Unsuitable investment in high-risk products and over concentration lead to financial harm

Key lessons

• High-risk investments may not be suitable at all for some investors. For a medium risk investor, significant concentration in high-risk investments is not “balanced” by an allocation to low-risk investments.
• If an investor knows that an investment is unsuitable or risky but chooses to make the investment anyway, they can be partially responsible for their losses.

Ms. T was a retired book editor, living on her own. Her government retirement benefits were supplemented by a small employment pension. Her only financial assets were approximately $30,000 invested in Government of Canada bonds. She had very little knowledge about investing. In 2007, her mother passed away and she inherited half of her parents’ estate – around $420,000. She turned to her late mother’s investment dealer for help deciding what to do with the money.

The dealer had had an investment relationship with Ms. T’s parents since 1990. The dealer was only licensed (or “registered”) to sell exempt market investments, which are usually considered high-risk investments. 

Inheritance invested to generate extra  retirement income

Ms. T planned to use the money she inherited to supplement her retirement income. On the recommendation of her dealer, she agreed to invest the money in a balanced manner that would provide her with both growth and income throughout her retirement. The dealer helped Ms. T open two investment accounts, and she signed a new account form for each. Ms. T’s risk tolerance was listed as mostly low risk and her investment objectives were 60% income-producing investments and 40% growth-oriented investments. 

Increasing risk and concentration

Ms. T’s dealer explained to her that lower-risk investments would not provide enough monthly income to meet her income requirements and recommended a mix of investments in low-risk GICs, high-risk exempt market products, and some medium-risk mutual funds that could be sold through a different dealer. Over the next three years, Ms. T’s accounts mostly held medium and high-risk investments that exceeded her stated risk tolerance. Ms. T’s accounts had also become concentrated in two specific securities.

Dealer’s departure sheds light on the accounts

In 2015, Ms. T’s dealer left the firm, and her accounts were transferred to a new dealer at the same firm. When this happened, Ms. T reviewed her accounts and was alarmed to learn that the value of her investments was much lower than she expected. She contacted the firm to find out what had happened, and also complained about the concentration in the two securities in her accounts.

Ms. T did not receive a response from the firm right away. However, she signed an updated account form with her new dealer. Although exempt securities usually can’t be sold once an investor buys them, in this case, there was a resale option. Ms. T sold one of the concentrated investments but accepted her new dealer’s recommendation to continue holding the other.

The firm responds

When the firm responded to Ms. T’s complaint, they told her that they believed that her investments had been suitable based on her investment objectives and risk tolerance. They also told her that the dividends from her two concentrated investments were necessary to fund her monthly income requirements. However, they offered her $40,000 as a goodwill gesture. Ms. T. did not agree with the firm that her investments were suitable. She contacted OBSI.

What did OBSI do? 

We investigated and found that Ms. T’s KYC information with the firm accurately reflected her investment objectives and risk tolerance but that her dealer had failed to ensure that his investment recommendations were suitable for her based on her KYC information. Even after 2015 when a new dealer was assigned, her portfolio continued to be invested unsuitably for another two years until Ms. T withdrew her investments from the firm. 

We found that Ms. T had raised her concerns about losses and concentration in her accounts appropriately. Her accounts were both unsuitably invested in higher risk equities and did not need to be concentrated in two securities. As a result, she incurred significant losses. However, in 2015 she chose to continue holding one of the unsuitable investments based on her new dealer’s recommendation. For these reasons, we found she shared some responsibility for her losses after 2015 and apportioned 30% of the f inancial harm she incurred after that to her.

Our recommendation

We found the investment firm responsible for 100% of Ms. T’s financial harm incurred before September 2015 and 70% of the financial harm she incurred after September 2015. We recommended that the investment firm compensate Ms. T $265,000 and take back the unsuitable exempt investments she still held but couldn’t sell.