Managing Risk in Client Relationships

David Youngwirth
David Youngwirth

02.22.23 in Compliance & Regulation

Estimated Reading Time: 7 Minutes (1346 words)

Couple speaking with financial advisor.

There is no such thing as a risk-free business. Some risks are inherent in the financial services industry, such as the risk of regulatory reviews and market downturns. But there’s one type of risk that presents unique challenges at an individual level: the risk in client relationships.

When it comes to managing risk in client relationships, your strategy will vary depending on the individual, but there are some practical steps to keep this risk exposure to a minimum:

  • Target your client base: Consider the clients who work well with you and those you can serve best.

  • Establish the parameters of each relationship: Be clear on what clients can expect from you and what you can expect from them.

  • Document all contacts you make with clients: This should include any recommendations or investment decisions you discuss.

These steps are effective for protecting your practice against known risks. But, despite the best precautions, unexpected risks are always possible. To prepare for potential challenges when interacting with clients, here are four scenarios that pose risks to your firm—and what you can do to mitigate them.

1. Actions That Contradict the Client’s Investment Objective

Some clients are eager for a “hot stock” and always looking for the next big thing. Against your own advice, they may insist on investing portions of their account into penny stocks or similarly risky investments. You run the risk of clients coming back if the investment does poorly and asking why you didn’t talk them out of it.

At the same time, clients don’t have to be interested in especially risky investments to prompt concern around their account activity. Some clients may be buying and selling based on emotions, easily swayed by the news or swings in the markets. Others may be living outside of their means, withdrawing assets at a rate that could negatively affect their financial future.

What can you do? An important part of managing risk in client relationships is documenting your conversations with and advice to your clients. For clients who are persistent about a particular move that goes against their long-term goals, send a follow-up email or letter to remind them of their objectives. This can also serve as documentation of your consistent advice.

Regardless of your communication method (in person, on the phone, or written), use these follow-up opportunities to reinforce your role as their advisor, as well as the account’s goals. During this process, you may find that your management is appropriate for only a portion of the client’s assets. Perhaps they are better off trading a portion of their assets in a brokerage account as opposed to an advisory account. Or maybe the client’s suitability and overall financial picture have changed.

For a client who continually refuses to follow your advice, it may be time to consider parting ways. A one-off unsolicited or speculative transaction may not necessarily be concerning, especially if your client’s risk tolerance and investment objective are more risk-oriented. But clients who show a continued pattern of acting against your advice may pose an untenable risk to your practice.

2. Unresponsive Clients

Most clients regularly respond to emails, calls, and meeting requests from their financial advisors. Every once in a while, though, you may come across a client who is MIA. Maybe this person misses a meeting to review account suitability or doesn’t return your call about an intended RMD this year. These scenarios can put you in a tough spot and cause undue risk to your practice.

What can you do? Documenting your communications is critical, even for times when you’re not able to actually connect with clients. Be sure to log your attempts to get in touch with an unresponsive client and maintain copies of these efforts.

To prevent an unresponsive client scenario, establish reasonable expectations for communicating with clients from the get-go. Determine the client’s preferred level and manner of contact at the earliest stages of the relationship. Depending on your firm’s policies, you may be required to conduct periodic—even annual—review meetings for advisory accounts. Your ability to manage the account effectively is hampered if you cannot maintain up-to-date suitability and investment objective information for your client.

You’ll also want to have a process in place for any clients who become unresponsive over time. It should include using and documenting multiple contact methods. You could start by emailing and calling. Then, you might stop by in person after a period of time if the client is local. You may also decide that the client would be better served by a different type of account.

3. Complicated Client Relationships

Client relationship management can be challenging. Adding to that complexity is the fact that there are many people and other trusted advisors who are important to your client. This gives you more interactions to manage during the relationship and after the client’s passing. Knowing how to safely navigate these relationships is key.

Here, some potential risk scenarios include:

What can you do? Ask for and maintain a list of important relationships for each client. It’s important to obtain clearly documented permission to speak with anyone not affiliated with the account in question. This could include family members the client may want you to communicate with and other professionals, such as the client’s attorney, accountant, or tax specialist.

In the event of a strained family relationship, draw clear lines from the beginning of getting to know your client and who they don’t want you talking to. An estranged family member or a household in the midst of a divorce can often complicate the status quo.

For an older client or a client with diminished capacity, you may suspect exploitation could be in play after several unexplained withdrawals. This scenario can be complicated further when a power of attorney designee or trustee is the one providing instruction. Be sure to understand your clients’ financial needs and their capacity. If you sense a change in a client’s behavior or spending habits, connect with your compliance team to discuss the potential risk or exploitation.

Managing risk in client relationships is essential to your firm’s success, but you don’t have to go it alone. Learn about Commonwealth’s collaborative approach to compliance and how our team will work with you to create solutions—not roadblocks.

4. Time to Reevaluate the Relationship

Clients can ask a lot of their financial advisors. You are expected to give investment advice, but depending on market conditions, clients may also need you to calm their anxieties. In times of health issues or life changes, they may just need someone to talk to. Many advisors end up with friends becoming clients or clients becoming close friends. But knowing your business and following your instincts will help you recognize when some tasks may be outside of your scope.

Perhaps clients want guidance on private investments that aren’t offered on your firm’s platform. Maybe they ask for legal or tax advice, even though you aren’t an attorney or CPA. Or, they could request you to be named as their POA, executor, or some other control role that goes beyond your comfort level.

What can you do? Address your role early on in the client relationship, and be prepared to make referrals as needed. This will keep your relationship equally understood between you and your client—you know your clients and their needs best. Some tips to help you in your client relationship management efforts include:

  • Trusting your judgment

  • Continually evaluating the relationship, making sure you are on the same page

  • Maintaining open and ongoing communication

  • Documenting your interactions

Know the Signs

If you notice any signs of risk in your client relationships, it is always best that you confront them sooner rather than later—for the sake of both your clients and your business. And remember to start a conversation about any concerns that have surfaced, as this can be immensely helpful in clearing up potential problems.

Editor’s Note: This post was originally published in March 2015, but we’ve updated it to bring you more relevant and timely information.

This material is for educational purposes only and is not intended to provide specific advice.

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