Protecting vulnerable aging clients

As clients age and laws evolve, the securities industry faces incalculable risks that require rigorous internal controls to properly manage relationships with vulnerable aging investors. An unsuitable investment recommendation to a client once was the greatest risk to an adviser. As a result of changing demographics and new legislation, the greater risk to the stability of the securities industry today is the financial exploitation of elder clients.
Four types of laws are designed to protect vulnerable clients: mandatory reporting requirements, criminal penalties, civil penalties and civil liability. One byproduct of these protective measures is that the securities industry must develop and implement new internal controls to comply with state laws.
The term “vulnerability” is difficult to define with precision. Beyond its colloquial definition — easily hurt or harmed physically, mentally or emotionally — each state applies its own unique definition. The defining characteristic is that vulnerability is associated with age or mental capacity. Finra’s definition of a vulnerable client includes investors who are ill, elderly or retired.
Advanced age is an important yardstick because it is associated with mental deficiencies, such as Alzheimer’s and dementia. One of the early symptoms of Alzheimer’s is the inability to make sound financial decisions. The AARP states that even ordinary skills, such as identifying and counting money, understanding debt and loans, conducting cash transactions, and paying bills, may be compromised before there is a medical diagnosis of mental impairment. This gradual decline can go unnoticed for long periods of time and leave those affected by it more susceptible to financial exploitation.

MISAPPROPRIATION

Currently, 5.4 million Americans are living with Alzheimer’s. By 2050, that number is expected to rise to 14 million. State agencies, regulators and advocacy organizations reason that vulnerable clients are often exploited through the misappropriation of property for personal use by family members, those with powers of attorney, caretakers and securities industry professionals.
At the same time, the modes for retirement savings have shifted from employer-sponsored retirement plans to privately managed investments. The significant loss of savings by ordinary investors during the financial crisis left many without sufficient resources to fund their retirement. Now many of them, especially baby boomers, are exposing themselves to heightened risk by, for example, chasing higher yields and falling prey to “too good to be true” investment scams, hoping to recoup their losses. This dichotomy creates an opportunistic climate for financial exploitation.
Securities professionals must ascertain through reasonable diligence a client’s investment profile and any other information the client may disclose in relation to recommendations. When dealing with senior citizens, Financial Industry Regulatory Authority Inc. guidance says the investment profile and financial situation should include the client’s life stage, income and expense needs, as well as the client’s health care needs. The suitability requirement presents a tightrope that advisers must walk — a balancing act between their duty to advise clients for marketplace success and their duty to protect against investments that are too risky in light of the client’s profile and goals. Clients with mental, cognitive or physical impairments pose new challenges for these suitability considerations.
It takes trained medical staff to effectively identify and diagnose these impairments, yet the burden ostensibly has been placed on the securities industry to recognize “warning signs” and act accordingly. The securities industry has responded by: providing multiple studies, reports and guidelines to help advisers communicate more effectively with their aging clients; creating training and resource tools to identify signs of mental or cognitive impairment; and requiring reporting of abuse to supervisors in an effort to continue the security industry’s shared mission to protect aging investors.
But advisers’ attempts to spot symptoms sometimes produce “false positives” that, if raised with the client, may embarrass or offend them and could breach the duty of confidentiality. On the other hand, if an adviser fails to identify signs of impairment, the pitfalls could be severe.
Advisers can improve the manner in which they handle such difficult demands with some concrete steps.
Create a questionnaire. The suitability of investments depends on a variety of factors including, but not limited to, the client’s age, investment experience, time horizon, liquidity needs, risk tolerance, other holdings, financial situation and needs, tax status, and investment objectives. Advisers would benefit from gathering additional information such as life stage, expenses, income, retirement savings and health insurance to better understand their clients’ circumstances. A Notice to Member 07-43 questionnaire would memorialize these characteristics and the situational questions posed in 07-43.
Other financial decision makers. Clients should be asked whether they have a (durable) power of attorney in the event they are unable to make financial decisions. Once a client begins to experience a marked and systemic decline in financial capacity, the decision about who will make financial decisions on his or her behalf will be complicated — with family members and friends trying to convince clients to turn over their finances to them. Advisers should encourage their clients to authorize power of attorney to take effect in the event that they are incapacitated. Alternatively, advisers may encourage clients to discuss their finances with a trusted family member or friend who the adviser could contact if mental or cognitive impairment or exploitation is suspected. Whether the client decides to authorize power of attorney or share information with a trusted person, it is imperative to attain the name and contact information of the client’s choice and receive written permission to contact the person if needed.
Seek client updates on an annual or biannual basis. Certain life events, such as retirement, illness or divorce, may materially change a client’s investment profile. Advisers should make it a practice to confirm client information and profiles on an annual basis or, in the case of a vulnerable client, either biannually or quarterly. All notable changes in a vulnerable client’s financial or mental capacity should be documented and reviewed with the firm’s compliance department.
Strengthen vulnerable client guidelines. The securities industry should consider strengthening guidelines for dealing with vulnerable clients. These may include “concentration” limits for investment products with limited liquidity and creating product lists that specifically approve and disapprove investment products for vulnerable clients. Opt-out provisions for these restrictions should be included to ensure clients seeking to invest their proceeds as they see fit are not prevented from doing so because of general guidelines.
Create action plans for life events. The events that may change an older client’s investment goals are different than they were in the past. As individuals live longer, there is a greater likelihood they will become divorced later in life, offer financial support for their adult children or require 24-hour medical care. Each of these situations would necessitate adjustments to investment products and strategies, as they could easily result in clients outliving their resources. Advisers should create action plans to outline changes to goals and investments that will take place if these changes actually occur.
Document the potentially unsuitable investment. If a client decides to purchase a speculative investment, pursue a risky strategy or take a concentrated position in a volatile security, are securities industry professionals prohibited from fulfilling these requests if they believe it is not suitable for the client? It poses a unique issue when the client is considered vulnerable. It is essential that these decisions and advisements are properly documented. Examples of good documentation include presenting the client with a written disclosure that identifies the risks and requires the client’s signature to confirm that the transaction is unsolicited.
Train representatives to deal with vulnerable clients. By virtue of their access to client accounts, advisers are in the best position to identify financial exploitation. Signs of diminished cognitive ability will be less severe than those of diminished mental capacity. Symptoms of diminished cognitive ability, which are early indicators of mild Alzheimer’s, may include situations where the client expresses difficulty understanding investment options and determining returns. Although clients with symptoms of diminished cognitive ability may be able to function on their own without supervision, they are vulnerable to financial exploitation.
A corollary to recognizing diminished capacity is the ability to distinguish between normal symptoms of advanced aging and diminished capacity. Advisers should foster an open relationship with their older clients by being forthright, explaining their education and training, and making their offices hospitable to older clientele. Older clients without cognitive deficiencies often experience physical impairments such as loss of hearing, reduced vision and reduced mobility that can make it difficult to engage openly. An adviser can sometimes accommodate these impairments with large print, a magnifying lens, and a meeting space with low ambient noise levels and high-quality lighting.
Guidelines for an escalation action plan. Industry guidelines should educate securities industry professionals on the following issues: how to conduct an investigation where suspected elder abuse may be ongoing, who the supervisor should contact and when a “stop” in trading on their client’s behalf should be placed on the account.
While awaiting guidance, act with caution.
Brandon S. Reif is the managing partner of Winget Spadafora and Schwartzberg’s California office. He would like to thank his associate, Rachel Dardashti, for her assistance with this Op-Ed.