Compliance as a Protective Mechanism

The explosion of financial scandals in the late 1990s and the early 2000s, followed by the onset of the financial crisis, has led to increased scrutiny by regulators and self-regulatory bodies in the financial sector, and to the adoption of new laws and regulations.

The implementation of processes and procedures to ensure compliance with all applicable statutes and regulations, as well as effective surveillance and monitoring systems within financial-sector businesses themselves, are now well established features of the industry.

Organizations that have neglected or failed to implement effective compliance mechanisms are exposing themselves not only to significant liability to legal claims by investors, but also to stringent sanctions by regulatory bodies.

It may well be the case that a single instance of misconduct will lead to an award of damages by a Court, disciplinary sanctions by a self-regulatory body and suspension of the right to practice by a regulator.

While some may view compliance as an annoying financial burden, for prudent financial intermediaries it can prove to be a useful measure of protection in the event of civil litigation.

Some examples of this can be seen in the case law…

Know your client

The obligation to know your client thoroughly is bound up with the duty of competence and professionalism incumbent on every financial intermediary.

Thorough knowledge of one’s client is essential for an intermediary to properly advise the client.

The Québec Court of Appeal has stressed the key role this obligation plays in the professional relationship between intermediary and client:

“[TRANSLATION] Knowing the client allows the broker to accurately assess the former’s financial needs and goals, and to determine how much guidance, information and advice the client needs.”¹

As this obligation is constantly evolving and depends on the circumstances of the relationship between the intermediary and the client, the intermediary should keep a written record of all information provided by the client and any cautionary advice given to the client.

By doing so the intermediary is not only respecting his or her regulatory obligations but is amassing a compelling file that can be relied on in the event of litigation. The intermediary will then be able to justify each step he or she took with a contemporaneous record, which will greatly enhance the intermediary’s credibility.

Respect your client’s goals

The corollary of the obligation to thoroughly know one’s client is the duty to recommend products that suit the client’s profile.

That being said, clients often inquire about products that aren’t really suited for them or that the intermediary is not familiar with.

If that is the case, take the time to familiarize yourself with the product, and if it is not suitable for the client, explain why you cannot recommend it.

If the client insists nonetheless on investing in the product, put your negative recommendation in writing and have the client sign it, or else you may be exposing yourself to liability. The courts have occasionally imposed on financial intermediaries the obligation to protect clients against themselves².

Inform and educate your client

“[TRANSLATION] …as it is given by a layperson to a professional, every mandate involves the duty to advise …The degree of that duty will be all the greater if the client’s investment knowledge is poor.”³

Your obligation to advise, and thus the extent of your liability, are directly proportional to your client’s level of knowledge.

Most financial intermediaries send their clients a lot of information. However, not all intermediaries take that extra step that could eventually protect them, which is to make a note of the information sent.

Moreover, if you have a client who is not interested in information you want to send him or her, don’t hesitate to leave the documentation with the client nonetheless, and suggest that he or she read it. Be sure to note in your file which documents you left with the client.

Finally, feel free to invite your clients to group information sessions on products you want to recommend. Not only will you strengthen your relationship with your clients, but you will be contributing to their education and to your protection. And be sure to take attendance!

As your business relationship with your client develops, the intensity of your obligation to inform will be inversely proportional to your client’s level of knowledge.

A recent decision of the Court of Appeal has confirmed that while financial intermediaries have certain obligations, investors themselves are bound to take cognizance of the information sent them by the intermediary and cannot plead ignorance if they do not bother to do so⁴.