According to FINRA’s estimates, for the next 15 years, an average of 10,000 Americans will turn 65. Those of us who work with the elderly regularly, need to be attuned to deciding whether our clients have the capacity to make decisions regarding their financial affairs? All lawyers, be it in the practice area of estates, securities, or virtually any other discipline often have to make a capacity determination, while contracting services and sometimes along the way. We often have to determine if our client has the capacity to have entered into certain legal transactions.
According to the American Bar Association, Rule 1.14 that provides guidance on Client With Diminished Capacity (ABA):
(b) When the lawyer reasonably believes that the client has diminished capacity, is at risk of substantial physical, financial or other harm unless action is taken and cannot adequately act in the client’s own interest, the lawyer may take reasonably necessary protective action, including consulting with individuals or entities that have the ability to take action to protect the client and, in appropriate cases, seeking the appointment of a guardian ad litem, conservator or guardian.
There are different tools available to lawyers in order to make capacity judgements. American Psychological Association (APA) together with the American Bar Association (ABA) developed a Handbook for Lawyers that focuses on the assessment of “civil” capacities in older adults including financial capacity and identifying capacity red flags. Financial capacity reflects the ability of an individual to manage his/her financial affairs in consistence with their self-interest. According to the handbook a preliminary screening of capacity by an attorney can lead to these conclusions: capable, mild capacity concerns, more than mild concerns or incapable. If the attorney suspects more than mild capacity concerns, he/she should refer the client for formal clinical assessment, which may involve a clinical interview and functional assessments to determine how they plan to manage their investments and how that relates to the individual’s life-long values (e.g. is a moderately risk averse individual willing to suddenly invest in a high yield, risky stock?)
There are several ethical guidelines in the handbook that can help lawyer’s assess client’s capacity: observing and interpreting signs of diminished capacity like memory loss and comprehension problem; evaluating the client’s understanding of specific transactions and its consequences; how the decision fits in with the client’s long-term goals and values; the client’s rationale for decisions and its articulation. The handbook also provides a worksheet to help attorneys gather information about the client prior to making capacity judgement.
From a legal standpoint, financial capacity encompasses not only the ability to handle one’s finances but also other capabilities like contractual, donative, and testamentary capacity, and is the basis for determining conservatorship of the estate. In most cases the legal standard for contractual capacity is high in comparison to testamentary capacity, requiring the subject to understand the nature and effect of the business transaction. Assessing financial capacity is more complex than mere ability. For instance, a Schizophrenic person with high financial ability may still make poor decisions conflicting with his own self-interest. At present, assessment of financial capacity is based on neuropsychological tests, and basic financial skills and subjective clinical judgment.
Judgments of overall financial capacity can be framed using the categorical outcomes of capable, marginally capable, and incapable. Marginally capable outcome is important because an elderly person suffering from mild cognitive impairment may have limited ability to perform basic financial activities (e.g. write checks) but not make complex financial decisions like investing in variable annuities, MLPs or distressed or leveraged bonds. As a Securities attorney, when we see the elderly make these kinds of questionable investment decisions, it immediately raises a red-flag concerning their financial capacity and possible abuse.
There continues to be a struggle between financial autonomy and protection for the elderly. The potential negative outcomes of financial decisions made with to diminished capacity can be very destructive including unintentional self-impoverishment, victimization and exploitation by others. Therefore, it is important for attorneys to take a systematic approach to determining capacity issues by following these systematic approaches. When the elderly find themselves victimized, there are many legal recourses available to them. Institution like FINRA, and criminal and civil statutes allow for aggressive legal action to provide protection for the elderly.