Home – FINRA® Reports on Best Practices to Avoid and Mitigate Conflicts of Interest in Manufacturing and Selling Financial Products

FINRA® Reports on Best Practices to Avoid and Mitigate Conflicts of Interest in Manufacturing and Selling Financial Products

 Saying it recognizes the progress made by financial broker-dealer firms in better managing conflicts of interest, the Financial Industry Regulatory Authority, Inc. (FINRA®) issued a 44-page report recommending best practices―not new regulations, the Authority stressed―to “carry forward” the progress made in this area.

                      

Basing its recommendations on surveys and reviews of a number of broker-dealers since July 2012, FINRA focused its attention on identifying and managing conflicts in what it determined were three critical areas.

 

1.  Enterprise-level frameworks to identify and manage conflicts of interest.   

This discussion examines how firms address conflicts across their business lines “from a top-down perspective,” the report says. “To be effective, firm leadership should require not only adherence to the letter of the law, but a commitment to the highest ethical standards and to putting customers’ interests first.” The framework to support leadership should include:

    1.  Defining conflicts relevant to a firm’s business and assisting staff in identifying conflicts.
    2. Articulating employees’ roles and responsibilities in identifying and managing conflicts.
    3. Establishing mechanisms to identify conflicts as a business evolves.
    4. Outlining procedures for escalating conflicts across the business.
    5. Avoiding severe conflicts even if it means passing on business opportunities.
    6. Disclosing conflicts to clients.
    7. Training staff to identify and manage conflicts.
    8. Reporting significant conflicts to the CEO and board.


       

 2. Approaches to handling conflicts of interest in manufacturing and distributing new financial products.

 

 “Firms at the forefront of financial innovation are in the best position, and are uniquely obligated, to identify the conflicts of interest that may exist at a product’s inception or that develop over time,” the report reads. Effective practices to avoid such conflicts include: 

      1. Implementing a product review process that includes a mandate to identify and mitigate conflicts of interest.
      2. Disclosing conflicts to customers “in plain English” so they understand them.
      3. Implementing “Know Your Distributor” policies to mitigate the temptation to use channels that do not have adequate controls.
      4. Performing post-launch reviews and taking remedial action to address conflicts.
      5. Declining to offer products where serious conflicts are beyond mitigating.

     

“To reduce conflicts,” the report says, “firms’ private wealth businesses should operate with appropriate independence from other business lines within a firm. FINRA is encouraged by firms’ general adoption of open product architectures (i.e., the sale of third-party in addition to proprietary products). Nonetheless, firms involved in both the manufacture and distribution of products should maintain effective safeguards to alleviate pressure to prefer proprietary products to the detriment of customers’ interests. This is particularly important as firms seek to leverage their brokerage and other platforms to cross-sell products and services. Equally important, firms with revenue sharing or other partnering arrangements with third parties should exercise the necessary diligence and independent judgment to protect their customers’ interests.”

 

3. Approaches to compensating their associated persons, particularly those acting as brokers for private clients.

 Many firms have taken steps to mitigate conflicts in compensation for associate persons directly through changes to compensation and arrangements, and through supervision of registered representatives’ sales activities, the report says, sharing best practices that include: 

    1. Using “product agnostic” compensation grids to reduce incentives for registered representatives to prefer one type of financial product over another, such as when sale of one generates a higher commission over another . 
    2. “[Linking] surveillance of registered representatives’ recommendations to thresholds in a firm’s compensation structure to detect recommendations, or potential churning practices, that may be motivated by a desire to move up in the compensation structure and, thereby, receive a higher payout percentage.” 
    3. Enhancing supervision of a representative’s recommendations as that person approaches significant compensation milestones. 
    4. Enhancing supervision of a registered representative’s recommendations around “key liquidity events” in an investor’s lifecycle, such as during a 401(k) rollover. “The recommendations a representative makes at this stage of an investor’s life have profound implications for the investor and deserve thorough scrutiny and review.” 
    5. Reducing a representative’s preference for one product over another by capping the credit he or she can receive for a comparable product across providers.  
    6. Imposing compensation adjustments on representatives who do not properly manage conflicts.

  The full report may be downloaded from the FINRA website at:  http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p359971.pdf