How To Avoid Not-In-Good-Order Errors And Improve Suitability, Know Your Customer Compliance

Swiss AlpsFinancial services businesses are mired in the timely processing of transactions, preparing and updating customer data, tracking sales and investments and, lest we forget, compliance reviews. When regulatory agencies return forms and records because they are not in good order, the business suffers from an efficiency and competitive standpoint. With expanded requirements in existing Know Your Customer and Suitability rules in the sale of financial products, this preciseness in terms of the accuracy and fullness of information pertaining to customers is critical – and now is the time to review one’s policies and procedures.

Where the problem begins

There are many places in which not-in-good-order (often called NIGO) can present itself. Customer data accumulation at the front-office stage can be particularly problematic. A busy agent’s ability to process forms in good order and to have them maintained in good order depends on a well-trained staff, efficient processes, regular updating and smooth interaction between the many hands in which such documents travel.

“The review process is overwhelming. You are gathering so much information on customers and have so many more complex products to offer them today that it is hard to avoid not-in-good-order problems,” said David Fetter, CEO of Quadron Data Solutions. “There is a large error rate that compliance needs to be concerned about at account-opening.”

In the securities industry, about one-third of the time a new account application is submitted, it will be rejected because of it not being in good order, reports Robert Powell, VP of sales and marketing at Laser App Software. “That comes out to 25 to 30 percent of all applications – and a whopping 75 to 80 percent in the insurance industry – that will get held up and not experience what we call ‘straight-through processing.’”

The high rate in general can be attributed to a lack of a central system for processing these customer forms and a lack of continuity in workflow between departments.

And the higher rate associated with the insurance industry? “Those agents often don’t understand the forms and the training they receive can often be a bit subpar, as compared to those in other financial sectors. Plus, those agents get rewarded in terms of volume, which can be a problem, and sell so many products that they often don’t know enough about each of them.”

Reasons for rejection

There are several reasons that agencies return forms for not being in good order. One of the most common reasons for rejection is incomplete forms. Sadly, since this requires an agent to redo an application and have the client re-sign it, the reputation of the firm is questioned.  And if an agent takes the shortcut of signing the forms on the client’s behalf, it can be considered forgery and can result in sanctions against the agent’s license.

Incorrect data on forms can occur easily in the data entry stage, so careful attention needs to be paid here on how information is keyed in and how the forms are reviewed prior to being moved along in the process. “This mistake occurs when people work in silos, so building in review stages can reduce this type of error,” Powell said.

Other problems entail forms being out of date or having one or more required forms missing. Compliance can step in here to make sure that the forms being used and archived are complete and accurate, since having them returned for not-in-good-order only makes compliance audits later more difficult. “Compliance in the back office depends on smooth processing of customer data in the front office – you cannot have one without the other,” Powell noted.

Reducing the error rate

To reduce the error rate associated with not-in-good-order, what are the steps companies can take right now?

“Extra layers of review, for one thing,” said Fetter. “And reducing the number of workflow stages is essential. You want as much information to get to an adviser or broker that you can and not have him or her trying to fill in the missing pieces.” And since human and transfer errors can occur each time client information is entered into a firm’s systems, reducing the number of data entry stages can reduce the odds that not-in-good-order or other errors will creep into the firm’s processes.

The client’s application — before being submitted up the chain for approval — should be as full and accurate as possible.

The tools to integrate information and send up red flags when information is missing or forms are outdated exist, Fetter notes. “Often they just need to be integrated into the other systems a firm uses in terms of data aggregation and compliance software to work properly.”

Know Your Customer and Suitability

Effective July 9, 2012, FINRA Rule 2090 (Know Your Customer) and Rule 2111 (Suitability) combine to expand greatly the amount of customer information required of brokerage firms.

Know Your Customer requires a firm to use reasonable diligence in regard to opening and maintaining each account, including knowing and retaining the essential facts about a customer and who has the authority to act on behalf of that customer.

Suitability requires a member firm or registered representative to have a reasonable basis to believe its recommendation of a transaction or investment strategy is suitable for the customer, based on information obtained through reasonable diligence according to the customer’s investment profile.

To make a recommendation a broker must use reasonable diligence to have an investment profile of the customer.

“An investment profile includes a customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance and other information the customer may disclose,” explains Morris Simkin, a securities practitioner and partner at McLaughlin & Stern LLP in New York.

The customer details that the front office must process in good order and completely just got more complicated.

“In terms of complex products, a firm needs to make sure its salespeople knows what it is selling, “notes Ari Berman, a partner at Vinson Elkins LLP in New York. “Firms must make sure procedures are in place for the sales staff and their supervisors to review the types of products being sold to particular clients.”

Berman notes that document retention is a critical element here, as is training. But also important is the “tone at the top.”

“The senior people at the firm need to know what the people on the ground are doing.” This includes supervisors and compliance professionals who can step in to point out the difference between discussing basic approaches to investing (not requiring documentation), as opposed to giving specific advice (requiring documentation), for instance.

Simkin notes that getting around the “not-in-good-order” problem and complying with the know-your-customer and suitability rules entail some of the same approaches by compliance departments.

– Review the research distributed to customers to see if specific recommendations or specific calls to action are being made that trigger the suitability rule.

– Make sure your sales team making recommendations to buy, sell or hold an investment are familiar enough with the products and the strategies they are recommending that they can make the suitability determination.

– Make sure your forms are IN GOOD ORDER so all of the required information about a customer exists, so you can make the suitability determination at account-opening. If there is missing information, is the missing data material to the recommendation?

– Keep good records: The more complex a product or investment strategy is, the more prudent it would be to record the basis for the suitability determination.

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Julie DiMauro reports on financial services regulatory compliance issues for Thomson Reuters.

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