Standards & the CFP Practitioner’s Exposure to Liability

As we stand at the edge of the implementation of CFP Practice standards, much concern has been expressed about the impact of these newly drafted standards. At its most extreme, the opponents of standards have asserted, sometimes in strident tones, that these very standards will result in drastic changes in the liability climate in which the profession practices. The purpose of this article is to critically examine the issue of how these standards are likely to affect the profession, as well as to examine the validity of the views of the opponents of standards.

As we look at the draft standards, the drafters, the CFP Board of Practice Standards itself, appear to acknowledge the concerns of the practitioner that the standards implemented may result in a change in the liability climate. In Standard 1, the Board of Standards notes:

Conduct inconsistent with a standard in and of itself is not intended to give rise to a cause of action nor to create any presumption that a legal duty has been breached. The standards are designed to provide CFP designees a structure for identifying and implying expectations regarding the professional practice of personal financial planning. They are not designated to be a basis for legal liability.

The Planner’s Difference. We currently represent, as National Program Manager, a program which provides E&O Insurance for financial planners and RIA’s. A number of years ago we also underwrote group E&O programs for broker/dealers. Consistently, and for several years, our claims experience for broker /dealers was considerably worse than that for financial planners.

The reasons for the differences in experience from these two similarly situated professions became clear to us with a series of claims reported in 1993. A NYSE company had filed for bankruptcy resulting from the misappropriation of funds by the officers of the Company. Within the first two weeks following the bankruptcy filing, four claims involving investments in the company were filed against four different registered reps of the same broker / dealer alleging lack of investment suitability. In no case was there a defensible assessment of the client’s investment objectives or tolerance for risk. The claims could not be easily defended because there was little apparent justification of the choice of the investment in the first place.

Three years later, long after this series of four claims had been settled, we were having a discussion with a financial planner who had also recommended this same investment to his client. He patiently explained to us the efforts to document the client’s objectives at the time that the investment had been made. He also pointed out that the client had, in the engaging documents, explicitly acknowledged the inherent risk that the client could not assume away, no matter how well or poorly an investment performed. As a result, the policyholder asserted that it was highly unlikely that a claim would be filed. No claim was ever filed. In later years we came to learn that several of our other policyholders had had a similar exposure to this same security. No other claim involving this investment was ever filed by those of our policyholders who were financial planners.

This series of claims, as well as the lack of any claims reported by those financial planners who had placed the identical investment, lead us to an important conclusion — the difference between financial planners and other similarly situated financial advisory professionals was the process of financial planning itself, together with the resultant documents identifying the client’s investment objectives, tolerance for risk and, most importantly, the meeting of the minds between professional and client. These three elements of documentation are all important when something goes wrong, as it surely always will. These same elements are the very subject of the standards soon to be implemented.

In defending a claim, the documents crucial to the providing of a defense include:

• Assessment of investment objectives;
• Assessment of client tolerance for risk; and
• File notes made contemporaneous to the alleged wrongful act

The existence of these documents, and in fact the financial planning process itself, already distinguish the financial planning professional from other financial advisory professionals. These standards serve to reflect practices already widely applied by many practitioners.

While the debate surrounding standards is far from over, we can at least hold it up to the light of day. In other words, when rational discourse breaks down, we can at least look at the facts.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

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