FINRA Publishes Report on Conflicts of Interest in the Broker-Dealer Industry (with Lofchie Comment)

FINRA has published a report regarding conflicts of interest in the broker-dealer industry in order to highlight effective conflict management practices that go beyond regulatory requirements. FINRA provided numerous recommendations to help firms build an effective conflict management framework, a few of which were as follows:

• identify and manage conflicts on an ongoing basis through an enterprise-level approach that carries through to the organization's structures, policies, processes, training and culture;
• establish new product review processes that include perspectives independent from the business line proposing the relevant product;
• make independent decisions in the wealth-management business about the products they offer without pressure to favor proprietary products or products for which the firm has revenue-sharing agreements;
• mitigate conflicts of interest through disclosures and other information that enables customers to understand the factors that may affect a product's financial outcome; and
• include "best-interest-of-the-customer" standards in codes of conduct that apply to brokers' personalized recommendations to retail customers in order to maintain and increase investor trust.

Lofchie Comment: This is a significant and thoughtful report, particularly with regard to conflicts of interest. Senior compliance and business people should review the report carefully, both as a means of evaluating their own policies and as an indication of the direction in which the regulators are heading.Regulatory recommendations should be viewed with a critical eye in light of business practicalities and regulatory risk. A FINRA recommendation that should be viewed with great caution is the requirement that a firm adopt a "best interests of the customer" standard in its compliance manuals. This seems to me to be an invitation to both an enforcement action and litigation. For example, anything that a firm puts in its compliance manual becomes, effectively, "law" as to that firm; and, accordingly, a firm may be subject to sanction for failing to comply with the terms of its manual. In short, a firm that requires itself to act in the best interest of the client is liable to be subject to sanction or lawsuit for failing to comply with an ambiguous standard in a situation in which a client may have lost money.

See: FINRA's Report, Report on Conflicts of Interest. FINRA Press Release.Related news: SEC Charges Hedge Fund Adviser with Breaching Fiduciary Duty by Participating in Conflicted Principal Transaction (September 18, 2013).