The COVID-19 pandemic and the related market dislocation could potentially cause an increase in client mis-selling complaints. In this article, we look at the impact of large client losses and discuss how to reduce the risk of a complaint turning into a costly dispute.
The global markets have been extremely volatile since February 2020 as they adjust to the reality of the social and economic impacts of COVID-19 on the world's major economies. There have been huge intra-day swings in the world's stock markets, with big down days followed by equally huge rises the following day as sentiment reverses. To quote one market commentator, "10% is the new 1%". The VIX index,1 a commonly-used yardstick for market volatility, hit a record high of 85.5 in February 2020. Volatility is likely to continue while uncertainty prevails.
It is worth putting some of this in perspective. On 12 February 2020, the Dow Jones index hit its highest closing record of 29,551.42 points. It has since dropped nearly 40%, hitting 18,000 points on 23 March 2020 before recovering somewhat. From 6 January to 31 March 2020, the price of Brent Crude oil dropped over 60% and, recently, the WTI near term contract went into negative territory.
While some investors will be able to weather the current storm, extreme market volatility can have a very destructive impact on client investment portfolios. This is particularly the case where a portfolio is leveraged. Leverage, or borrowing money secured on investments in the portfolio in order to increase the total portfolio asset base, is a very effective way to increase portfolio returns. However, in a highly volatile market, large intra-day falls in asset prices can result in margin calls, with investors having to sell assets to pay back their loans. Leverage multiplies returns when markets are going up, but it exacerbates portfolio losses when markets fall, and in the worst-case scenario, can result in a total loss. The recent market dislocation has seen margin calls increase to their highest level since the 2008 financial crisis.
Consequences of large client losses
Inevitably, massive market dislocation will result in large losses for some clients. Invariably, large client losses will result in mis-selling or negligence complaints by clients against financial institutions (FIs).
Reputational damage
Mis-selling litigation can cause serious reputational damage. Litigation is generally public in most jurisdictions, so if the FI does not have an arbitration clause in its terms of business to protect the privacy of the dispute, at the end of a contested court hearing, publication of the judgment can exacerbate the reputational damage.
Regulatory consequences
Additionally, the escalation of a client complaint can also have important regulatory consequences. Clients sometimes (tactically) complain to the FI's financial services regulator about the alleged mis-selling. If the relevant financial services regulator decides to investigate the matter, and eventually makes findings of contraventions by the FI, this may result in the imposition of significant fines and other sanctions against both the FI and its directors or employees, with consequent financial and reputational damage.
Assessing litigation risk
Mis-selling litigation is expensive, time-consuming and commercially risky. It is difficult to prevent outright, but if a potential dispute arises there are some basic things that FIs can do to assess the risks and their potential exposure:
- Do a full internal review of the matter which is subject to the complaint. Ensure that the internal review is performed by someone independent of the matter, or by an external firm;
- Review and check the client file and onboarding documents to ensure that, for example, the client's risk profile was properly documented and matches the investments recommended or purchased – a strong case can be entirely undermined by poor record-keeping or incomplete documents;
- Ensure that the product information provided to the client by phone/email was in line with the product documentation – client facing sales staff have been known to over-sell a product and underplay its risks;
- Ensure that you make a record of correspondence (including Whatsapp or similar messaging services) between employees and the client – these messages are often very revealing and can be crucial to the outcome of a dispute;
- Check your insurance policy to understand whether it covers mis-selling or negligence claims and whether there is a deductible – understanding your after-insurance exposure is crucial to decisions, such as whether and at what level to settle the matter if necessary; and
- Keep written records of all interactions with clients. This includes voice recordings (with the client's consent), voice notes, and any form of written correspondence. If a recording cannot be made, follow up a conversation with a written summary by email (i.e. call note, meeting note). Such records might become very helpful evidence if regulatory or legal proceedings are brought.
How to manage client complaints in order to reduce risk of escalation
There is no sure-fire way to prevent a client complaint from escalating to litigation but there are ways to reduce the risk of such litigation. The aim for FIs should be to "flatten the curve of litigation", preferably to zero. A key factor that can lead to a complaint escalating to litigation is the failure to deal effectively with a dissatisfied client. The extent to which a complaint may escalate will depend on a number of factors, including the type of client and even their personality traits. We set out below some good and bad practices to take into consideration when dealing with client complaints.
Good and bad practices for dealing with client mis-selling complaints
| Good practice | Bad practice |
|---|---|
| Listen to the client's grievances. More often than not, the client just wants to be heard and acknowledged. Some clients may just want to vent. Let them. The risk of escalation increases if the client does not feel heard. After listening to the client, make sure you address each concern to show that the client's grievances are being taken seriously. | Don't be defensive or reject the client complaint or concerns off hand. Being overly defensive risks triggering greater client animosity and an escalation of a grievance. |
| Explain the unusual circumstances. In the current market, a neutral and brief, fact-based explanation of the highly distorted market conditions can help put the client's complaints into perspective. | Don't avoid the problem by dodging the client's calls or messages. The complaint won't go away and avoidance gives the impression that the firm does not care about the client's complaint and risks making the matter worse. A client that feels rejected or not heard is far more likely to escalate the matter to litigation. |
| Keep the client informed. Once the complaint is under review, let the client know it is in hand and provide an update if the client calls to know what is happening. Make the client aware of the likely timeline for the review and proactively communicate delays. | Don't be dismissive. Downplaying client grievances only triggers client animosity. |
| Offer a solution. If possible or appropriate, offer a way to mitigate the client's losses. For example, if a client is overweight in one investment or sector, recommend diversification, or going into cash until the markets improve. | Don't call the client's bluff by saying "fine, we'll see you in court". This is a guaranteed way to escalate. |
| Keep the discussion factual and avoid emotions, which risk escalation. | Don't over-promise just to keep the client happy. Claiming that you will make their money back in no time is just a way of kicking the can down the road, and losing client trust and credibility in the process. Remember that recovering a 50% portfolio loss requires a 100% return. |
| Empathise. Don't apologise for the client's losses but do let the client know that you understand why they are so upset. An apology doesn't come across as genuine unless you mean it. | Avoid relativism i.e. seeking to deflect criticism by saying "other clients have suffered bigger losses". This does not provide comfort to the client, and may be seen as the firm not taking a grievance seriously. |
Footnotes
1 The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility -- widely reported by financial media and closely followed by a variety of market participants as a daily market indicator.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
