Whether you’re an RIA, private fund, or broker-dealer, effectively managing conflicts of interest in financial services is vital to build trust and sustain long-term client relationships.
Mishandling conflicts invites legal challenges, penalties, suspensions, and reputational damage. But if you can navigate conflicts of interest efficiently and transparently, you can inspire trust and prove your professional integrity and authenticity.
This blog explores how to best manage and communicate conflicts of interest and how leveraging solutions like our Fiduciary Suite helps RIAs, broker-dealers, and other financial professionals mitigate conflicts of interest and keep their reputation and client trust intact.
Understanding Conflicts of Interest in Financial Services
In layman’s terms, a conflict of interest occurs when an individual financial adviser’s or the firm’s interests act against the client’s best interests. In these instances, the objectivity can be compromised, potentially harming the client’s financial situation.
A case study in conflicts of interest: Recently, the SEC charged a registered investment adviser and its co-founder for making false and misleading statements to investors and failing to disclose one of the founder’s conflicts with operating a separate hedge fund. As a result? The firm and its founder had to pay civil penalties in the hundreds of thousands and the co-founder was also suspended for 12 months from industry-related work.
Beyond the monetary penalty and damage to client trust, navigating a punishment like this is a serious operational burden. Could your firm survive this type of penalty? Many would not have the ability to continue if they suddenly found themselves without their founder for 12 months.
Mishandling conflicts of interest can have long-lasting effects on client attitudes toward your services and business. And in the worst case scenarios, if trust is compromised, clients may doubt the accuracy of the advice they receive and even terminate the relationship.
The Regulatory Landscape
Before we go further, it may be helpful to establish a quick refresher on the different expectations and guidelines depending on the type of firm where you work.
Registered Investment Advisers (RIAs)
Adhering to the fiduciary standard means RIAs must act in the best interest of their clients at all times. If conflicts of interest occur, RIAs must disclose them in full and mitigate the conflict.
Broker-Dealers (BDs)
BDs and their personnel must comply with Reg BI, which is designed to ensure that clients’ financial interests take precedence over their own. However, broker-dealers can be compensated via commissions or other sales incentives, unlike RIAs, provided the conflict is disclosed.
Department of Labor (DOL)
The DOL Fiduciary Rule aims to extend fiduciary duties to all financial professionals working with retirement accounts. At present, the DOL fiduciary rule and amendments to the DOL prohibited transaction exemptions is on pause, leaving RIAs and broker-dealers to rely on Prohibited Transaction Exemption (PTE) 2020-02 and relevant industry regulations when navigating whether, when, and how to disclose potential conflicts.
Identifying Potential Conflicts of Interest
The best way to manage conflicts of interest is to identify them before they occur.
To identify – and even prevent – potential conflicts, you can take the following steps:
- Create appropriate internal guidelines per SEC and/or FINRA rules and establish a written code of ethics. These should govern how to recognize, address, and resolve conflicts of interest.
- Conduct audits to check for potential conflicts, particularly concerning fee structures and compensation practices. Also, review all of your third-party relationships and record any concerns you may have.
- Disclose all conflicts of interest (whether from outside business activities, fee structures, compensation arrangements, relationships with third parties, or otherwise) to clients from the get-go.
COMPLY’s Fiduciary Suite offers tools for RIAs, private funds, and broker-dealers to track and manage potential conflicts systematically. For private funds and other RIAs, it supports compliance with the adviser’s fiduciary standard, and for broker-dealerss, it facilitates compliance with Reg BI by automating conflict disclosures and managing advisor behavior.
Click here to find out more about our Fiduciary Suite.
Managing Conflicts of Interest
Even with preventative measures in place, certain conflicts of interest are inevitable. And while you may not always be able to avoid a conflict, you can always manage it when it does occur.
Follow these steps to better manage conflicts of interest when they are present:
1. Full Transparency and Disclosure
- Whether it’s third-party relationships, commissions or fees, advisers should be honest about conflicts of interest with complete transparency.
- Written documentation of conflicts, such as in Form ADV or Form CRS , can ensure clients are aware of potential influences on the adviser’s recommendations.
2. Put the Client’s Interests First
- For RIAs, adhering to their fiduciary duty means always putting the client’s best interest ahead of the adviser’s personal gains. This can include recommending lower-cost investment products or advice that would reduce the adviser’s assets under management, even if that advice means a lower overall fee for the adviser.
- Independent, unbiased research can lead to better decision-making and avoid products that pay higher commissions if not in the client’s best interest.
3. Use a Fee-Only or Fee-Based Structure
- Advisers who charge a flat fee or a percentage of assets under management (AUM), rather than earning commissions from product sales, inherently minimize potential conflicts.
- And if using a commission-based model, advisers should be clear about how they are compensated and how that compensation could influence their decisions.
4. Ongoing Monitoring and Compliance
- Regularly auditing internal processes means that conflicts of interest are identified early and managed effectively.
- Compliance software like COMPLY’s Fiduciary Suite can automate potential conflicts and ensure timely, accurate disclosures.
5. Offer Clients Alternatives
- If there’s a potential conflict, advisers should offer clients alternative investment options, outlining the pros and cons of each.
- Explain clearly and in detail why a certain recommendation is made – reasoning and transparency are crucial.
6. Maintain Documentation
- Keep records of all disclosures and conversations regarding conflicts of interest. This protects the adviser but also strengthens transparency with the client.
- Ensure that disclosures are updated as circumstances change, such as changes in compensation structure, new outside business activities, or regulatory shifts.
7. Seek Client Feedback
- Ask clients if they are comfortable with the disclosure process and if they have any concerns.
- Hold periodic reviews of client accounts and discuss any changes in the adviser’s potential conflicts.
Retaining Client Trust in Conflict Situations
The way a firm manages conflicts of interest can either build trust or damage it. Best practices for client retention include:
- Once a conflict has been disclosed, provide clients with alternatives or solutions that reinforce your commitment to their best interests.
- Explain what steps are being taken to resolve the conflict and prevent similar issues from happening in the future.
- After disclosing and resolving a conflict, ask for feedback so the client feels comfortable with the solution and remains confident in your firm’s services.
Leveraging Technology to Manage Conflicts of Interest
For financial advisers, implementing modern compliance technology can be a game changer in preventing and managing conflicts of interest. Our Fiduciary Suite is designed to help firms automate disclosures, track potential conflicts, and comply with Reg BI, the investment adviser fiduciary standard, DOL requirements, and other evolving regulations.
With tools for continuous monitoring, reporting, and client communications, firms can stay ahead of potential issues, reducing both regulatory risk and the risk of losing client trust.
Managing conflicts of interest is critical for maintaining client trust and meeting regulatory obligations. By taking preventative measures, communicating transparently, and leveraging technology like Fiduciary Suite, advisers can navigate the complexities of today’s and tomorrow’s regulatory environment, while inspiring client confidence.