The Questions Any Good Financial Advisor Will Ask You When You First Meet Them

A ubiquitous compliance protocol that has become even more critical in the digital era is KYC, which stands for Know Your Client/Customer. The publicly stated core purpose of KYC guidelines is to put the onus of determining product suitability for new clients. However, KYC serves other purposes as well, with assistance to law enforcement and interdiction of criminal enterprise funding a less publicized, but even more crucial justification for its existence.

The roots of KYC lie with the 1970 Bank Secrecy Act (BSA). BSA laid the groundwork for identifying potential fraud, money laundering, and other financial practices to support criminal enterprise. The rise of drug smuggling, illegal arms smuggling, human trafficking, and other crimes during this period funneled billions of dollars through the global financial system.

The Financial Action Task Force (FATF) was created in 1989 at the G7 summit to combat financial crimes, many of which had been adopted by terrorist organizations. FATF organized the original KYC guidelines that would become the playbook for the financial industry.

KYC gained even further urgency in the aftermath of the 9-11 terrorist attack on the World Trade Center in New York and became a cornerstone of The Patriot Act. An added bonus to the due diligence inherent in KYC compliance was a better understanding of client profiles, risk tolerances, and financial goals to ensure suitability. Acclaimed financial advice author, TV host, and podcaster Suze Orman was herself a victim of a rogue Merrill Lynch broker who wiped out her savings with risky options trades, something for which the novice Orman at the time was completely unsuited. 

A savvy financial advisor will ask a series of questions in order to acquire the right information to concurrently protect their firm, as well as their clients.  

Client Protection Questions

The Wolf of Wall Street (2013) starred Leonardo DiCaprio as Jordan Bellfort, the founder of the notorious Stratton Oakmont brokerage firm. Stratton Oakmont routinely committed fraud on cold called clients, and many of the stocks that were sold to these clients were completely unsuitable to their risk profiles. This was just one of many practices that led to Stratton Oakmont’s fall and to Belfort’s convictions on multiple counts of securities fraud, money laundering, deceptive practices, and conspiracy to defraud the United States. 

In order to prevent a repeat of the Stratton Oakmont practices, a savvy KYC-compliant Financial Advisor will ask questions and input the response answers to create the new client profile record. While a new client with ulterior motives could conceivably lie, the vast majority of new clients will usually answer truthfully, for their own protection. In addition to basic client ID, address, and contact information, the Financial Advisor should ask the following questions:

What is the client’s previous financial experience? 

• Does the client have previous brokerage or bank accounts, and if so, with which institutions, and what was the dollar size range of each account?
• Has the client presently or previously worked in the financial industry, and if so, in what capacity?
• What types of activity does the client wish to engage in? Buying and selling stocks? Options? Trading commodity futures or cryptocurrency? If so, what level of prior experience does the client have?
• Does the client intend to manage the account on their own via an online link, or will a Financial Advisor’s assistance be required to execute orders and give advice? 

Institution Protection Questions

From the perspective of the financial firm, they not only want to have cover from unwarranted or frivolous complaints from a client who refuses to take responsibility for their own decisions but also need to demonstrate to bank regulators or bodies like FINRA that they are doing their part to screen new clients for prospective Anti Money Laundering or Suspicious Activity Reports, such as the over 150 SARs that were lodged against Biden family accounts by a number of US banks. 

The KYC process is composed of three fundamental parts: Customer Identification Program (CIP), Customer Due Diligence (CDD), and Enhanced Due Diligence (EDD). Each of these components serves a unique purpose in the fight against money laundering and financial crime.

What is the client’s occupation and income source?

• What is the client’s occupation and source of income?
• Does the client work for a publicly traded company? 
• From where or from what institution will the funds entering the account be coming?
• If the amount of the initial deposit exceeds the firm’s average threshold, further due diligence verifications will likely be required.
• Does the client qualify as a Politically Exposed Person (PEP)?
• Has the client ever been arrested and convicted of a financial crime?
• Has the client ever been sanctioned or banned by a regulatory body of a financial institution?
• If the client has foreign citizenship, copies of his or her passport and further questions might be necessary, depending on the country in question, its political relations with the US, and the client’s level of prospective political influence. 

Once the client profile information has been compiled, any red flags should prompt review and perhaps checking with various terrorist watchlists or other sanctioned person databases to see if the client’s info can be verified.

KYC in the RobinHood and Cryptocurrency Era

Online accounts like RobinHood have become the New Wild West of the financial industry. While they technically comply with KYC, many of its customers are Millennials or Gen-Z investment novices who are unaware of a multitude of risks but want to enter the fray to join the action. This was especially prevalent with the meme stock booms of Gamestop and AMC, to name a few examples. Alex Kearns, a 20-year-old day trader who didn’t fully understand option risks but signed off on his willingness to deploy it, committed suicide when he thought he owed $730,000. Tragically, the amount was discovered later on to stem from an accounting error on RobinHood’s part. 

From the perspective of financial firms, the majority of cryptocurrency platforms are subject to AML laws, which require customer ID programs and recordkeeping protocols. As many cryptocurrency exchanges involve fiat currency conversions, KYC compliance will likely extend internationally, depending on the national fiat currency in question on a given transaction.

After the accounts have been opened, KYC compliance extends to client transaction monitoring and periodic updates, especially if a client submits additional new transaction sign offs for riskier activities, such as options, forex or commodity futures, for example, ensuring that the client has been briefed on the risks and acknowledges them is crucial. At the same time, activity that may be cause for a SAR, especially if large sums without provenance are involved, will need to be alerted for the firm’s liability protection. 

The Financial Advisor who is candid about why the answers to questions such as those listed above is one that demonstrates honesty about the risks on both sides and is not afraid to lose a client by being faithful to the rules. When a client understands that KYC questions are for reciprocal protection, the better a cooperative relationship can be fostered over the long haul. 

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