know your client form kyc

The Canadian industry’s minimum standards are defined by the “know your client” form. The other minimum industry standard is that no advice/recommendation need be in writing, although all trades need to be confirmed in writing.

TAMRIS considers this form to be insufficient to determine the suitability of an investment and incapable of properly constructing, planning and managing assets to meet financial needs over time.

Much of this section of the site is taken from the TAMRIS report on Suitability, Minimum Standards and Fiduciary duty in the Canadian Financial Services Industry.

“Know Your Client” form

The standard industry Know Your Client form as exemplified by the Mutual Fund Dealers Know Text Box:

Your Client form stipulates that only the following are needed before advice can be given.

Individuals may also not realise that you do not actually need to sign this form in order to validate its use within the organisation. In fact, you do not even need to receive a copy of it.

The KYC was only ever intended to assess the suitability of individual transactions and not the suitability of a portfolio or the suitability of a transaction within a portfolio. Indeed, this presumption is supported by securities case law.

As discussed in suitability and education (section 2.6), merely asking a client’s investment knowledge is insufficient to communicate the necessary information needed to establish suitability within the wider context.

Merely asking the extent of an individual’s investment knowledge is sufficient to assess whether a client who is initiating a transaction request, and who may not rely on their advisor to assess suitability, has the expertise needed to initiate the transaction; although, even here, investment advisors can effect client initiated transactions that are not suitable within the parameters of the KYC.

A general statement of risk tolerance is insufficient to assess suitability in the wider context. Indeed many investors make an assessment of their risk aversion based on their perceived need for security; how a portfolio is structured, planned and managed to meet financial needs over time and how that portfolio is designed to manage significant risks is key to the individual’s ability to assess their attitudes to risk.

For suitability to be confirmed, investors need education over the basics of investment and of the advisor’s investment discipline and risk management process. If the risk assessment process does not educate the client over the risks likely to impact the ability of their portfolio to meet their financial needs over time, then logically, it is unlikely that the recommendations can be proven to be suitable. In this case, there are two conclusions.

· The first is that the KYC can only be used to assess the efficacy of a transaction on a transaction by transaction basis by someone who understands risk and who is initiating the transaction request.

· Secondly, where a KYC is used for clients who are relying on their advisors for their expertise to provide a portfolio solution, the advisor is taking a fiduciary responsibility with regard to the provision of a wealth management solution.

Moreover, if the risk assessment process does not assess all the key risks likely to impact on the ability of the portfolio to meet financial needs as well as the performance risks of an investment style, then the advisor will have failed to properly satisfy their fiduciary duty. Most risk assessments fail to educate the client over risk, fail to properly assess risk and fail to provide the client with a meaningful illustration of the impact of their risk preferences.

Time horizons are rarely singular and are more likely to be multiple and relative. All transactions impact on the risk/return relationship of all assets and on the relationship between all assets and all financial needs. For this reason, service processes that rely on singular time frames cannot manage the suitability of the transaction.

Only the individual that can break down their needs and objectives into multiple time frames and multiple individual allocations per time frame (meaning they will have needed to carry out a complex asset and liability analysis), can initiate transactions on a transaction by transaction basis.

Because of this, the “know your client” form has little or no relationship with the fundamental precepts of suitability and is an inappropriate foundation for delivering wealth management solutions that need to address the total portfolio management problem.

The investment objective approach noted in the “KYC” is at best an antiquated approach to selecting broad portfolio options. It provides no information about the size and timing of financial needs over time and hence no information as to the actual structure of the portfolio needed to meet actual needs.

The objective of the client can only be determined by the relationship between financial needs over time and the size and disposition of assets over time. Broad objectives, while sometimes useful for delivering broad model portfolio options, are totally unsuitable for defining the suitability of individual security transactions. Likewise, broad, fixed, model portfolio options are inefficient in providing personalised solutions.

Unless an advisor has knowledge of the disposition of all assets and all financial needs it is impossible to work out from a broad objective just what asset class and specific security the individual is deficient in. Additionally and, logically, if the advisor does have an idea of disposition of assets and needs over time, without written communication of the rationale for the allocation and the asset class, security selection is actually a discretionary decision; if one assumes that suitability is the framework and the transaction merely an allocation within it.

As with many of the other components of the KYC, the only way the “investment objective” can work on an individual security transaction is for the client to take responsibility for the rationale and reason. Perversely, this implies that the investor has significant ability to structure, plan and manage allocation, which is far from the truth.

Both important pieces of information, yet the KYC totally ignores the importance of finding out the size and disposition of financial assets (key to working out where the gaps are in the portfolio structure and what to buy and/or sell) and the actual financial outgoings key to determining the relationship between assets and financial needs.

Within a transaction led industry, minimum standards were designed to provide structure to the process in which transactions were recommended. They were not designed to provide minimum standards for the delivery of transactions within a portfolio construction capable of managing the ability of assets to meet financial needs over time. As such, they do not cover suitability for individuals relying in their advisor for their expertise in crafting wealth management solutions.

Is the objective of a transaction industry to provide total wealth management solutions?

Is it possible to raise standards within a transaction driven industry so that transactions are suitable to financial needs, reflect total assets and the relationship between assets and financial needs and risk preferences?

The only way you can do it is to change the objective of a transaction driven industry. This is difficult if regulation is still focussed on managing a transaction led process and, the arbitration and legal system one which assesses the parameters of a transaction driven framework in determining fault.

At the present moment in time minimum standards are important because they keep the status quo in check. It is debatable whether the industry could actually move to a service led business process that would be demanded by raising the minimum standards governing suitability of advice.

While it is in the industry’s interest to keep standards at a minimum, if legal precedent were to start looking at wider standards governing suitability, current minimum standards could become a liability.

The “Know Your Client form” is an archaic form appropriate to a transaction driven industry. While it may still be appropriate for basic client initiated trades, it is clearly inappropriate for individuals looking for financial advice.

What makes the “KYC” of greater relevance is the extent to which it is used to determine fault in arbitration and within the legal system. One could conclude that the industry and those charged with policing the industry have little or no understanding of suitability and erroneously consider the KYC to fulfil basic suitability requirements.

By keeping minimum standards, is the industry in breach of its fiduciary duty?

If the service it is providing is below the service it is capable of providing, given its resources and expertise, if the individual investor relies, in good faith, on the industry to manage their assets and needs, and the industry accepts this trust, knowingly, then by keeping standards low it is consciously in breach of its fiduciary duty to the individual investor. Yes.

Minimum industry standards

“Know Your Client” form

Investment knowledge

Risk tolerance

Time horizons

Investment objective

Individual income/household net worth

Why do minimum standards exist, what are their objectives?

Conclusion KYC