One of the more complicated aspects of fiduciary responsibility rests with a firm's ability to adequately identify and disclose potential conflicts of interest. What may not appear to be a conflict can nevertheless violate securities laws whether it be a material misstatement or omissions in reports filed with the Securities and Exchange Commission (SEC).
In June, the SEC charged Fieldstone Financial Management Group LLC and its principal Kristofor R. Behn, of Foxboro, Mass., with defrauding retail investment advisory clients by failing to disclose inherent conflicts of interest.
The conflicts were related to Fieldstone's recommendations to invest in securities issued by affiliates of Oregon-based Aequitas Management LLC. The SEC also charged Behn with fraudulently misusing approximately $500,000 of one investor's funds to pay personal expenses. Read the entire SEC press release here.
The SEC found that the above described conduct violated:
- Sections 206(1) and 206(2) of the Advisers Act, which prohibit fraudulent conduct by an investment adviser.
- Section 17(a)(2) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5(b) thereunder, which prohibit fraudulent conduct in the offer or sale of securities and in connection with the purchase or sale of securities.
- Section 207 of the Advisers Act which makes it "unlawful for any person willfully to make any untrue statement of a material fact in any registration application or report filed with the Commission . . . or willfully to omit to state in any such application or report any material fact which is required to be stated therein."
When Competing Interests Collide
Investment advisors are responsible for the success of their business. They also have a fiduciary duty to put the interests of their clients first. These separate loyalties often create areas where interests compete and conflicts arise.
Not all conflicts of interest are easy to detect or clearly define. But the mere perception of a conflict of interest can imperil an advisor's reputation and have serious effects. As an example, clients who allege harm by a conflict of interest can bring lawsuits.
It's important to recognize and consider the many situations in which conflicts of interest can occur. While early detection of an apparent conflict can mitigate potential harm, knowledge of what can create conflicts, the implementation of related policies, and an ongoing commitment to supervise and enforce those policies are the best preventatives.
Common Areas of Conflict
Here are a few of the related pitfalls investment advisors must safeguard against in terms of potential conflict of interest:
Self-dealing occurs when an advisor has outside conflicting interests and acts in their own interest rather than the best interest of their client. It arises when someone in a position of trust violates that trust. An example would be advising a client to invest in financial products that are too expensive or unsuitable to earn a bigger commission.
All trading activity by employees in their personal accounts should require pre-approval. This prevents the perception that employees have traded in their personal accounts based on their knowledge of client trading. Pre-approval also eliminates the possibility of employee insider trading based on public non-material information.
Client favoritism is a conflict of interest that manifests in a variety of ways. Some of the biggest problem areas are giving incentives, additional services, or fee discounts to clients with higher assets under management. A notable exception is when a mutual fund offers breakpoints in the form of a reduction in front-end sales charges for larger investments.
A major area of concern is the potential for investment advisors to favor certain clients or service providers by providing excessive gifts or entertainment. Best practices to prevent these inherent conflicts of interest and implementing policies that provide for specific limits and requiring preapproval on all related expenses.
Let Our Knowledge and Experience Work for You
Jacko Law Group has worked with investment advisers to identify, eliminate, and mitigate conflicts of interest. If it's time to file the annual update of your firm's Form ADV Part 2A, we can assist in the review of disclosures to assess whether they provide enough transparency and information about the circumstances surrounding conflicts of interest and how they are handled.
For more information, contact one of our attorneys here.
- Senior Associate
Mr. Boeche provides strategic legal counsel to investment advisers, broker-dealers, private funds and other financial professionals. Mr. Boeche advises clients on all aspects of formation, registration, and ongoing ...
Add a comment
- Amadeus Wealth Advisors, Three Bridge Wealth Advisors Settle SEC Unlawful Proxy Charges
- Charging Fees for Inactive Accounts can be as Problematic as Churning
- SEC: Prudential Failed to Disclose Conflicts of Interest to Fund Boards
- SEC Charges Investment Bank Junior Analyst with Insider Trading
- SEC Files Charges in Fraudulent Token Manipulation Scheme
- OCIE Risk Alert: Guidance for Compliance, Supervisory and Disclosure Procedures
- Jury Returns Verdict for SEC in Case Against Broker Charged with Fraudulent Excessive Trading
- SEC Charges Investment Advisor with Defrauding Clients by Failure to Disclose Conflicts of Interest
- Charging Clients Fees Not Disclosed in Form ADV: State Street Settles with SEC for $88 Million
- The CFP's Revised Code of Ethics and Standards of Conduct Takes Effect
- Securities and Exchange Commission (SEC)
- Advisers Act
- Policies and Procedures
- Investment Advisers
- Office of Compliance Inspections and Examinations (OCIE)
- Form U5
- Ponzi Scheme
- Aging Clients
- Due Diligence
- Virtual Currency
- Regulation Best Interest
- Dodd-Frank Act
- Transition Services
- Private Equity
- Private Funds
- Personally Identifiable Information (PII)
- Hedge Funds
- Regulatory Examinations
- Government Shutdown
- Risk Alert
- Securities Law
- Social Media Marketing
- Exchange-Traded Funds (ETFs)
- Investment Company Act
- Rule 6c
- Broker Protocol
- Wells Fargo