The Securities and Exchange Commission (SEC) has issued new guidance for brokers, firms and financial professionals to avoid conflicts of interest with clients. The staff bulletin aims to help firms and professionals comply with their obligations to provide advice and recommendations in the best interest of retail investors. Here’s what financial advisors should know.
What Does New Guidance From the SEC Say?
In an August staff bulletin, the SEC reiterated and illustrated in concrete terms how broker-dealers and investment advisors must identify and address conflicts of interest.
The publication includes 13 questions and answers highlighting the SEC’s focus on conflicts of interest and procedures required under Reg BI and the IA fiduciary standard.
Reg BI refers to Regulation Best Interest, which says that broker-dealers must recommend products in clients’ best interest. The IA fiduciary standard refers to the fiduciary standard for investment advisors under the Investment Advisers Act of 1940.
The SEC reaffirms that “firms must address conflicts in a way that will prevent the firm or its financial professionals from providing recommendations or advice that places their interests ahead of the interests of the retail investor.”
The commission also points out that broker-dealers, investment advisors and firms that are incentivized by commissions could put their own economic interests above fiduciary obligations to clients.
“The staff believes that identifying and addressing conflicts should not be merely a ‘check-the-box’ exercise, but a robust, ongoing process that is tailored to each conflict,” the SEC bulletin says. “It is therefore important that firms and their financial professionals review their business models and relationships with investors to address conflicts of interest specific to them.”
What Are Examples of Conflicts of Interest?
Conflicts of interest can happen when a broker-dealer, financial advisor or firm receives compensation, revenue or other benefits for the sale or distribution of a product.
This compensation can include fees and other charges for the services provided to retail investors, or payments from third parties, independently of whether it is directly related to sales or distribution.
One common example can involve selling products such as annuities and life insurance in exchange for commissions. The sales can incentivize brokers, firms and fee-based advisors to promote those products over a client’s best interests.
The SEC lists gifts that include tickets to forms of entertainment, meals, travel and other related benefits as common examples of benefits or perks that could influence financial professionals to undermine client interests.
How Financial Advisors Can Avoid Conflicts of Interest
Broker-dealers, investment advisors and firms are expected to identify the conflicts of interest within their own company and capacity. This includes reviewing policies and procedures for loopholes that could pose a conflict of interest.
Here’s a breakdown of specific guidance issued by the SEC:
Broker-dealers. The commission requires broker-dealers to have written policies and procedures. The brokers have to create rules that identify as well as eliminate bonuses, noncash compensation, sales quotas and sales contests that are based on, “sales of specific securities or specific types of securities within a limited period of time.”
Investment advisors. The investment advisors have to disclose conflicts of interest to their clients, so the client can provide informed consent. If the client can’t do that, the SEC believes the advisors need to eliminate the conflict involved.
Firms. The SEC says that there are situations where firms find conflicts in which they can’t provide advice or recommendations in the client’s best interest. In those cases, the firm must decide whether to eliminate the conflict or stop offering advice or recommendations that could undermine a fiduciary obligation to act in the best interest.
Additionally, the SEC says financial professionals must define conflicts in a manner that is relevant to the firm’s business, which includes taking into account conflicts of the firm, its financial professionals and any affiliates, and any other way that involves appropriate personnel, including compliance professionals.
The finance industry is always changing, which means conflicts of interest can surface in many ways. The SEC has offered guidance for broker-dealers, firms and investment advisors to review and update their policies frequently to make sure that they are in compliance with their fiduciary obligations. Failing to comply could lead to fines and possibly even losing licenses to provide advice and recommendations to clients.
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