The seriousness of Conflicts of Interest in Financial Services

August 29, 2022

I am authoring a new book about the stock market. It will be published this year.

It’s because capital markets have become downstream to the financial services industry culture, which is killing independent investment and making the bankers and their closest associates wealthier.

Agents in financial services have become far more powerful than the principal owners of capital. As a consequence, bottom-up capitalism is eroding and being turned into a tightly controlled socialist market economy like China’s with a few people like Larry Fink and Mark Carney advising political leadership.

The book is my way of helping the average person take back control of the system by motivating them and enabling them to make important personal decisions with their capital. I am also hoping that political conservatives will soon recognize the need to replace the 1933 and 1934 Securities Acts with legislation that puts power into the hands of individuals and not their agents.

For several decades I have complained in government task forces and formal hearings about how the Securities Act and Securities Exchange Act are structured to facilitate conflict of interest. Now, apparently, the SEC is looking into the matter but is focused on only a small part of the big picture. Rather than take on the egregious conflicts within Humongous Bank and Broker (HB&B), this article in Financial Advisors magazine proves to me they are unprepared to reconsider the whole body of 90-year-old legislation that broke down over 50 years ago and now is impossible to oversee as regulators in the electronic age.

Here is the magazine article:

SEC to Advisory Shops: Resolve FAs’ Conflicts of Interest, Quick

Advisors getting commissions, bonuses, gifts, and other incentives? Companies must have policies in place and make sure advisors are compliant, according to the regulator.

By Sam Del Rowe|August 29, 2022

The Securities and Exchange Commission is taking a more aggressive posture toward conflicts of interest, requiring broker-dealers and registered investment advisor firms to disclose and, when possible, eliminate them.

The regulator issued a question-and-answer bulletin earlier this month, outlining how broker-dealers and RIA firms should handle conflicts of interest.

And industry lawyers say that the increased complexity of the advice business — from shifting models to emerging products — similarly complicates the nature of conflicts advisors face.

Both Regulation Best Interest for broker-dealers and the fiduciary standard for RIA firms under the Investment Advisers Act of 1940 are “drawn from key fiduciary principles that include an obligation to act in a retail investor’s best interest and not to place their own interests ahead of the investor’s interest,” the SEC reminded the firms.

The bulletin “should be seen as a roadmap for firms to prepare for examinations.” Bates Group

Examples of conflicts include compensation, revenue or other benefits — such as commissions, markups, bonuses, gifts, entertainment, travel and sales or offers of proprietary products or services — made to the firm, its financial professionals or its affiliates, according to the SEC. Such conflicts may also arise from attending a third-party-sponsored conference or training event, for example.

Roadmap for Examinations

The bulletin “should be seen as a roadmap for firms to prepare for examinations,” according to Bates Group, a financial consulting firm.

The SEC “is reiterating standards of conduct for handling conflict situations under the Investment Advisers Act of 1940 and Reg BI — and focusing on compensation and proprietary products as examples,” according to law firm The Wagner Law Group.

Prior to Regulation Best Interest, disclosure was the primary way of handling conflicts of interest, but the SEC now has “a much stricter stance on conflicts” and requires firms to eliminate or mitigate them in addition to disclosing them, according to Amy Lynch, founder and president at FrontLine Compliance, a Rockville, Maryland-based compliance consultant. Lynch is a former SEC examiner.

Advisory firms should first look to eliminate conflicts and move to mitigation if those conflicts are intrinsic to its business model, according to Ira Kustin, a partner in the investment-management practice at law firm Paul Hastings.

“To the extent that you can eliminate conflicts, that obviously is ideal from the SEC’s perspective. In a lot of circumstances, especially for larger, global advisors with multiple business lines, it’s impossible to eliminate certain conflicts,” Kustin said.

When conflicts can’t be eliminated, the SEC wants the firms to do their best mitigate the conflict and reduce the potential harm to an investor, according to Kustin.

Sometimes, the SEC “expects you to disclose the fact that the conflict is out there, describe to the extent that you can how you attempt to mitigate it, and be clear…”Ira Kustin  Paul Hastings

“That’s a situation where the SEC, at a minimum, expects you to disclose the fact that the conflict is out there, describe to the extent that you can how you attempt to mitigate it, and be clear about situations where a certain type of conflict just can’t be eliminated,” Kustin said.

Mitigating or eliminating conflicts can be trickier with multiple business lines, according to Kustin.

“If you have multiple business lines with multiple teams of investment professionals, for one reason or another they may have ethical walls in place and those multiple investment teams are prohibited from discussing details with each other, they may be taking an approach to similar investments that are in conflict,” Kustin said.

“That’s one situation where it’s impractical to eliminate the conflict and it’s just part and parcel of the advisor’s business model,” he added.

‘Mom and Pop’ Investors

Kustin notes that the SEC’s guidance is aimed at protecting retail investors.

“A lot of the content of that latest guidance seems geared more towards advisors who have a retail investor base. For larger managers of private funds, most of them will already have policies and procedures in place to address these issues and it’s something that they’ll already be documenting in writing,” he said.

Consolidation may be one reason for the SEC’s increased attention toward conflicts of interest, according to FrontLine Compliance’s Lynch.

“There’s been a lot of consolidation in the industry since the financial crisis. The fact that there have been so many mergers and acquisitions, joint ventures and new affiliations created — that is a primary way that conflicts are created is through new relationships,” Lynch said.

“Twenty-five years ago, all we were talking about were stocks, bonds and mutual funds — that was it. But look at the market today and what we have — there are so many different types of products … [that could cause] conflicts.”Amy Lynch FrontLine Compliance

“When firms have multiple entities that they are doing business with, that means multiple revenue streams and various ways that conflicts can be created,” she added.

New products and services may be another reason for an increase in conflicts, according to Lynch.

“Twenty-five years ago, all we were talking about were stocks, bonds and mutual funds — that was it. But look at the market today and what we have — there are so many different types of products available that can be offered to clients that just the sheer number and complexity of the types of products also causes conflicts,” she noted.


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