In 2007, as problems emerged in global credit markets and certain banks were beginning to be seen as vulnerable, a former colleague (who we will call Tom) received a call from a high net worth client.
“Hi Tom, it’s Edward. Given today’s events, with the share price down, I think this is a great opportunity to buy some stock in [UK-based mortgage lender] Northern Rock.”
“Er…have you actually seen the news, Edward? There are mile long queues outside every branch…”
“No, it’s fine, just a storm in a teacup. Buy me fifteen thousand shares, will you?”
This conversation left Tom with a dilemma. The contract between Tom, the adviser, and Edward, the client, was “Execution Only”, meaning that the client had first and final say over how his money was to be spent – he was just using our wealth management house as an investment platform.
"I think this is a great opportunity to buy some stock in [UK-based mortgage lender] Northern Rock"
Tom had no choice but to place the trade. Even pointing out that there was currently an unprecedented run taking place on Northern Rock was beyond his remit as an Execution Only broker. The fact remained, however, that the trade was clearly not in the client’s best interest.
As per regulatory requirements, and despite his own misgivings, Tom bought the stock. The client called forty minutes later in a state of panic and sold again, but in the meantime he had lost a quarter of his investment.
So what do financial advisers do if clients insist on doing something that is clearly not in their best interests?
Client’s interest comes above all else in the profession of financial advice. That was the reason for Tom’s hesitation. In any regulated environment, there are very strict rules as to what investments can be recommended to what clients. Potential investors must be assessed according to a number of criteria, including their knowledge of the market and their appetite for risk.
The questions, known colloquially as a “fact find”, are designed to ensure that any financial instruments recommended to a client, from government securities to triple-leveraged oil futures, are both suitable and affordable. No one should be losing their homes, and if they are, it is their financial adviser who should be held responsible. A qualified and licensed adviser is legally obliged to act in the client’s best interests.
These regulations work in both in principle and in practice, as long as the client is rational and the adviser is professional. There is, however, an immitigable situation that occurs from time-to-time, when a person decides upon a certain course of action that they think is a stone-dead winner, but that the adviser, who is both qualified and experienced, does not.
When this happens, the adviser’s cards are, rightly, very limited. Advisors can’t actually decide what you do with your money. Even when clients actually say “You decide!”, it’s not actually the advisor’s decision – they still have to gain explicit agreement, and cannot go ahead until they are sure that the client understands what is being done.
The only club advisors have in their bag is a strong protest. They can point out all of the drawbacks and risks, ask the client to get a second opinion, even threaten to terminate the relationship once the trade is complete, but absolute refusal is not allowed. It isn’t the advisor’s money, so it is not their decision. I have heard tales of advisers pleading with clients not to force them to do something misguided.
One associate even appealed to a higher power: “I texted his wife. She put a stopper on it, thank heavens!”
I’m not sure if that’s entirely compliant with regulations, but at least the client was protected.
Paul Seligman, Meyado Private Wealth Management, Singapore