FINRA Addresses Conflicts of Interest In the Sales of Securities

In the securities industry conflicts of interest can arise where a duty of care or trust exists between two or more parties.  While the existence of a conflict does not always mean that one party will be harmed by the other party’s interest, brokerage firms have been involved in many situations where they did not effectively and fairly manage conflicts of interest.

The Financial Industry Regulatory Authority (FINRA) recently issued a “Report on Conflicts of Interest” that focused on enterprise-level frameworks to identify and manage conflicts of interest; approaches to handling conflicts of interest distributing new financial products; and approaches to compensating their associated persons.

Part of FINRA’s focus on conflicts on interests focused on the introduction of new financial products.  FINRA recommended a number of effective practices to address conflicts in the issuance of new securities.  First, firms can use a new product review process that includes identifying and mitigating conflicts that a product may present. Second, firms should disclose those conflicts in plain English to ensure that customers comprehend the conflicts that a firm or registered representative have in recommending a product.  FINRA reminded firms that conflicts may be particularly acute where complex financial products are sold to less knowledgeable investors, including retail investors.

Third, firms can perform post issuance reviews of new financial products to identify potential problems with a product that may not have been readily apparent during the initial review.  These problems can arise as a result of economic events that occur post launch.  FINRA reminded firms that they should take remedial action to address discovered flaws.  Fourth, firms can decline to offer products to customers when the conflicts associated with those financial products are too significant to be mitigated effectively.

Finally, to reduce conflicts, firms’ private wealth businesses should operate with appropriate independence from other business lines within a firm.  Independent operation can limit conflicts that exist across multiple groups within the company that are involved in the transaction.

FINRA also identified the following firm vs. client conflicts that can arise in the sale of securities and that should be mitigated.

–        The firm offers or recommends products for which the firm receives greater fees/ compensation than other products.  Such products may not be suitable for certain clients.

–        The firm may be involved in multiple roles with respect to the securities transaction as advisor, underwriter, lender, principal counterparty, or derivative counterparty

–        The firm engages in trading activities for its own account or client accounts while other clients of the firm are also active in the market at the same time.

–        The firm may provide investment advice to its clients and the firm also recommends products that it or affiliated companies issue.

Identifying and mitigating conflicts of interests is important to ensuring that brokerage firms’ recommendations to clients are not being influenced by other factors other than the client’s best interests.

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