Cashin' In

What's an advisor's obligation when an elderly client wants to liquidate her investment portfolio, which consists entirely of stocks

Q:

I'm handling an account for an elderly client who has several million dollars in assets for which I am making recommendations. The account, overall, is concentrated in one sector of equities.

Despite the fact that the account has made money (as did equities in general), the client says she's satisfied with the profits and wants me to go to cash. I believe this is the wrong way to go. The customer insists. What should I do?

A:

If you have an order to liquidate the portfolio, then you must follow that instruction. If you fail to do so and the market tumbles, you have clear liability for failing to honor your client's request and a problem with your compliance department.

Even if the market holds and your difference of opinion never rises to the level of a complaint, you run the high risk of alienating a good account and watching it transfer to someone else. A common concern among investors is a sense that they have unwillingly lost control over their wealth — even when the concern is not coupled with a loss.

You haven't said much about the client other than that she is elderly, wealthy and concentrated in one sector of equities. Even the limited amount of information in your question sets off some alarm bells. You might want to rethink your advice. The older your client is and the more concentrated in one sector she is, the less defensible your advice to create and hold the portfolio becomes.

You already know from your training and experience that your recommendations must match the overall profile of your client. The details of her age, health, non-investment income and lifestyle needs, as well as other factors peculiar to her situation, all come into play.

With the elderly, even the wealthy elderly, you should be realistic in your assessment of how these pieces of the puzzle fit together, and you must be sensitive to the fact that, in hindsight, others reviewing your conduct won't give you much leeway. One compliance manual for a major broker/dealer even puts older clients in a discrete category of investors and takes the time to spell out extra precautions to take when advising them. Swinging for the fences with their money is not one of the recommendations made in the manual.

That said, there is still a lot of solid work you can do for this client.

Consider enlisting the assistance of her other professionals. Her tax accountant and estate attorney, for instance, should have valuable input into her decision to sell off and what to do with the proceeds. Her decision to sell and go to cash may make perfect sense for reasons you are not aware of, or it might make no sense from the overall perspective of her near- and long-term tax situation and her estate-planning goals. More likely there is a complex answer to which you can add real value with your services.

To the extent your client can be persuaded to go beyond cash, there are any number of resources available recommending diversification models for older clients under differing circumstances. If your employer does not provide them, you can find them on the Internet.

Another approach is through the use of lifecycle funds for those with retirement as a goal. You pick a target retirement date and purchase a fund which matches this target date. The manager automatically adjusts the balance of the portfolio as time passes so that the mix of equities and income products reflects the upcoming deadline. The thinking of the several fund managers varies, but an equity component of no more than 55 percent at retirement seems to be the upper extreme. We could not find any recommendation of 100 percent equities at or post-retirement.
Anthony V. Trogan, Esq. and Lysa Postula-Stein, Esq.
West Bloomfield, Mich.
248-737-2150
[email protected]

A:

NASD Suitability Rule (2310) provides that in recommending to a customer the purchase or sale of a security, the representative shall have reasonable grounds for believing that the recommendation is suitable for the customer upon the basis of the facts, if any, disclosed by the customer. When customers realize investment losses, they frequently commence arbitration proceedings to recover their investment losses. At the hearings on these disputes, a common point of contention is whether the representative recommended the investment(s) at issue. Representatives frequently contend that they did not recommend the subject investment(s), or that the customer would not follow his or her recommendations.

If you recommend that the client diversify her equity holdings into different sectors and the client does not agree, you should save the recommendation should the need arise to defend your management of the account in the future. At a minimum, consider noting the recommendation in the client's file. A letter to the client, either from you or your supervisor, about the recommendation would be even more effective. In the absence of any evidence that you made such a recommendation, it will be your word against hers.

On the other hand, you should proceed with caution before attempting to convince an elderly customer not to convert some or all of her equity holdings to cash. Should the market move against the customer's equity holdings, either the customer or her heirs will likely raise your recommendation as the reason why the customer lost money. At a minimum, if the customer has instructed you to liquidate some or all of her equity portfolio, refusal to execute instruction exposes you to potential liability for any resultant losses.

Protection of elderly investors has become a high priority for the SEC, NASD and the North American Securities Administrators Association. As recently as March 24, 2006, SEC Chairman Christopher Cox announced new initiatives aimed at protecting older Americans. As Chairman Cox said “When it comes to protecting the most vulnerable of our ordinary investors, no group is more at risk, or has a greater impact on our entire economy, than older Americans.” Representatives must act cautiously when making recommendations to elderly investors that may be construed as overly aggressive when the customer wants to invest conservatively.
Steven M. Malina, Esq.
Morgan Lewis & Bockius
Chicago
312-324-1155
[email protected]

Ethical Rep is a monthly feature in which more than 30 prominent securities attorneys, experts and law school professors help Rep. readers deal with work-related ethical quandaries. Have you encountered a situation at work that makes you uncomfortable? Are you confused about how your responsibilities to clients might change as regulations continue to evolve? Drop a line to Rep.'s contributing editor, Ann Therese Palmer, and our group of experts will help you work through the problem.
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