Conflicts of Interest - Disclosure and Management
Understanding prohibited activities is essential, but not every conflict of interest results in a prohibition. Many conflicts are manageable through proper disclosure. This final section covers the disclosure frameworks for both investment advisers (IAs) and broker-dealers (BDs).
IA Conflict Disclosure Requirement
Under Model Rule 102(a)(4)-1(j), investment advisers must disclose in writing before rendering any advice:
- Every material conflict of interest that could reasonably be expected to impair the rendering of unbiased and objective advice
This includes but is not limited to:
- Additional compensation arrangements beyond what the client pays
- Receiving commissions for executing trades pursuant to the advice given (dual compensation)
The key phrase is "in writing before any advice is rendered" - oral disclosure alone is not sufficient, and the disclosure must come before the advice, not after.
Exam Tip: Gotchas
- Oral disclosure alone does NOT satisfy the IA requirement. The disclosure must be in writing. An exam question asking whether verbal disclosure is sufficient for an IA has only one answer: no.
- The disclosure must come before the advice is rendered, not at the same time or after.
BD Conflict Disclosure (Regulation Best Interest)
Under SEC Regulation Best Interest, broker-dealers and agents have four obligations when making recommendations to retail customers:
| Obligation | Requirement |
|---|---|
| Disclosure Obligation | Provide a brief summary of the material facts relating to conflicts of interest associated with the recommendation |
| Care Obligation | Exercise reasonable diligence and care to ensure the recommendation is in the retail customer's best interest |
| Conflict of Interest Obligation | Establish, maintain, and enforce policies to address conflicts of interest |
| General Obligation | Not place the BD's or agent's financial or other interest ahead of the retail customer's interest |
Exam Tip: Gotchas
- Reg BI is a best-interest standard, not a suitability standard. A recommendation can be suitable but still violate Reg BI if a better option existed for the client. Suitability only asked "is this appropriate?" Reg BI asks "is this in the client's best interest?"
BD Control Relationship Disclosure
Under NASAA BD Dishonest Practices 1t:
- Must disclose control relationships with issuers before entering into any transaction with the customer
- If oral disclosure is given first, it must be supplemented by written disclosure at or before completion of the transaction
- Control relationships include: controlled by, controlling, affiliated with, or under common control with the issuer
IA vs. BD Conflict Disclosure Comparison
| Investment Adviser | Broker-Dealer | |
|---|---|---|
| Standard | Fiduciary duty | Regulation Best Interest |
| Timing | In writing before any advice is rendered | Before or at the time of the recommendation |
| Scope | All material conflicts that could impair unbiased advice | Material facts relating to conflicts associated with the recommendation |
| Form | Written (required) | Form CRS (Customer Relationship Summary) + written disclosure |
| Ongoing | Continuous obligation | Per-recommendation |
Practical Examples of Conflicts Requiring Disclosure
- An IA that also receives commissions as a registered representative of a BD (dual registration)
- An IA that receives referral fees for recommending specific products
- A BD that earns revenue-sharing payments from mutual fund companies whose products it recommends
- An agent who receives higher commissions for selling proprietary products versus third-party products
- An IA that has a control relationship with a company whose securities it recommends to clients