RIA Compliance: The Conflicts Resulting from Wearing Multiple Hats
Many Registered Investment Advisor (RIA) firms offer insurance, tax and accounting, legal, business consulting, and other services to their investment advisory clients. Some registered Investment Advisor Representatives (IARs) are also Registered Representatives at broker-dealers, or are registered with more than one RIA in order to provide different types of investment advisory services or investment products.
The lure of offering services other than investment advice is attractive, but not all RIAs understand that compensation the RIA, its affiliates, or its associated persons receive in connection with the investments they recommend and related services they provide can result in conflicts of interest between the RIA and the client.
Conflicts may include, but are not limited to:
The incentive to recommend services not in the client’s best interest.
The receipt of additional compensation.
The incentive to recommend investment advisory services where a higher fee can be earned.
Material business relationships with affiliates.
Federal and state securities laws require RIAs (even those not required to be registered) to abide by Section 206, the anti-fraud provision of the Investment Advisers Act of 1940 (the Advisers Act). Fundamental to the Advisers Act is the notion that an RIA is a fiduciary to its clients and as a fiduciary is obligated to avoid overreaching or taking an unfair advantage of a client’s trust, and to eliminate or disclose potential conflicts of interest.
This fiduciary duty is not explicitly set forth in the Advisers Act, SEC rules, and state securities laws, or the result of an advisory contract (i.e., it cannot be negotiated away). Rather, an RIA is a fiduciary by operation of law because of the nature of the relationship between the RIA and its clients.
SEC guidance touches on the disclosure requirements an RIA must make with respect to conflicts of interest arising from investment recommendations made by the firm:
An RIA has a fiduciary duty of loyalty to disclose conflicts of interest, but also must abide by the specific disclosure requirements in Form ADV.
An RIA must make full and fair disclosure to its clients of all material facts relating to the advisory relationship, including conflicts of interest that may incline the RIA – consciously or unconsciously – to render advice that is not disinterested.
At a minimum, the RIA should mitigate conflicts of interest, if it cannot eliminate them entirely.
The SEC has stated the disclosure Brochure should be concise, direct, appropriate to the financial sophistication of the adviser’s clients, and must be written in plain English. As a result, longer disclosures may not be better disclosures.
While Form ADV requires that material conflicts of interest must be clearly disclosed in the written Brochure, we frequently advise our clients that material conflicts should also be orally disclosed to the client at the time the services are offered. State and federal securities examiners frequently inquire during routine firm examinations how the IAR explains to the client that a material conflict of interest exists, and what the RIA does to mitigate or eliminate the conflict.
For example, suppose an IAR is also a licensed and registered insurance producer. The IAR has determined an insurance product is suitable based on the client’s investment profile. How does the IAR explain to the client that the IAR is a fiduciary at the time the investment recommendation is made, but that the IAR is no longer a fiduciary when they put on the insurance producer hat and recommend a specific insurance product?
In this rather simplified example, the IAR should explain to the client at the time the investment recommendation is made that they are acting as a fiduciary, but when they act in the capacity of an insurance producer they have no fiduciary duty to place the client’s interests before their own. The IAR should explain that the RIA has procedures in place to ensure that if the IAR receives a commission or fee on the sale of insurance products, the client will not also be charged an advisory fee for the management of the product in the client’s account.
Given the potential consequences of violations of federal and state securities laws related to full and fair disclosure of material conflicts of interest, we urge RIAs to seek guidance with respect to possible issues that may arise. IARs should seek guidance from the firm’s Chief Compliance Officer. If a particular transaction or situation does not cause a real or potential conflict of interest, or if the RIA can establish appropriate safeguards, the RIA may grant exceptions to situations involving a material conflict of interest. Such exceptions should be requested in writing, and should only be granted by the Chief Compliance Officer after a fulsome review.
Determining whether a particular situation may create a potential or apparent conflict of interest and resolving such a conflict may not always be easy. Situations will inevitably arise that require application of a qualified compliance consultant to particular circumstances.
If you would like to learn more about whether your RIA’s other services or activities create a material conflict of interest, or if you need help mitigating or eliminating a material conflict of interest, please contact us at Info@AdvisorGuidance.com.
