According to IIROC (Investment Industry Regulatory Organization of Canada), more than half of the complaints they receive are about investment issues – in particular, unsuitable investments. Many of these problems can be avoided with an accurate “Know Your Client” (KYC) document in place. This document is not just another piece of administrative paperwork. It is one of the cornerstones of securities legislation and an essential part of investor protection.
This information is used when assessing the validity of a client complaint. Most retail investors don’t understand the implication of an inaccurate, incomplete, or outdated form.
Why is this personal information needed?
Most of us are familiar with completing a KYC document as it always accompanies a “New Client” application form.
Completing this form is mandatory when a client opens an account at Mutual Fund Dealers Association (MFDA) or IIROC dealer. Your adviser’s firm is required to gather certain information about you. This information is designed to provide a framework for the suitability of any investment recommendation made by an investment adviser.
You are obligated to update the form when there is a significant change in your personal situation such as retirement, divorce, death of a spouse, or receiving a large inheritance.
If you don’t, you may receive unsuitable investment recommendations, and any resulting complaint may be dismissed.
Know Your Client: It starts with you!
Your financial situation, objectives, investment experience and tolerance for risk can only be assessed by collecting accurate information from you. It’s not just another piece of tedious paperwork where you quickly tick off the boxes and move on.
A Know Your Client form asks questions about your age, income, net worth, time horizon and investment goals. The most inaccurate (and least considered) answers come from the questions about investment knowledge and risk tolerance.
Describe your current knowledge of, and experience with, investments?
Research shows there is a natural tendency to overestimate investment knowledge, particularly among men. Don’t let your ego drive your response. If you overstate your experience and knowledge and understanding of different investments, this could harm you in the event of a dispute.
What is your tolerance for risk?
We all know that equity investments are riskier than GICs. We believe that we have a high risk tolerance because we have equities in our portfolio, especially when the stock market is having a good bull run like it has recently. However, most investors are more risk-averse than they initially believe.
Consider the question, “With a $10,000 investment which outcome would you be most comfortable with?” and two possible answers:
- Potential increase of $2,000, or a loss of $1,300
- Potential increase of $10,000, or a loss of $3,600
Most people focus on those potential gains.
However, more to the point is your tolerance for loss. How much can you lose without putting your investment plan in jeopardy? Nobody enjoys an unfavourable outcome, but if a loss actually does occur, how would you react? Really?
Limitations of the KYC form
The theory behind the Know Your Client form is based on the view that the more an adviser knows about a client, the better he or she can serve them.
Another tool that is sometimes used in addition to the KYC is an Investment Policy Statement (IPS) which provides a lot more detailed information. Professional advisers use this to establish such things as return objectives, income needs, liquidity requirements, tax considerations, estate concerns and any unique needs and circumstances. Both documents support the overall financial and investment plan.
In any case, there needs to be a meaningful conversation between an investor and advisor to really understand the needs of a client.
Document any information you provide and any information the adviser told you, and never, never sign a blank form.
A word about suitability
In Canada, the only financial professionals that are under fiduciary obligations (required to act in your best interest) are those registered as portfolio (or wealth) managers with discretionary authority over their clients’ accounts. They are required to determine the suitability of every proposed transaction in your account, whether recommended by the adviser, or initiated by you, yourself.
Be aware that most financial advisers (most often employees of banks, credit unions and mutual fund companies) are not “fiduciaries”. They need only recommend investments that are suitable. Each order or recommendation must be in keeping with the client’s KYC information – often a pre-established model portfolio based on a numerical score of your answers.
Online discount brokerages are exempt because they only execute transactions. They are not responsible for making a suitability determination when accepting your order.
“Knowing Your Client” goes far beyond the questions on the KYC form. Nevertheless, this is the primary tool used by many advisers in deciding suitable investments and justifying recommendations when a complaint is filed.
That is why you need to be really clear about your investment profile. Engage your adviser in a detailed discussion so he or she obtains a more accurate profile than can possibly be obtained by ticking off a few boxes on a form.
If you can’t have a detailed discussion about your financial situation with your investment adviser, you need to find someone you are more comfortable with.
After all, you wouldn’t accept a medical doctor’s treatments without first giving a thorough description of your symptoms, would you?