The U.S. Securities and Exchange Commission (SEC) recently released the staff bulletin Standards of Conduct for Broker-Dealers and Investment Adviser Conflicts of Interest to reiterate the required standards and obligations for broker-dealers under Regulation Best Interest (Reg BI) and for investment advisers the fiduciary duty standards under the Investment Advisers Act of 1940.
The bulletin defines a conflict of interest as any interest that might incline a broker-dealer or investment adviser—consciously or unconsciously—to make a recommendation or render advice that is not disinterested. Or in other words, to act in their own best interests or in the best interests of the firm and not in the best interest of their clients. Read more about how conduct risk remains an ongoing priority for the SEC.
The bulletin takes the form of a question and answer document. Highlights include:
Identifying Conflicts of Interest
Do all broker-dealers and investment advisers have conflicts of interest?
Yes. The bulletin states that all broker-dealers, investment advisers, and financial professionals have at least some conflicts of interest with their retail investors. The bulletin notes that compensation issues including commissions and fees, internal quotas and contests, gifts & entertainment and sales of proprietary products could potentially incline a broker-dealer, investment adviser, or financial professional to provide advice that is not disinterested.
Is my firm expected to identify conflicts of interest?
Yes. Under Reg BI, firms must establish, maintain, enforce and periodically review written policies and procedures designed to identify conflicts of interest. Under the Advisers Act, conflicts and other factors impacting risk should also be identified when developing policies and procedures that apply to the firm’s particular operations, and the adequacy and effectiveness of the policies and procedures should be reviewed no less than annually.
Steps to identify conflicts of interest that SEC staff believe firms should consider include:
- Clearly defining policies and procedures and ensuring that they are relevant to the firm’s business
- Defining policies and procedures in a way that considers the relationship with the retail investor
- Establishing a process to identify conflicts employees might face and how such conflicts might impact recommendations
- Providing for an ongoing, regular and periodic process to identify conflicts
- Clearly communicating policies and procedures to staff, including defining roles and responsibilities and providing training
SEC staff also thinks that firms should establish a “culture of compliance” where conflicts are taken seriously and employees are encouraged in taking an active role to identify and address them.
Eliminating Conflicts of Interest
Once a firm has identified all conflicts of interest and disclosed them to retail investors, have we satisfied our obligations under Reg BI and the IA Fiduciary standard?
No. Disclosure of conflicts of interest alone does not satisfy obligations. Certain conflicts should or must be addressed through mitigation. And where the conflict cannot be addressed through mitigation firms must determine whether to eliminate the conflict or refrain from providing advice or recommendations.
Are there circumstances where a particular conflict should be eliminated?
Yes. Broker-dealers and investment advisers have a duty to act in the investors best interest, and that includes eliminating conflicts when appropriate. Reg BI expects broker-dealers to have written policies and procedures designed to identify and eliminate potential conflicts including sales contests, quotas, bonuses and non-cash compensation based on the sale of specific securities. Investment advisers must fully and fairly disclose conflicts to clients so the client can provide informed consent. If the client cannot provide informed consent, and the nature of the conflict makes it difficult to fully disclose and mitigate, SEC staff believes the adviser should eliminate the conflict. In cases where the firm finds a particular incentive practice is causing its financial professionals to place the best interest of the professional or the firm, the firm may need to revise their incentive program to eliminate the conflicts of interest.
“Yesterday’s synergies are today’s conflicts. It is incumbent upon broker-dealers and investment advisers to endeavor to define, understand, document and mitigate conflicts of interest in a continuous and repeatable manner. Conflicts management programs are not one-size fits all. The requirements associated with Reg BI and the investment adviser fiduciary standard further illuminate the need for organizations within the industry to take proactive measures to create appropriate, right-sized conflicts management programs in line with their respective business models and overall risk profile.”
—Mitch Avnet, Founder and Managing Partner, Compliance Risk Concepts
Read CRC's Take on July 2022 Regulatory Activity
Mitigating Conflicts of Interest
What factors are relevant to a firm’s approach to mitigating conflicts of interest?
SEC Staff believe that appropriate mitigation measures will depend on the firm’s specific business model, but may include sources of compensation, affiliate relationships, the use of incentives, the extent compensation depends on product, the firm’s size and structure, dual licensing and outside business activities, characteristics of the firm's retail investor base and the complexity of recommended investment strategies.
Disclosing Conflicts of Interest
How should my firm satisfy its obligations to disclose conflicts of interest fully and fairly?
Disclosures should allow investors to make a more informed decision about a recommendation. In the case of IAs, disclosures must also provide informed consent to the conflict of interest. Facts relating to conflicts of interest associated with compensation or benefits that should be disclosed to retail investors include:
- Nature and extent of the conflict
- Incentives related to the conflict of interest and how that could impact recommendations
- Sources and scales of compensation for the firm and/or financial professional
- Compensation and other benefits derived for the firm and/or professional based on their recommendation or advice
- Nature and extent of costs or fees incurred, directly or indirectly, by the retail investor as a result of the conflict
My firm has established policies and procedures to identify and address my firm’s conflicts of interest through a combination of elimination, mitigation, and disclosure. Can we stop worrying about this now?
No. SEC staff believes that identifying and addressing conflicts of interest is not a “set it and forget it” exercise. Firms should monitor the effectiveness of their policies and procedures over time to help ensure continued compliance with Reg BI and the IA fiduciary standard.
SEC staff also recommend documenting the measures it takes to address and monitor conflicts of interest in order to demonstrate compliance under Reg BI and the IA fiduciary standard. See how MCO helps firms gather compliance data and assurance information around the operation of polices and controls from across the organization.
Identifying and addressing conflicts should not be merely a “check-the-box” exercise, but a robust, ongoing process that is tailored to each conflict.
—SEC Staff Bulletin Standards of Conduct for Broker-Dealers and Investment Adviser Conflicts of Interest,
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And watch the on-demand webinar Taking the Broad View: Better Risk and Compliance through Holistic Oversight featuring Mitch Avnet from Compliance Risk Concepts and Richard Pike from MCO for practical guidance around develop a clear and holistic view of compliance risk that helps compliance set regulatory priorities, identify gaps in policies and procedures and streamline operations.
