Investment professionals have a responsibility to learn the financial circumstances and investor knowledge of their clients, so they can make suitable investment recommendations. To accomplish this, they must fulfil two obligations:
- Know Your Client (KYC)
- Know Your Product (KYP)
To some degree, each investor is unique. Therefore, advisors are not permitted to make “one-size-fits-all” investment recommendations. Examples of “one-size-fits-all” advice include:
- advising all clients to borrow to invest
- advising all clients to buy gold, or gold mining stocks
- advising all clients to invest their whole balance in small company stocks, or emerging markets.
What financial advisors are required to do is to take the unique circumstances and knowledge of the client into account (KYC) and then to tailor their investment suggestions (KYP) accordingly. To learn the circumstances of the client, the advisor should determine what the client knows, understands, and appreciates about investment concepts. Just as a teacher will adapt a lesson to the ability of the student, so should the advisor present information to a client based upon the client’s ability to understand it. In the KYC jargon of the industry, this is referred to as “investor knowledge” and sometimes as “sophistication.”
Levels of Investor Knowledge
All KYC forms include a space for financial advisors to describe the level of investor knowledge, after speaking with the client. Depending on the form, any of the following terms might be used to describe the levels of investor knowledge:
- “novice” or “limited” or “none” (low level of investment knowledge)
- “medium” or “moderate” (middle level of knowledge)
- “sophisticated” or “extensive” or “commercial” (high level of knowledge)
Protecting the Investor
A novice investor cannot be expected to understand a sophisticated investment strategy (for example, investing in options, using leverage, or day-trading). Therefore, the KYC process is essential to the creation of a suitable Investment Policy Statement (IPS) for the client. It will be obvious to a trained and experienced professional whether the client does or does not appreciate different investment concepts and strategies. The financial advisor must accurately identify and record the extent of the knowledge and update this record, should the extent of the knowledge change.
This record will help a supervisor or compliance officer to judge whether a recommended investment activity is suitable for the client. Without the KYC process and a suitable IPS, the investor cannot be properly protected from making bad investments.
A word of warning: just because an investor has a history of investment activity does not make the investor an expert. Someone can hit golf or tennis balls for years without achieving any skill or knowledge of the game. An investor who accepts all recommendations, and does not receive (or understand) details about the recommendations will still have little investment knowledge.
If you have become the victim of a discretionary advisor who has not fulfilled the KYC process or created an appropriate IPS, you may have the right to receive compensation. For a free consultation to discuss your rights, please complete and submit our online form.