This is an archived article that was published on sltrib.com in 2014, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.
What's a conflict of interest?
An interesting case was reported recently by the Securities and Exchange Commission that gives a good example of the type of conflict of interest that might arise between a financial firm and its clients.
The case had to do with a Houston-based firm that sold mutual funds to its clients, with a payment coming back to the firm from another party.
Let me paint the picture: The firm had an arrangement with a registered broker-dealer. The broker would pay from 2 to 12 basis points as "eligible shareholder servicing fees on eligible NTF mutual funds" based on varying levels of NTF assets. NTF stands for "no transaction fee," meaning when an order to buy or sell is entered, there is no charge to the client.
So, effectively, the clients were buying funds for which they were not charged a transaction fee. However, the firm managing the client's money was getting paid to put the clients in those funds.
That's a conflict of interest.
Why? The payment arrangement creates an incentive for the firm to favor those mutual funds over others.
Even more importantly, the firm had a chance to let its clients know the arrangement, but did not. These payments were undisclosed, asserted the SEC, even though clients were told that the firm "may receive compensation" from the broker.
Payments were actually being received by the firm from the broker. Hence, quoting from the release, "Unbeknownst to investors, [the firm] had an incentive to recommend these funds to clients over other investment opportunities and generate additional revenue for the firm."
According to Marshall S. Sprung of the SEC Enforcement Division: "Payments to investment advisers for recommending certain types of investments may taint their ability to provide impartial advice to their clients. By failing to fully disclose its agreements with the brokerage firm, [the Houston firm] deprived its clients of important information they were entitled to receive."
In another 2012 case, two Portland, Ore., firms had a revenue-sharing agreement for a particular category of mutual fund. Once again, the SEC found that to be a conflict of interest.
"Payments to investment advisers for recommending certain types of investments may corrupt their ability to provide impartial advice to their clients," said Bruce Karpati, chief of the SEC Enforcement Division's Asset Management Unit, quoting from a 2012 release. "[The firm] kept their clients in the dark about this and other conflicts of interest that investors are entitled to know about and advisers must disclose."
These are two examples of conflicts. I'm certain we will be seeing more enforcement actions as time goes on. Regulators want to ensure that clients are fully informed of potential conflicts, especially since the consumer would be in the dark about these particular types of arrangements.
One way to protect yourself is to ask the firm you are working with for a full explanation of any incentive to recommend a particular investment or course of action. You'll run across sales incentives for financial advisers to sell a particular product or service, sales contests, referral fees and so on.
Disclosure documents are your first line of protection. Then there is nothing better than good old-fashioned face-to-face questioning. Just ask: What incentives do you have to recommend a particular product or service over another? You'll want to hear that there are none. That's a conflict-free environment.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/ comments (readers@juliejason.com).