The Securities and Exchange Commission has put out a questions-and-answers bulletin explaining how broker-dealers and investment advisors should approach conflicts of interest.
The SEC starts the Q&A by confirming that yes, all broker-dealers and investment advisors do indeed have conflicts of interest.
“Specifically, they have an economic incentive to recommend products, services, or account types that provide more revenue or other benefits for the firm or its financial professionals, even if such recommendations or advice are not in the best interest of the retail investor,” the SEC wrote.
The conflicts can include those related to compensation, revenue or other benefits — including commissions, markups, bonuses, gifts, entertainment and travel — to the firm, its financial professionals or its affiliates for the services rendered to retail investors, according to the regulator.
The SEC also emphasizes that it’s the firms’ responsibility to identify the conflicts of interest, as per Regulation Best Interest and the Advisers Act.
To do so, firms should define conflicts of interest, establish a process to identify them, ensure an ongoing and periodic process to do so and establish training programs for financial professionals about identifying conflicts of interest and bringing them to the management’s attention, according to the regulator.
“Finally, the staff believes that firms should establish a ‘culture of compliance,’” the SEC wrote. “As applied to conflicts of interest, creating an environment where conflicts are taken seriously and financial professionals feel empowered and encouraged to take an active role in identifying conflicts so that they may be adequately addressed may significantly decrease the likelihood of a violation."
The regulator also said that identifying and disclosing any conflicts of interest isn’t sufficient, as some of them “should (and in some cases, must) be addressed through mitigation.”
To do so, the SEC suggests that firms avoid compensation thresholds that promote incremental sales of certain products or services, minimize compensation incentives favoring one type of account over others, eliminating compensation within comparable product lines, adjusting compensation for professionals who fall afoul of managing conflicts of interest and limiting the types of products or strategies that can be recommended by their financial professionals.
In addition, certain conflicts of interest must be eliminated altogether, with particular attention to benchmarks, quotas and other performance metrics set on the firms’ financial professionals, according to the regulator.
Back in 2020, Merrill Lynch said it was restricting what its staff can accept as gifts and entertainment from investment managers and other third parties.
Due to “potential conflicts of interest,” third-party product and service providers will no longer be able to “pay for gifts, meals and entertainment for employees” of Merrill, the firm told staff at the time.
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