While experts continue to debate whether the economy has officially entered a recession, signs point to increasing financial uncertainty for many. Inflation is up, layoffs are mounting and markets are volatile. In short, it’s a recipe for claims.
Official recession or not, economic downturns of any sort can create anxiety for financial advisors and their clients. Recent history has shown that if losses are sustained, it is common for clients — rightly or wrongly — to blame their advisor, leading to an increase in claims for insurers.
Here’s a look at some notable economic downturn claims, plus tips on what you can do to minimize your risk of a claim with your own clients.
Economic Downturn Claim Examples
You don’t have to look far to discover examples of claims tied to an economic downturn or recession. Here are a few cases that stand out, as well as the details involved.
Billings v. Merrill Lynch
By the summer of 2008, Bear Stearns had failed, AIG was in distress and the Dow was in decline. However, few advisors knew what else was around the corner. In July, one Merrill Lynch broker recommended a sizeable investment in Fannie Mae preferred shares to investors Robert and Michele Billings. Yet just 45 days later, Fannie Mae would be placed in a conservatorship and the Billings’ investment virtually wiped out.
The Billings filed suit and the case came before a FINRA arbitration panel in 2011. Though Merrill Lynch strongly defended against the claim, the arbitration panel found a breach of fiduciary duty and awarded the plaintiffs over $1.3 million in compensatory damages. The decision has since gone down in history as one of the largest Fannie Mae preferred recoveries for public investors.
Whitley v. J.P. Morgan
In 2009 and 2010, Richard Whitley and other retirement plan participants invested in various J.P. Morgan stable value funds began to see losses from what were supposed to be their rather conservative investments. According to the complaint, J.P. Morgan’s stable value funds were heavily invested in an intermediate bond fund and an intermediate public bond fund. The participants claimed these fund assets were highly leveraged and included then-risky mortgage-backed securities. The investors also claimed the funds had underperformed the benchmark Hueler index over the preceding two years.
The ensuing ERISA case against J.P. Morgan grew to include 12 named plaintiffs invested in five stable value funds through nine 401(k) retirement plans of various employer plan sponsors. Eventually in 2017, a class settlement of $75 million was reached on behalf of the impacted participants of more than 300 different retirement plans invested in 78 of J.P. Morgan’s stable value funds.
Fitzpatrick v. AXA Advisors
By 2011, James and Sandra Fitzpatrick reportedly had put aside $20 million in savings, thanks to a successful farm business. Around this time, their longtime advisor at AXA retired and a new one was assigned to their account. According to the complaint, the new advisor recommended the purchase of two life insurance policies, two variable annuities and one fixed-income annuity.
After the purchase, the client claimed the investments were costly and unsuitable and accused the advisor of recommending them to generate large commissions for himself. Initially, AXA defended against the client claim, even presenting audio recordings of customer service calls they claimed as evidence in FINRA arbitration hearings. However, the Fitzpatricks were ultimately awarded $3.2 million in compensatory damages, attorneys fees and costs in 2019.
Economic Downturn Risk Management Tactics
When an economic downturn or recession does arrive, there’s not much an advisor can do about the reality of it all. However, it is possible to manage the risk a downturn poses to your firm. The right steps can reduce client anxiety, strengthen relationships and ensure the stability of your business.
Here are six things to try:
1. Take a More Proactive Approach
For investors weathering a downturn, an advisor’s silence can be deafening. Even if you have led clients through a previous downturn, the context is likely to be different this time around. Knowing their advisor is staying on top of the situation is one of the quickest ways to calm clients’ nerves and instill confidence in your expertise.
2. Consider Switching to a Flat-Fee Basis
Flat per-participant fees can provide you and your firm with a more predictable revenue stream when market uncertainty rises. Compared to an assets-under-management fee basis, flat fees also result in fewer surprises for clients. Most importantly, switching to a flat-fee model is one of the best ways to reduce your risk for an excessive fee lawsuit.
3. Develop New Resources to Address Needs
Bringing the right conversation to a client at the right time in their financial life is key to offering comprehensive advisory services. In a downturn, you could develop and make available new client resources addressing personal budgeting, government programs or business topics. It’s another idea to help retain clients and minimize complaints.
4. Expand Your Professional Network
To meet the new needs of your clients during a downturn, you may need help. Getting out and meeting people is a great way to expand your professional network and add value to the services you provide. Being able to point clients to a trustworthy real estate broker or tax attorney can be invaluable in an economic downturn.
5. Organize More Client Group Events
During any difficult time, people are likely to feel more alone than usual. It can be a huge help when a client sees that they aren’t the only ones with worries and questions. Consider hosting a series of client group events or webinars, where you can get together to discuss market updates and portfolio management, introduce resources and answer FAQs.
6. Protect Your Firm with the Right Insurance
Claims during a downturn occur for a number of reasons, from trading errors to advisor-client miscommunications, product suitability complaints, failure to disclose and breach of fiduciary duty. Claims can also be brought for more complex allegations of professional negligence, such as excessive fee lawsuits. With all these risks, the right E&O coverage is a must.
E&O Liability Insurance from Lockton Affinity Advisor helps protect you and your business from a broad range of professional negligence claims. Fiduciary coverage is automatically included, and our E&O meets ERISA standards, including services as an ERISA 3(21) and 3(38) advisor, ensuring any fiduciary duties you perform are covered.
As an advisor during a recession or economic downturn, your actions are likely to be under greater scrutiny. Rightly or wrongly, clients may blame you if their investments are impacted by market events. The right awareness, proactive approach and risk management strategy can help to minimize your risk.
