allocation to
get the numbers to “work”
• Tell client “to go back to work and earn some
more money”
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19. Themes of Mistakes
Avoiding This Problem
• Have a research-backed, consistent
methodology
• Follow it with each client, even when it means
saying: “You may want to retire, but you
can’t.”
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20. Themes of Mistakes
Handling The Spendthrift Client
Identifying potential spendthrift clients
• Retirees with lump sum distribution
• Clients with limited earning potential
• Heirs and trust beneficiaries
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21. Themes of Mistakes
Handling The Spendthrift Client
Signs of problems
• Living expenses beyond reasonable levels
• Unwilling to limit expenses or change
lifestyle
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22. Themes of Mistakes
Handling The Spendthrift Client
Solving problems
• Communication with customer regarding
expenses
• Avoiding growth investing for income model
• Reevaluating client goals and expectations
• Documenting problems and solutions offered
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23. Themes of Mistakes
Digging the Hole Deeper
“No good deed goes unpunished.”
• Admitting that a past strategy was not a good idea
• Offering to waive fees or give a discount for poor
performance
• When a client does not have the stomach to take
losses, don’t fight him
• Sell a position that is going down and revise the
questionnaire to reflect that the client “can’t sleep”
with certain investments
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24. Themes of Mistakes
Avoiding Digging the Hole Deeper
• If you and a client no longer have the same ideas
about investing, end the relationship
• Document any time that a client took an action
against your advice
• Never admit that an investment was a bad idea or
a mistake
• Never give a refund/discount for services due to
investments performing poorly
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25. Themes of Mistakes
Dealing With a Customer Complaint
• DO NOT meet with the customer or communicate
with the customer
• Notify compliance
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26. V. Senior Issues
FINRA NTM 07-43:
• “To urge firms to review and, when appropriate,
enhance their policies and procedures for
complying with FINRA sales practice rules, as well
as other applicable laws, regulations and ethical
principles, in light of the special issues that are
common to many senior investors”
• Defined as those “at or nearing retirement”
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27. Senior Issues
No “special rules,” but:
• “Age and life stage (whether pre-retired, semi-retired
or retired) can be important factors, and firms should
make sure that the procedures they have in place take
these considerations into account where appropriate”
• Suitability of recommendations and communications
aimed at older investors are “of particular concern”
• Refrain from making an unsuitable recommendation
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28. Senior Issues
Note:
“A customer’s net worth alone is not determinative of
whether a particular product is suitable for that
investor, even when the investor qualifies as an
accredited investor.”
– FINRA states that over-reliance on net worth is “particularly
problematic” where the investor has met the accredited
investor standard based largely on the value of his or her
home, “which may represent the largest asset of many senior
investors.”
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29. Senior Issues
Suitability
• Age and life stage
– “As investors age, their investment time horizons, goals, risk
tolerance and tax status may change.”
– “Liquidity often takes on added importance. And, depending on
their particular circumstances, seniors and retirees may have less
tolerance for certain types of risk than other investors.”
– “Retirees living solely on fixed incomes may be more vulnerable to
inflation risk than those who are still in the workforce, depending
on the number of years those retirees are likely to rely on fixed
incomes.”
– “Investors whose investment time horizons afford less time to or
opportunity to recover investment losses may be
disproportionately affected by market fluctuations.”
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30. Senior Issues
Suitability
• Liquidity needs, consider
– Customer’s primary expenses (Mortgage?)
– Sources of income (Fixed?)
– Amount of retirement savings (How invested?)
– Health insurance coverage (Relying on assets to pay for health
costs?)
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31. Senior Issues
Risk
• Caution: older investors may “reach for yield to
maximize retirement income without the
appreciation of the concomitant risk”
• Must present a “fair and balanced picture of the
risks, costs and benefits”
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32. Senior Issues
Particular concerns
• Deferred variable annuities, equity indexed annuities
and some real estate investments and limited
partnerships
– “Have withdrawal penalties or otherwise lack liquidity”
• Using home equity to make investments
• Using retirement savings (including IRA withdrawals)
to invest in high risk investments
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33. Senior Issues
FINRA Report: “Protecting Senior Investors:
Compliance, Supervisory and Other Practices used by
Financial Services Firms in Serving Senior Investors”
1. Senior investor not defined by age, but “to include
investors who have retired or are nearing
retirement”
– Age, life stage & “diminished mental capacity” are critical
components
– Diminished mental capacity may be more prevalent among older
investors, who may also be more frequent targets for financial
abuse
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34. Senior Issues
2. Firms are communicating effectively with seniors
– Firms increased frequency of contact so they remain informed
about changes in the investor’s financial needs, employment
status, health and other life events
– Firms adopted practices to encourage their financial advisers to
avoid financial jargon & to document conversations with
investors, including by sending follow-up letters
– Firms have drafted written materials, in larger-font versions,
aimed at educating senior investors
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35. Senior Issues
3. Some firms consider training on how to identify
diminished capacity a critical program for
employees, especially identifying “red flags”:
– Of diminished capacity, including the inability to process simple
concepts, memory loss, difficulty in speaking or
communicating, disorientation and erratic behavior
– In financial matters, including refusing to follow appropriate
investment advice, making investment decisions inconsistent
with long term goals, concern or confusion about missing
funds, being unaware or not understanding recently completed
financial transactions
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36. Senior Issues
4. Practices regarding specific products
– Limiting or prohibiting purchases of certain investment
products, such as “structured products” based on life stage and
risk profile
– Prohibiting purchases of certain variable life insurance products
by investors over a certain age
– Requiring a heightened review of annuity applications for
investors over a certain age in a low tax bracket or with low
liquid net worth
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37. CONCLUSION
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38. Questions?
For more information on the securities practice group at SNSFE, or if you have a
question about this presentation, please contact:
James J. Eccleston
JEccleston@snsfe-law.com
312.621.4400 Shaheen, Novoselsky, Staat,
Filipowski & Eccleston, P.C.
20 N. Wacker Drive, Suite 2900
Chicago, IL 60606-9719
312.621.4400 (T)
312.621.0268 (F)
www.SNSFE-law.com
Thank you! www.FinancialCounsel.com
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