Understanding conflicts of interest
Dealing with conflicts of interest is of critical importance to a true professional. What is a conflict of interest, why are conflicts important, and what should you do about them? A review of the FPIA Code of Ethics, and the current interest in regulation and the role of professional advisers, make this a good time to think about these important questions.
Wednesday, July 13th 2005, 9:33PM
by Simon Hassan
Dealing with conflicts of interest is of critical importance to a true professional. What is a conflict of interest, why are conflicts important, and what should you do about them? A review of the FPIA Code of Ethics, and the current interest in regulation and the role of professional advisers, make this a good time to think about these important questions.
What do the rules say?
The FPIA Code of Ethics and Professional Conduct (the “Code”) requires members to disclose “any possible conflict of interest in relation to” their recommendations , and to include in their written disclosure document a disclosure of “any conflict of interest which could impair [their] independence and objectivity as an adviser or provider of financial services”.
Definition
While the Code does not specifically define the term “conflict of interest”, it uses the word “interest(s)” in this sense eight times, including in its very first rule, which states: “The member shall act in the client’s best interests, above consideration of personal gain”.
In society at large the term “conflict of interests” can cover a range of things, including bribery and corruption among government officials and politicians, but for a financial adviser a potential conflict of interests exists whenever the interests of an adviser – or a related person or entity – even another client – and the client, may be in conflict (“in conflict” meaning either “directly opposed or even not entirely aligned”).
Clear? Maybe. But before you toss this article aside, glance down the list of examples below: you may be surprised. I’ve always found it helpful to use examples when looking at an issue like this, and I have to say that I had something to learn while researching this article.
Some examples of conflicts
· Taking advantage of an elderly, juvenile, or incapacitated client.
· Buying an insurance policy, a property, or investment from a client.
· Recommending that a client take some action that you suspect is not in their interests (eg, if you have some knowledge you are aware that they don’t have, and which makes a difference.
· Recommending a product that you or your firm or a related party has an interest in (eg, suggesting clients purchase shares in or lend money to a company that you own shares in – or that they purchase insurance from a company in which you hold shares).
· Receiving a share of commission or fees, a finders fee, or any reward from a third party you send your client to (say you recommend a particular real estate agent, or a bank).
· Any undisclosed relationship or tie with or to a product provider, and any undisclosed remuneration.
· Advising two clients who themselves have competing interests (eg, continuing to advise both parties after a divorce, advising one person to sell and another to buy the same investment, or potentially, even a husband and wife with different risk profiles).
· Recommending product A, which provides more commission than product B, even if “the research” says the two are about the same.
· Recommending product A, which has the same commission as product B, but brings the possibility of some other reward (a soft dollar).
Grey areas
Some conflicts of interest are just wrong (like taking advantage of an elderly or incapacitated client). But others are not so clear, and some may not even matter.
Say you are recommending income insurance, and company A’s product and company B’s product are much the same in other respects. If A pays commission of $100, and B pays commission of $95, the conflict is less than if A paid $100 and B paid $50 – or if both paid the same commission, but recommending A could help you qualify for a bonus or a trip.
Using an investment example, if you are recommending that a client place $10,000 in a cash management product, and if company A will pay you a trailing commission of 0.25% ($25) pa, and company B will pay you 0.30% ($30) pa, the conflict is likely to be insignificant, but if the amount being invested is $300,000, or if you make the same recommendation to 300 clients, the difference is $1,500 a year, which may well be significant.
Because of grey areas like these, it is important to be clear about which kinds of conflicts matter, and how you should deal with them. The answer is often common sense.
Avoid, refer, disclose
All conflicts must be managed, and some avoided outright. When you become aware of a potential or actual conflict of interest you should point this out, and if serious enough to be avoided, politely decline to provide advice – or refer the client to another adviser. Even if the client says “No problem”. The nature of conflicts of interest is that you are almost always in a better position to understand the situation than a client. Regardless of the apparent attitude of a client, all serious conflicts should be avoided.
Where a conflict is slight (as in the $5 income insurance or trail commission advantages above) the conflict need not be avoided – but it should be clearly and effectively disclosed at the earliest opportunity (and always before conducting the transaction concerned).
In the grey area in between serious and slight, the best approach is caution. If in doubt, avoid the conflict – or at the very least disclose it and if you have any doubts about its significance, advise the client in writing to seek a second opinion from a disinterested party.
A heavy responsibility
I often find myself talking with other FPIA members on a variety of professional things, and I have to say that the overall impression is humbling. FPIA are good people, and it is a privilege to belong to a community where so many are so highly motivated, and are genuinely professionally inclined. But in this day and age high ideals and genuineness are not always enough.
Belonging to the FPIA brings with it a heavy responsibility towards clients. As professionals who undertake to act in our client’s best interests FPIA members may be bound by the higher-level duty of care required of a professional trustee – in other words we have a “fiduciary” role. Unlike many other careers, our unique knowledge and skills place us in a position of power in many situations. Like a doctor, a lawyer or an accountant – or the guardian of a child – we are obliged to openly, fairly, and faithfully act in their interests – protecting them even from ourselves.
One day …
The ultimate, acid test is not what you think, or what your client may think, but what an independent complaints authority – or a court of law – is likely to think. Early in my career I had the very good fortune have an excellent mentor , and I will never forget the key rule he taught me: “Remember, whatever you say or do; one day you’ll be standing in court and defending it”.
This has got to be the best approach to real or potential conflicts in your business. Perhaps it’s time to examine our consciences, our business models, our disclosure documents, and various standard documents to ensure that good ideals are matched by good practice – in everyone’s interests.
Simon Hassan, CFP CLU Simon is a practising financial planner, a professional mentor, and also lectures at Massey University and is occasional writer and speaker on professional issues. He is also currently FPIA Vice President and chairs an FPIA Task Force on the Code of Ethics. These are his own ideas and do not necessarily reflect the views of the FPIA or of Massey University. © Jul 2005. This article is protected by copyright and may not be used stored or reproduced without the express permission of the author. Simon Hassan acknowledges the assistance of Tower Health and Life, and through Tower, Australian lawyers Tim Nethercote and Grant Holley who provided some advice on the article.
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