Investors dismissed advisor's concerns

A couple in their 40s deposited $100,000 with a mutual fund dealer, obtained a “2 for 1" loan, and invested a total of $250,000 in mutual funds.

The clients, who were experienced in the mutual fund industry, listed their investment knowledge as “Extensive" and their risk tolerance as “High" and “Extensive". On several occasions their advisor informed them that they had undertaken a very risky investment strategy and he confirmed in writing that they were fully appreciative of this fact.

The next year, the clients gave their Power of Attorney to a relative and began what was planned as several years of travel in foreign countries. By the time of their departure, the mutual funds had started to decline in value.

During their travels, communication between the clients, their Attorney and the advisor took place by telephone and e-mail. The Attorney forwarded the clients' statements and occasionally, at the clients' request, the advisor faxed statements to them. Cash withdrawals were sent to the clients to pay their travel expenses.

The value of the portfolio continued to decline and, within a year, was at the point where the lender would soon issue a margin call.

Through their Attorney, the clients asked their advisor about switching their investments to a bond or dividend fund, hoping this would allow them to continue their travels. The advisor warned that a bond or dividend fund would not generate enough income to pay the interest on the loan, and the clients headed home.

By the time they contacted their advisor, a margin call had been issued. Once the clients learned of the margin call they arranged to pledge collateral to support the loan.

The advisor recommended that the clients take steps to insure against further margin calls, such as collapsing their portfolio to pay off their loan, but they took no action and received a second margin call several weeks later.

After being forced to sell their investments to cover the margin, the clients complained that the $75,000 loss on their investments was due to their advisor's failure to respond to their requests for alternative investment strategies, and to notify them of margin calls in a timely manner.

In our investigation, we observed that the clients knowingly and deliberately committed to a high-risk strategy of using borrowed funds. The advisor recommended alternatives which the clients did not accept.

We rejected the complaint because the actions of the client demonstrated they not only were authors of their high-risk strategy, but as well they recommitted to it even when they got into trouble. The advisor appropriately advised them of the risks, kept them informed of their portfolio's performance and suggested alternative strategies. Importantly for our investigation, the advisor also kept good notes of his meetings and calls with clients, which is good standard practice.

(2004)