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Avoid stockpiling ‘lightweight’ documentation

23 November 2007 Gareth Stokes

FAnews Online recently attended a presentation by Anton Swanepoel, an independent business and compliance consultant in the financial advisory and intermediary services industry. Swanepoel, a specialist on the topic of compliance within the FAIS Act, addr

Swanepoel spoke extensively on the importance of investment objectives over risk profiling before recounting a case study which demonstrates what the FAIS Act demands from today’s financial advisers. He suggests that advisers take note of the findings to avoid stockpiling “lightweight documentation” that offered negligible legal protection.

Beware of hard-coded risk profiling

Before addressing documentary requirements, Swanepoel warned advisers that the risk profiling practices many of them apply could be contrary to provisions in the FAIS Act. Swanepoel believes that the ‘coached’ process of determining the appropriate risk profile and then selecting the asset classes based on the outcome (i.e. an aggressive profile requires an overweight equities portfolio) is not adequate. To simply categorise a client as conservative, moderate or aggressive, and make investment decisions based on that categorisation is extremely dangerous.

The first problem with risk profiling is the manner in which the risk category is determined. Clients are allocated a particular category based on their responses to a series of questions. And inevitably the client’s answers are tainted by their own fear, greed, ignorance and expectations. The irony is that the client, and not the adviser, determines this risk profile…

The second issue is that every client has different expectations regards risk and return. To demonstrate this, Swanepoel asked the audience to indicate which of the three categories they believed they belonged to. He then asked that each attendee indicate their investment return expectation. After some debate over whether nominal or real rates had been indicated, the following emerged. People who classified themselves as moderate investors expected nominal returns of between 7% and 14% per annum. The aggressive investors expected returns of between 14% and 30%. Swanepoel questions how such divergent return expectations can be successfully accommodated under a ‘blanket’ portfolio.

The correct attack

A final condemnation of excessive reliance on risk profiling is the fickleness of clients. Swanepoel notes that investors easily swing from one category to another based on their emotional responses to market news. One of the audience members suggested this problem was best dealt with by addressing the client correctly at the outset, stressing to the client that he is committing to a five to seven year investment term.

The solution to the risk profiling problem is a focus on the correct identification and definition of investment objectives. Swanepoel says the “prime focus when dealing with clients is to aim at their objectives.” And one of the best ways to achieve this is to move the focus from age (used in the traditional risk profiling) to term. Advisers should still complete a risk profile – but ensure this process reveals the investors objectives.

Gathering the right documentation

“The record of advice is an overrated legal document,” says Swanepoel. Instead, advisers should focus on creating an Investment Advice Agreement. This document should incorporate the advice given in the tradition record of advice and also outline the client’s investment objective. Most important, the financial adviser MUST ensure that the client signs the Investment Advice Agreement.

Financial advisers should take heart from the fact that the FAIS Ombud (and his staff) are also legally compelled to follow and apply the rules set out in the FAIS Act. This means, in terms of S23 of the Act, that in the event of a dispute the FAIS Ombud must look for documentary support of the contractual relationship between the adviser and the client. If the adviser is able to provide the content of the agreement in a written form, with the client’s signature attached, then he has a very strong position.

This is what saved Fidentia Financial Advisers when Dr Malcolm Birken brought a case to the FAIS Ombud in 2005. The case (FOC 2629/05) was finalised on the 8 December 2006 in favour of the defendant. Financial adviser Arno Burger’s saving grace was a contract agreement in which the following were clearly stated: the client’s investment objective and term, the investment benchmark, and comments that neither the capital nor the targeted return could be guaranteed.

Swanepoel says that ensuring this single document is correct and in place (a mere 20% of all documentary requirements) could safeguard the financial adviser in 80% of possible cases.

Editor’s comments:
Issues raised during this presentation suggest that financial planners still have some work to do in adopting a consistent FAIS compliant approach to the advice process, particularly where documentation is concerned. As Swanepoel says, what is the point of keeping excellent records of lightweight evidence? What are your views on the risk profiling versus investment objectives debate? Post your comments directly after this article, or send them to gareth@fanews.co.za

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