Posted by on December 21, 2015
By Rich Lynch, President of fi360
Even as the DOL’s proposed “Conflicts of Interest” Rule continues to dominate the attention of the financial services industry and its practitioners, it is clear to us that not everyone has a clear understanding of what, exactly, constitutes a conflict of interest. One of the most common types of question we receive from advisors is for our opinion on whether a situation they are encountering qualifies as a conflict. The short answer to that question is almost always, “if you felt compelled to ask, it’s probably a conflict.” But while these situations almost always do involve a conflict, that doesn’t necessarily make them prohibited. What matters in the end is that conflicts and their severity are recognized and that a plan for addressing conflicts is in place and followed.
A good working definition of a conflict of interest is a circumstance that makes fulfillment of the duty of loyalty less reliable. For that reason we always advocate walking away from or avoiding the conflict. It is important to understand that it is the circumstance itself that creates a conflict; there is no such thing as a “potential” conflict. The conflict either exists or it doesn’t; whether a conflicted party’s conduct changes as a result of the conflict is a separate matter.
In our fiduciary handbook for advisors, Practice 1.4 (link to related handbook pages) addresses conflicts of interest. The four related Criteria require the following:
- Policies and procedures related to conflicts of interest are defined.
- Conflicts are avoided when possible and always when required.
- Unavoidable conflicts are disclosed in writing and managed in the best interest of the client.
- Conflicts are explained and informed written consent is obtained from the client.
One conflicted scenario we see often is when an advisor is asked to be a member of an investment committee for a local charitable organization that has an endowment or foundation with investable assets. As the relationship evolves, the advisor is often asked to assume the advisory role when the committee becomes dissatisfied with the current advisor or believes they can save on advisory fees. A variation of this scenario is when a committee member is asked by or encourages the committee to hire their personal advisor. In each of these scenarios there are clearly conflicted parties that will make the fiduciaries’ fulfillment of their duties less reliable.
When recommending what steps the advisor should be taking in these scenarios, we look to the above Criteria and suggest the following:
- Avoid the conflict if possible. Ideally, the advisor wears only one hat by making a choice of being a committee member or the advisor. This would also mean not allowing the personal advisor of any committee member to compete for the investment advisor role of the endowment or foundation. In either case, the committee’s ability to conduct an objective due diligence process for evaluating the advisor and advisory services is compromised.
- If the decision is made to allow the conflict, the conflicted advisor/committee member should recuse themselves from any discussion or decisions related to their advisory role. It should also be documented that the conflict was discussed and approved by the committee.
There may be situations where allowing or creating a conflict between the advisor and client makes sense because it is an unequivocally better option that the available alternatives, but that should be rare. In the long run, the work that is required to continually demonstrate that a conflict (which is often permissible) has not in fact created a situation of self-dealing (which is prohibited) is more trouble than it’s worth.
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