As the number of older Americans continues to climb, investment advisors face a a critical challenge — how to take care of clients experiencing diminished capacity or financial exploitation without subjecting themselves to legal liability. This article presents a roadmap to help advisors do just that by discussing, among other things, the critical elements of early planning, tools to address privacy concerns, helpful contractual protections, identification of red flags, and measures to take once red flags are identified.

Early Planning

One of the best prophylactic measures an advisor can take to minimize the risks associated with diminished capacity and financial exploitation is to directly address such issues with the client at the beginning of the relationship. As difficult as it may be, clients should be urged to think and talk about how they want their financial affairs handled should they face cognitive impairment in the future (e.g., do they want a springing power of attorney or health care proxy?)

A client and the advisor both benefit if the advisor encourages the client to bring family members and other professional advisors into these conversations at an early stage as this allows the advisor to gather information about family dynamics and existing estate planning measures as well as to ensure that everyone is on the same page. If the client already has estate planning documents in place, an advisor can request those documents from the client so that, if the client becomes cognitively impaired or faces financial exploitation in the future, the advisor has someone to turn to that has authority to take action with respect to the client's affairs. Of course, the advisor should revisit these conversations (and documents) with the client periodically to ensure that nothing has changed with respect to such arrangements.

Addressing Privacy Concerns

Confidentiality obligations owed to a client often preclude an advisor from turning to a client's loved ones when the advisor suspects that the client is experiencing diminished capacity or financial exploitation. As such, to avoid breaching privacy laws (such as Regulation S-P under the Gramm-Leach-Bliley Act), an advisor should, at the outset of the client relationship, ask its clients to designate an authorized contact person (e.g., a family member or professional advisor) to whom the advisor can turn to should the adviser become concerned about the client in the future. The client can authorize the adviser to discuss the client's financial affairs with the authorized contact person and, if the client is comfortable, take instruction from the authorized contact person.

This designation can be included in the advisory agreement between the client and the advisor. Advisors should periodically revisit the designation to ensure that the authorized contact person continues to have a strong relationship with the client. An advisor can also obtain client consent at the outset of the client relationship to notify government authorities should the advisor suspect that the client has become the victim of financial exploitation.

Another method for addressing privacy concerns is to ensure that an advisor's employees receive sufficient training as to how to identify and handle situations where diminished capacity or financial exploitation are suspected. Providing such training is helpful because, among other things, the recently adopted Senior Safe Act of 2017 provides that an adviser will not be liable for disclosing suspected financial exploitation to covered government agencies if, among other things, the reporting individual received appropriate training relating to identification and reporting of financial exploitation and the disclosure was made in good faith and with reasonable care. In fact, certain states mandate that advisors report any suspected financial exploitation to government authorities, and so, advisors should review whether the state laws where they operate require such reporting.

Additional Contractual Protections

Advisers can build additional protections into their client agreements to protect themselves from legal risk when confronted with a client with diminished capacity. For instance, a provision can be included in the client agreement authorizing the advisor to refuse to follow client instructions (including fulfilling disbursement requests) when the adviser reasonably believes that the client is experiencing diminished capacity or financial exploitation. The advisor can also include in the agreement provisions that absolve the firm of responsibility should an advisor take actions in good faith to protect the client if diminished capacity or financial exploitation is suspected. Finally, advisors can include provisions in their client agreements authorizing the adviser to immediately terminate the client agreement if the client refuses to follow the adviser's instructions or if the advisor is receiving conflicting instructions from the client and a third party purporting to act on the client's behalf.

Red Flags

Because they are not mental health professionals, advisors face a daunting challenge to identify when a client is experiencing cognitive impairment. However, certain warning signs can prompt an advisor to take action to protect the client's interests. Potential signs of diminished capacity include:

  • client's memory loss, disorientation or difficulty speaking;
  • client's confusion about or inability to understand basic financial concepts or his or her financial circumstances;
  • failure to follow basic directions;
  • failure to pay bills or other financial obligations; and
  • other unusual and erratic behavior.

Potential signs of financial exploitation include, among others:

  • unusual cash withdrawals or other financial transactions;
  • sudden closure of financial accounts;
  • sudden changes to financial documents (such as powers of attorney or wills);
  • a third party shows excessive interest in the client's financial affairs;
  • the client is being prevented from speaking with the advisor;
  • the client provides unusually large gifts to relatives or caregivers; and
  • unexplained disappearances of the client's possessions.

Responding to Red Flags

Advisors should have policies and procedures in place to require employees to immediately report any suspected cases of diminished capacity or financial exploitation to firm management. In turn, management should review the client's file and, among other things, determine if any recent financial transactions set off any alarm bells.

Advisors must also review any documents granting a third party authority (e.g., a durable or springing power of attorney, trade authorization or other similar document) to determine whether the appointed representative can be contacted to discuss the client's situation. If the client has appointed an authorized contact person (as described above), the advisor can contact that person to discuss the client's financial situation. If no such authorized person has been appointed, the advisor can urge the client to bring in a trusted family member or friend to discuss the situation. If necessary, the advisor should bring in legal counsel to discuss any challenging issues, and, if necessary, whether reporting of suspected financial exploitation is appropriate.

Whether or not any immediate issues arise once diminished capacity or financial exploitation is suspected, advisors should increase monitoring of the client's account and attempt, if possible, to communicate with the client more frequently. Advisors should document any steps taken to protect the client should their any action (or inaction) be questioned at a later time.

Richard Chen is an investment management attorney who has been practicing for nearly two decades with several top multinational law firms and a leading compliance consulting firm. He now runs his own law firm practice, which serves independent wealth managers, hedge and private equity fund sponsors, financial planners, and other financial institutions. He can be reached at [email protected].