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A Lesson Learned

BP's Gulf spill serves as a reminder that this is a good time to re-review our compliance procedures and to rededicate ourselves to ensuring that we really care about our customers.

Judith A. Hasenauer, 06/03/2010

The news has been full of the debacle in the Gulf of Mexico, where hundreds of thousands of barrels of crude oil are on their way to pollute the delicate environment of the coastline. While it is not yet totally clear what caused the explosion that claimed a number of lives and will inevitably destroy valuable habitat, it is beginning to appear that there was a failure to comply with regulations applying to the operation of offshore oil rigs in a failed attempt to save money. It also seems that there was a failure to comply with common sense. The result is overwhelming bad press for the corporations involved, widespread finger pointing involving everyone concerned and the potential for billions of dollars in expense. It strikes us as a typical case of "penny wise, pound foolish!"

The reputations and careers of the people involved will never be restored and the corporations will be faced with open-end liability that will make previous environmental disasters pale to insignificance. This was all to save money in complying with legal requirements and a failure to apply common sense to business practices. There is a definite analogy to the financial services industry. We regularly tell our clients that good compliance is also good business. It means more than just not getting caught. Moreover, it is not merely the slavish following of nonsensical regulations, but reflects a caring for our most important assets--our customers. Perhaps this is a good time to re-review our compliance procedures and to rededicate ourselves to ensuring that we really care about our customers--and ourselves.

Oil rigs are inherently dangerous. They involve volatile substances in dangerous places with risk of storms, collisions and a variety of other possibilities. The financial services business is also potentially dangerous. Oil rigs do not regularly explode. However, financial markets do fluctuate as a natural element of their makeup. Market downturns are inevitable; oil rig explosions are not. Therefore, we should make sure our compliance procedures are comprehensive and correct. Otherwise the inevitable downturn in the natural progress of the market will catch us unprepared with the potential for long-term damage to our reputations and financial liability.

We are currently faced with a whole new system of consumer protection legislation and regulation. It is not possible to predict what course the new requirements will take, but a little common sense should enable us to be prepared for whatever comes down the path, and to be sure we are taking care of our customer's interests.

The principal concern with respect to consumer protection in the financial services arena at the present time seems to be suitability. FINRA has long applied suitability screening rules to the sales of securities and the state insurance regulators have followed suit with respect to life insurance products--particularly annuities. Fortunately, the state insurance regulators have deferred suitability screening procedures for variable annuities to FINRA so that any distributor of such products that is in compliance with FINRA rules will be deemed to have complied with state requirements. Nevertheless, it is obvious that greater attention will be applied to suitability screening that has ever been the case in the past.  

Now would be a good time for all distributors of insurance products to take a long hard look at their suitability screening procedures to be sure they are in tune with the latest standards. Since it is inevitable that markets will, at some point, decline, the only protection against unfounded claims of customers that they received unsuitable recommendations is thorough documentation. There is no "one size fits all" method for documentation, but we have seen some documentation that is so sparse that it would fit on the proverbial tombstone. Speaking as lawyers, we find it almost impossible to defend against an attack claiming that unsuitable recommendations were made for the sale of any financial product unless we have detailed documentation about the financial status of the customer and a clear indication that these facts were considered before the transaction was completed.
We also like signed acknowledgements by purchasers stating that they understand the features, costs and risks inherent in the products they are buying and understand the intended uses for the product. The more detailed the acknowledgements, the better. It is not unusual for a consumer who has lost money on the purchase of a financial product to claim that the disclosure materials were not provided or were never, in fact, read. However such a claim is very difficult to maintain in the face of a signed (and also initialed at each bullet point of the acknowledgment) statement that the consumer was informed about the very risks that are now the subject of the complaint. We live in a society that seems to treat everyone as a victim--with someone else responsible for any failures that take place. In the world of financial services, consumers often congratulate themselves for their investing skills when their investments perform well, but want to blame the advisor when they do not.

While it is a shame that we need to protect ourselves from false claims, we cannot avoid the reality of our position. Good compliance means more than just not getting caught. Therefore, being pro-active in our documentation of customer suitability screening is merely intelligent defense. Moreover, it is also good business.

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