Knowledge is power. This may be why in the sales process clients are not always willing to elaborate on personal details when making an investment. They are right to be concerned, the source of the ‘know your client’ trend with banks and professionals stems from American Anti-Money Laundering and Anti-Terrorism policy. Front line professionals like lawyers are considered the gatekeepers of information about the global flow of funds. Because money is power too.
How can you convince your clients to disclose all complete and relevant information without them suspecting that you are just trying to ‘spy’ or manipulate them? It is a good question. Without accurate data, it is impossible to give accurate recommendations. Without accurate recommendations, your client is not getting the best possible advice from you.
One thing I noticed about the behaviour of clients when I was an Advisor was that they would disclose everything to you, and provide supporting documents readily, when they wanted to borrow money. However, when they were investing, they were a lot more reserved, only telling me what they thought I needed to know, usually a partial picture. Clients also like to ‘try out’ an Advisor by giving them a small amount of business and then moving over more assets when they feel you have earned your stripes. This is rational behavior on behalf of the client, but can create very inaccurate KYCs.
The CSA states in Staff Notice 31-336 that, “KYC, KYP and suitability obligations are among the most fundamental obligations owed by registrants to their clients, and are the cornerstones of our investor protection regime.” In other words: get the basics right. How do you demonstrate you got them right? The paperwork. If you are a registrant, the suitability process must be done with all clients, regardless of what exemption is used. In addition, the suitability requirement cannot be delegated or outsourced.
The conversations with your clients need to be the basis of the KYC paperwork, not the other way around. I have seen varying types of KYCs, some only a few pages, the longest being eleven pages. We have suggested to the regulators that NEMA could create an industry KYC, one that would uniformly reflect the discovery process with the client. The answer we received was that they wanted the KYC form to be reflective of each EMD and their business model, so the variances in KYCs, and KYC quality, will remain.
So then how do you get robust enough information from a potentially guarded client not only to fulfill your KYC duties, but to know you made the best possible recommendation? Everyone’s effective style is going to be different. However, before diving into the great story of an exciting investment opportunity, I recommend focusing on the story of your client, and really listening to them to understand their specific situation. On the downside, this takes longer, but the upside is that you will have a stronger relationship with the client.
If a client just wants to buy the product and not discuss his or her affairs with you, you can tell him you (as a registrant) are obligated to learn about the prospect, and it is an extension of your duty to ‘deal fairly, honestly, and in good faith’ with clients. If they still do not believe you, pull out the CSA staff notice 31-331 you always keep handy, and show them (or show them this article). A registrant is more than just an order taker.
How do you find out about your client without grinding your way mechanically through the KYC? Start with a conversation, or with a ‘blank pad’ in front of you. Instead of asking for the spouse’s name and number of dependants, ask the client about his family dynamics. Ask the client general questions first. Instead of first asking your client to robotically list out his net worth, starting by asking him how he built his wealth and how that has worked for him.
Specifically, you should be attaining accurate information about:
Financial Circumstances – Before you can assist your client in determining the product(s) you are selling are a good fit for them, you have to know their current situation, indicating ‘financial capacity.’ The current situation includes the basics like age, dependants, marriage status, employment, and address. Age and family dynamics effect future cash flow needs. Keep an ear open for how often their circumstances change, as that will increase their liquidity needs and time horizons. In general, clients with higher instability (family, job, or otherwise) have a lower risk profile.
Financial circumstances also include net worth and cash flow. Net worth is more than assets minus liabilities. It is important to note the type of assets they have and the type of liabilities as it will give you a good sense of the client’s sophistication, experience, and risk profile. For example, clients may show bias to an asset class that has done well for them in the shorter term, and that will be noteworthy in your product and suitability discussions. You may also want to question the client on cash flow; as the type of cash flow they have will determine their need and size of a contingency account, and how often they may utilize it. In general, clients with higher cash flows have a higher risk profile.
Investment Needs and Objectives – After you have established their current situation, you can determine what they want their future situation to look like. This encompasses investment needs (bear minimum standards to live) and objectives (ideals and goals). This can be a very tricky conversation to have with clients, especially if they are not naturally planners and have not given it much thought. You can get canned answers like retire at 60 or 65 and maintain 70% of their income. Also, what constitutes as minimum standards in providing for their needs vary widely with clients.
Investment knowledge and Risk Tolerance The risk profile should be account specific, so you will mainly be concerned with what the client wants to do with the pot of money they will potentially invest with you. However, it is important to know the overall situation holistically, as the ‘pots’ of money can be moved around as the clients goals evolve. Investment knowledge and experience is a key indicator of risk tolerance, as generally the more knowledge and experience the client has with investing the greater the risk tolerance.
If the client’s risk capacity (financial situation) is less than their willingness to take on risk, the risk tolerance should be bounded by their capacity for risk. The risk/return relationship should be articulated as well, along with as accurate an estimation as possible about the clients ability to handle loss. In some clients, potentially losing money can aggravate severe health issues, and others will shrug it off. In general, men are more cavalier in their risk statements. Also, in general, clients risk tolerance will creep up after a period of really good earnings and will go down after a period of losses, something you have to watch out for.
Generally, clients all want the same thing: to build wealth to attain more financial independence in their lives. However, the reasons why they want this vary. Finding out the motivations of their financial goals as well as having them articulate the goals themselves will complement the grounding of the three areas of client information you have discovered (discussed above). The KYC is a living breathing document and should be updated with any material client change or once a year (or, if longer than a year, at least before every new subscription).
The KYC process is not only a regulator obligation, but is a way to build your relationship with the client, and keep it. The better quality information you have about you client, the better suitability recommendations you will provide, increasing long term business. Knowledge is not only powerful, it can be profitable too, for both you and your client.
Cora Pettipas CFP, CIM, FCSI, MSc. is currently the Vice President and a Board of Director of the National Exempt Market Association (NEMA) in Canada. Cora is also the editor of Exempt Edge Magazine, the Canadian industry trade publication on the exempt market/private equity. She is also currently representing Canada on the Body of Knowledge Committee for international education initiatives for the Financial Planners Standards Board and is a policy ambassador for the Financial Planners Standards Council. Cora has had tenures with several financial institutions in the capacity of financial advisor, wealth management, and financial planning. Her most recent previous position was as a Professor at Mount Royal University, where she taught Finance and Financial Planning. Cora holds a Bachelor’s degree from McGill University, a Master’s Degree (Finance and Controlling) from Swiss Management Center University and is currently a Ph.D. candidate in Finance there as well.