Avoid getting sued in a down market

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Q: With the recent market volatility, we’ve had several clients who are either complaining about unrealized losses in their account, or asking us to get them out of the market. These investments are mostly growth-oriented mutual funds for middle-aged clients who have no immediate need for the money.

I’ve tried explaining that the funds are solid performers and that the market will almost certainly come back, so if they liquidate now they’ll take significant losses. We went through this in ’08 when some clients panicked, sold, took big losses and subsequently blamed us when the market recovered. Even though we won the couple of arbitrations that were brought against us, it cost a lot of money in attorney’s fees. I’d like to avoid being sued again but it seems like these clients just don’t get it. Any suggestions?

Sometimes the most lucrative thing you can do is turn down a prospect.

A: Although it may be too late for this market correction, the way to minimize lawsuits starts with the initial client intake. (Note that I didn’t say “avoid” lawsuits since it’s difficult, if not impossible, to completely avoid being sued in this day and age. So your best bet is to simply try to minimize your exposure).

It may seem like common sense, but the first step is to analyze the prospective client for signs of litigiousness. How many other brokers and brokerage firms have they had in the past? Why did they leave those other firms? What is their experience with prior bear markets and how did they react in those situations? You’ll find that those clients who are most likely to sue are usually the ones who blame everyone but themselves when things go poorly. It’s always “My broker screwed up,” and never “I should have listened to my broker,” or “I panicked and sold too soon.”

Remember, no matter how big the account may be and how tempting it is to land that “whale,” you have to weigh those commissions against the cost in legal fees and time spent in arbitration hearings to determine the client’s real value. Sometimes the most lucrative thing you can do is turn down a prospect.

Assuming the client appears to be sane, it then goes without saying that the investments should be suitable for him or her. In particular, I would pay close attention to the client’s stated risk tolerance if that’s not something you’ve emphasized in the past. Some of the better suitability questionnaires I’ve seen include questions that ask the client what they would do in a down market.

Documentation from clients indicating that they would hold investments during a downturn until they recover can make an attorney think twice about taking a case where the client went against their own philosophy. Sometimes, however, even the best clients in the most appropriate investments can still panic when they’re watching their hard-earned savings shrink on an almost daily basis.

For those clients, the best you can do is to keep talking to them: Show them how the markets recovered after past crashes, and explaining why their investments are still solid and dependable. And most importantly, show them that you’re confident in your recommendations and that you’re on top of things. The absolute worst thing you can do is avoid talking to the client. No matter how upset they may be, no matter how painful the discussion. Keeping in regular communication with the client will go a long way towards allaying their fears.

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Lawsuits Arbitration Finance and investment-related court cases Investment strategies Volatility Investment returns