RIA Compliance and Practice Management Blog

Compliance for RIAs: How to avoid and address conflicts of interest

Posted by RIA in a Box

Nov 29, 2022 9:27:22 AM

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As a registered investment adviser (RIA), your firm is subject to various rules and regulations – each put in place to protect the firm, its employees and investors.  

One of the most important areas for investment advisory firms to monitor is potential or active conflicts of interest. Today, we’re discussing the most common areas related to conflicts of interest and what firms can do to both prevent and/or address these situations. 

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The fiduciary duty of RIAs

If you’re an investment adviser representative, fiduciary duty is nothing new to you. As a fiduciary, you provide advice and services to a client over the course of their relationship at a frequency that is both in the best interest of the client and consistent with the scope of advisory services you offer. It requires an agreed upon contract between the investment adviser and the client.  

As an extension, conflicts of interest must be carefully considered and monitored throughout the relationship. The Securities and Exchange Commission (SEC) recognizes it is impossible to eliminate all potential conflicts. Which is why the regulatory organization created certain filing requirements, including Form CRS (also known as the Client Relationship Summary) – so clients are made aware of conflicts prior to entering a fiduciary relationship with your firm.  

But, as conflicts are bound to arise for every RIA, it is important to understand how to respond when they do. 

Where can conflicts of interest arise for RIAs?

There are three main areas RIAs should be aware of when identifying conflicts of interest: 

Employees

Every employee within your firm should be reviewed for conflicts of interest. Conflicts may arise from relationships an employee has with a client or mutual third party.  

You’ll also need to be aware of any financial or business affiliations your employees may have if a conflict of interest relating to those affiliations arises.  

Compensation or Commission

Common conflicts of interest which arise in terms of compensation relate to partnerships advisers develop with fund managers. If an adviser at your firm generates profits from certain funds sold, you must inform your clients.  

In addition, any insurance products or partnerships your firm participates in could be a risk for conflicts.  

Advice

The advice RIAs give should be as close to free from conflicts of interest as you can get. If it isn't, then you are at risk of (consciously or unconsciously) putting personal stakes in the way of fiduciary duty – a violation of SEC regulations.  

While conflicts of interest can and certainly do arise outside of these three categories, these will give you a solid jumping off point for analyzing potential violations.  

What to do about conflicts of interest

When you identify a conflict of interest, take these three steps as soon as possible: 

Step 1: Disclose the conflict immediately

The number one rule when you identify a conflict of interest is to disclose it to all affected parties immediately and in writing. Any relationships potentially affected by the conflict must be promptly notified before any other action can take place. 

Remember, those disclosures must be clear and detailed enough for a client to understand and make reasonably informed decisions to consent or reject working with your firm. Avoid any words which leave room for interpretation, such as “may” or “could.” 

Step 2: Address the conflict

After it has been disclosed, your firm can work to address the issues. A conflict doesn’t automatically mean you can’t work with a certain client. Discuss the issue directly with them – are they okay with it? Is there some way you or the client can remove the conflict altogether? 

Step 3: Take action

Lastly, you will need to take action (if applicable). Whatever decision or agreement you and the client make should be put in place as promptly as possible to avoid regulatory penalties from the SEC and/or damage to your firm’s reputation. Make sure the disclosure is built into all appropriate policies and procedures going forward. 

How to protect yourself from conflicts of interest

The best way to create a firm with limited conflicts of interest is to implement tailored policies and procedures. Does your employee onboarding process explore possible conflicts of interest? What about your client onboarding system? If not, these are a great place to start. 

Another strategy is to implement the right technology. Look for software systems which include employee monitoring and compliance assistance which can integrate across all your processes. This can help take the heavy lifting out of identifying and preventing conflicts of interest from interrupting your financial planning.  

For more information on mitigating conflicts of interest, review our prior blog post on the SEC’s staff bulletin addressing conflicts and best practices. Keep in mind, advisers must determine if they can eliminate certain conflicts, and, if that is not possible, they must decide if the advice could be influenced by the conflict. In that case, the investment adviser should refrain from giving advice to avoid violating its obligation to act in the investor’s best interest.  

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RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

Topics: RIA Operations, RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

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