Most investment advisers are aware of the obligations they owe to clients who are experiencing cognitive decline. Typically, Registered Investment Advisers (RIAs) implement policies and procedures that articulate how Investment Adviser Representatives should handle situations where a client is suffering from diminished mental capacity. Many RIAs, however, have not planned for situations where one of the principals or an Investment Adviser Representative (IAR) is showing signs of cognitive impairment.

When a principal or IAR of an RIA begins to suffer from diminished capacity or a cognitive disorder, such as Alzheimer’s disease or dementia, the risk to the firm is substantial. He or she may be damaging existing and potential relationships. In some cases, the principal or IAR’s cognitive decline may cause the RIA to breach the fiduciary duty owed to clients. When members of the firm become aware of the problem, they should act decisively.

NASAA Study: Financial Professionals with Diminished Capacity

On July 21, 2020, the North American Securities Administrators Association (NASAA) released a study that examined issues related to diminished capacity and cognitive impairment that may affect financial professionals. NASAA observed that these professionals may fail to comply with their duties under the securities laws, including those related to standards of conduct, supervision, books and records, continuing education and fraud. In addition, when financial professionals suffer from diminished mental capacity or cognitive impairment, they may provide less than effective service to the client. RIAs must work diligently to avoid situations where clients suffer financial losses due to an IAR’s diminished capacity or cognitive impairment.

How RIAs learn that a member of the firm is deteriorating mentally

Firms typically discover that an IAR is potentially experiencing diminished capacity through:

  • Electronic surveillance;
  • Client complaints; and
  • Observation by firm staff.

When IARs work remotely or in their own offices across the country, it may take much longer for an RIA to realize that one of their representatives is suffering from diminished capacity or a cognitive impairment. Firms should develop procedures to identify ways to ensure that an IAR is providing cogent and clear advice to clients. If a firm has received any indication that an IAR may be suffering from diminished capacity or cognitive impairment, the RIA should implement enhanced supervisory procedures. Every firm should have procedures detailing what steps should be taken when dealing with a cognitively-impaired individual. NASAA’s study outlines the steps firms can take in their dealings with the person who appears to have a cognitive impairment.

According to NASAA, firms are able to detect issues with diminished capacity by using electronic monitoring and error reports. Firms can monitor call logs and trade corrections in comparison to a peer group. Firms may also use internal data analysis to identify trends and compare the financial professional’s activities to his or her peers.

Although complaints are sometimes a tip-off that an IAR is deteriorating mentally, long-term clients may not notify the firm about changes in their representative’s behavior. In some instances, compliance personnel, assistants, and other employees report circumstances where a representative is experiencing diminished capacity. Sometimes, a branch manager or a family member notices the problem and alerts the firm.

NASAA’s report identified several areas for firms to consider, such as training to recognize the red flags of diminished capacity and cognitive impairment. A typical red flag for diminished capacity is forgetfulness and confusion. An IAR may commit numerous transaction errors or might need passwords to be reset frequently.

Succession planning

NASAA’s study advised that firms should encourage or even require all IARs to create a succession plan, even if they are young and in good health. Diminished capacity or cognitive impairment can occur at any age due to an accident, medication, life changes or health conditions. This is especially important in small firms where there is only one IAR.

Aside from the compliance reasons for succession planning, NASAA’s report suggested that succession planning provides financial professionals with peace of mind for their later years. It also provides financial professionals, no matter what their age, with the ability and comfort of choosing who will take care of their clients if the need arises.

NASAA’s report can be found at


RIAs owe a fiduciary duty to implement business continuity plans. As part of an RIA’s business continuity and succession planning, firms should consider addressing the possibility that a principal or IAR will suffer from diminished capacity. RIAs should also ensure that clients are protected in case a key member of the firm dies or becomes incapacitated, especially when there is only one IAR or principal of the firm.

For larger firms, a diminished capacity clause in the IAR agreement between the firm and its IARs should address this issue. The agreement should address the risk of mental incapacity and what steps should be taken when it occurs. The lawyer who drafts the agreement should make it very clear what actions are required when an IAR is no longer able to meet his or her obligations to clients or to the firm.

With regard to the risk that a principal will become mentally incompetent, firms should make certain that their operating agreement addresses these issues. A well-drafted operating agreement will contain buy-sell provisions. In some instances, the parties will opt for a separate buy-sell agreement. The agreement stipulates what happens when a principal dies or becomes disabled and whether it will trigger a buyout option. The agreement will define incapacity. The agreement will also specify how the firm will compensate the incapacitated individual for his or her ownership interest.

If a firm fails to address the growing risk of diminished capacity and cognitive impairment, an RIA can become mired in litigation. Ultimately, without proper planning, having a principal or an IAR with diminished capacity or a cognitive impairment can lead to a loss of clients and might even result in the dissolution of the RIA.

RIAs with sufficient resources should strongly consider professional training from Human Resources and/or Mental Health Professionals who provide training related to employees with disabilities, mental , and other medical issues. Such sensitive matters extend well beyond normal business and compliance risks to include significant legal risks. RIAs should be acutely aware that when dealing with principals and IARs with diminished capacity or cognitive impairment may raise issues involving privacy, discrimination, and employment law.

To guard against these risks, RIAs should consult with qualified attorneys, who are licensed in relevant jurisdictions, and who are not only familiar with the firm’s business structure and industry, but also competent in matters of applicable privacy, employment, and discrimination law.

About RIA Compliance Group: RIA Compliance Group is an investment adviser compliance consulting firm based in Delray Beach, Florida. The firm’s mission is to provide affordable, timely, practical, and cost-effective compliance advice. We help investment advisers to comply with the myriad of state and SEC regulations and compliance obligations facing their firms. RIA Compliance Group takes pride in giving personal service and real world compliance advice, not theoretical concepts and legalese. The firm interacts on a daily basis with SEC and state securities regulators.

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