Avoiding conflicts of interest

In today’s economy, it’s hard to imagine how a firm or registrant can be profitable without offering a more holistic model of financial service to clients.

Insurance, financial planning, and tax preparation are all part of the “big picture” that advisors must offer. Clients want the convenience of one stop shopping. They also want knowledge and they want to trust in the advice they receive from a common source on all financial matters.

With increased emphasis by regulators on managing or eliminating conflicts of interest, how do we stay on the right side of compliance? IIROC suggests the starting point is rule 29.1 which requires that dealers and their representatives must observe high standards of ethics and conduct in the transaction of their business and not engage in any business conduct or practice unbecoming or detrimental to the public interest. MFDA rule 2.1.4 requires that material conflicts of interest must be addressed by the exercise of responsible business judgment influenced only by the best interests of the client.

The common thread in all conflict of interest rules is that we put our clients’ interests ahead of our own. This sounds like a simple concept but identifying where and when these sometimes diverging interests can clash can be tricky. National Instrument 31-103 for example, sets out a number of areas where conflicts can arise in a variety of registration categories. Section 13, Divisions 2 through 4 deal with:

• a) conflicts of interest generally
• b) in managed accounts
• c) selling securities of related or connected issuers
• d) referral arrangements
• e) recommending the use of borrowed money, and
• f) lending to clients.

Things such as advisor involvement in start-up companies and offering shares in those to clients, real estate ventures, renting office space in a building, tax preparation services, etc. all require special attention to the underlying question: are the clients interests first and foremost or is the advisor at risk of putting his or her interests ahead of the client’s? Even situations where an advisor is serving as a volunteer in the community, in a capacity where he or she is not compensated, could give rise to a conflict of interest. (e.g. investment committee of a charity).

Generally speaking, the expectation is that each firm will analyze its unique business model and advisor profile and identify areas where conflicts might arise. From there, it should develop policies and procedures on how to manage those, which should include a process for having the outside business activity, relationship or position giving rise to the conflict approved by the firm’s compliance department.

Developing the policies for compliance team use is not enough. The duty to act with integrity and in the best interests of clients has to be at the forefront of the thoughts of those who deal with clients day to day. This is not always an easy thing when business pressures, increasing compliance demands and other daily demands fill peoples’ calendars. The most successful firms manage this risk by continuous education and reminders to sales staff on the various scenarios where conflicts can arise. They offer electronic bulletins and newsletters with examples of recently identified conflicts and on-the-ground training of sales staff on how to “see” the conflict and on the need to bring compliance in early to help manage it. In a busy day, a reminder such as this can mean the difference between an advisor staying within firm policy or inadvertently falling outside it.

As a practical matter, full and clear disclosure of the conflict to the client prior to any transaction being entered into will usually meet the requirements. However, in the ascending scale of the seriousness of the conflict, additional measures such as extra supervisory steps (i.e. flagging and monitoring client accounts where a serious conflict has been identified) or requiring the client to obtain independent legal advice may be the only prudent course.

There are some conflicts that simply cannot be sanitized by disclosure or other internal measures. For example, except in cases where firms are approved for margin lending, lending to clients is prohibited by NI 31-103.

It is critical for advisors to report their outside business activities to the firm. This allows the firm to help advisors manage any possible conflicts and to help advisors meet their duties to report these activities to the regulators through the National Registration Database.

Our responsibilities in compliance are growing every day but by internal cooperation and viewing the compliance department as the risk management tool and friend it is, firms and advisors can stay on the right side of the law and in the black on their balance sheet.

Stephanie A. McManus, LL. B., is a member of the Bar in Ontario and Alberta and a Principal of Compliance Support Services , a firm that has been providing compliance help to the financial services industry since 2005. The above is not to be construed as legal advice but is provided for general interest purposes only. Please consult your legal or compliance advisor for matters related to your particular situation.