Less than one-in-three chance of defending 'know your client' complaint

Failure to ensure clients understand risk profile questionnaires can mean advisers fail the ‘know the client’ obligation and leave them open to a complaint, according to a report.

Risk management firm, Fourth Line, conducted a survey of 1,100 complaints to the Australian Financial Complaints Authority (AFCA) between 2012 and 2020, around 12% of total complaints.

Total complaints paid rose to $14.6 million in 2020, up from $8.6 million in the previous year.

One such complaint pertained to a complainant describing how they were advised to change super fund to a higher-cost fund but the risk profile questionnaire used was deemed too complicated by the complainants, who lacked the necessary financial literacy to understand certain questions.

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The firm argued that the tool had taken their investment experience into consideration and had categorised them as balanced investors, therefore it allocated them 50% exposure to growth assets.

Upon examination of the questions, AFCA found the answers were an unreliable indicator of the complainants’ risk tolerance, particularly as they had answered having ‘limited knowledge’ of investing.

It said: “Given the inadequacies of the risk profile questionnaire, it is up to a prudent adviser to assist the complainants understand and comprehend the questions to identify and understand their relevant circumstances. In this instance, the adviser has not discharged his ‘know their client’ obligation”.

The complaint was found in favour of the complainants who received $13,734.

AFCA recommended advisers considered previous investment experience, capacity and tolerance for risk, time horizon for investing, age and personal objectives and had a legal obligation to identify clients’ objectives as part of their duty to act in a client’s best interest.

In total, 18% of complaints related to ‘know your client’ but this was down from 70% in 2017 and total complaint claims paid totalled $23,315,121. There was a 32% chance of an adviser successfully defending a claim in this space, which included incomplete fact finds, incomplete risk profiles or failure to investigate clients’ circumstances.

For incomplete fact finds, there was a 0% change of an adviser defending this type of complaint.

“There has been a reduction in complaints determined related to ‘know your client’ issues in recent years suggesting advisers have improved their investigations into their client’s relevant circumstances,” the report said.

“It is worth noting that most of the high-risk and illiquid product [Global Financial Crisis] GFC-related complaints were determined or closed by 2017, when the majority of investment-related complaints related to failure in the adequacy of risk profiling and the fact-finding processes.”