Advisor had little knowledge of investors' financial circumstances

In 2005, Mr. and Mrs. N were 57 and 77 years old respectively, retired, and had combined household annual income of about $20,661. They were experiencing financial difficulty and having trouble paying their expenses. Their son introduced them to his advisor by telephone, hoping he could provide advice on how his parents could manage their finances.

The advisor worked in another province and never met Mr. and Mrs. N. The advisor recommended they borrow to invest in order to generate new income.

Based on his advice, in March 2006 Mr. and Mrs. N took out a $300,000 mortgage on their $540,000 home and property, and invested $250,000 of this money in mutual funds. The advisor then recommended two additional investment loans, each for $250,000. In total, Mr. and Mrs. N borrowed $750,000, using borrowed money as collateral for the second and third loans. The interest-only loan payments totaled about $5,522 monthly or $66,263 annually. The advisor's plan entailed taking cash withdrawals from the mutual funds to make the loan payments and using the excess, which he expected to be $1,000 per month, to help Mr. and Mrs. N meet their household expenses.

In 2008, the market volatility resulted in margin calls being issued on each of the two investment loans. Upon realizing the investment position his parents were in, the son of Mr. and Mrs. N complained to the firm. When the firm did not resolve the complaint in a timely manner, the complaint was escalated to OBSI.

Complaint upheld

During our investigation we found no evidence that the advisor gathered or assessed information about Mr. and Mrs. N's financial circumstances before he recommended the leverage strategy. Instead, we found that several key factors were apparently ignored.

The loan payments represented 321% of Mr. and Mrs. N's income. Aside from their home and property, they had no other assets of value and owed about $5,000 in credit card debt. The mortgage and loans represented 140% of their net worth and they had no savings or other liquid assets with which to have made loan payments or met margin calls.

In addition, neither Mr. nor Mrs. N had any investment experience before being introduced to the advisor. We found they had no understanding of investments or investing in general and no understanding of the leverage strategy or its risks. Despite the fact that they had signed leverage disclosure, we found no evidence to suggest the advisor had presented and explained the risks, including the risk that they could lose their home. We could not rationalize that Mr. and Mrs. N would have knowingly agreed to the leverage strategy recommendation, risking complete financial ruin if it failed. Therefore, we concluded they did not understand and could not have accepted the risks.

We found it clear that Mr. and Mrs. N were in no position to risk their home or their minimal income and they could not afford to make loan payments of any amount. Given Mr. and Mrs. N's complete lack of understanding about the strategy and its risks, we concluded that they were never in a position to have limited their losses and in fact, did not understand there was a problem until late 2008 when they stopped receiving the $1,000 of monthly income they were told they could expect. While the firm argued that Mr. and Mrs. N's son understood the strategy and was advising his parents, the evidence did not support that scenario. In any event, we noted it was not the son's responsibility, but rather the advisor's, to assess the suitability of a leverage strategy recommendation.

We calculated that Mr. and Mrs. N incurred investment losses (net of distributions received) and interest costs on the loans and mortgage totaling $227,440. In response to our investigation and conclusions, the firm offered and Mr. and Mrs. N accepted $220,000 in settlement of their complaint.

(2011)