A conflict of interest is defined as a conflict between the private interests and the official responsibilities of a person in a position of trust. In the investment business, investors are exposed to significant conflicts of interest. Clients are looking for advice. But financial firms are in the business of selling products and generating profits. Those products can be traditional brokerage services or investment advisory services. Advice from stockbrokers and financial advisors is typically considered incidental to the sale of products they are promoting or helping their client buy. In other words, broker-dealer firms are there to facilitate a transaction on behalf of the customer, with the focus on the transaction and not the advice.
Conflicts of interest present a source of risk to the attainment of client objectives. Investment firms should take all reasonable steps to mitigate and control for any conflicts of interest that arise in the course of business. This requires firms, where appropriate, to separate operating functions of the business; to establish vertical reporting structures; to make clear and complete disclosures; and to take measures to ensure independence, objectivity, and accountability in the investment decision-making process. Such measures are necessary to protect client interests.
To make matter more confusing, many advisors are dual registered as advisors and brokers. Additionally, they may also be insurance licensed. If one looks closely at the business card of many stockbrokers, one may see the words: advisory and brokerage services. But providing objective advice to clients is exceptionally difficult for the salespeople employed at these firms.
The U.S. Departments of Labor’s focus on conflicts in investment advisor arena culminated recently with its implementation of its so-called Fiduciary Rule (see Fiduciary Duty). Similarly, the Dodd–Frank Wall Street Reform and Consumer Protection Act Dodd-Frank of 2010 directed the SEC to study the appropriateness of adopting a fiduciary standard for broker-dealers when dealing with retail investors. Prior to Dodd-Frank, there were a number of studies suggesting that the majority of customers of firms dually registered as both broker-dealers and investment advisors had little to no understanding of the nuance of such relationships. That is, customers were largely unaware when their financial advisor was acting as a broker (subject to a “suitability” standard) versus as an advisor (subject to a fiduciary standard). Furthermore, neither did most customers understand the differences between each standard.
The SEC’s study at Dodd-Frank’s behest recommended that the SEC should exercise its rulemaking authority to implement a uniform fiduciary standard of conduct for broker-dealers and investment advisors when providing personalized investment advice about securities to retail customers. The SEC has not yet engaged in formal rulemaking.