A new report by Finra designed to help brokers avoid conflicts of interest encourages them to adopt a code of conduct that sounds similar to the fiduciary standard followed by investment advisers.
Last Monday, the Financial Industry Regulatory Authority Inc. issued a report based on its observations of 14 large firms.
Finra suggested that firms avoid conflicts by:
• Establishing a firmwide focus on conflicts to set a “tone from the top.”
• Implementing a code of conduct based on the “best interests” standard.
• Making investment recommendations that don't favor proprietary products.
• Compensating brokers independently of the products that they recommended.
“The word "fiduciary' jumps out on every page, even though it isn't mentioned,” said Duane Thompson, senior policy analyst at Fi360 Inc., a fiduciary-duty consulting firm. “Finra seems to be moving inexorably in the direction of emphasizing a fiduciarylike standard for disclosure of conflicts.”
Investment advisers must act in the best interests of their clients, or meet a fiduciary standard, while brokers adhere to the less stringent suitability standard.
The Finra report is a natural follow-up to its recent modification of the suitability rule, according to Mr. Thompson. That adjustment added more duty-of-care elements to suitability, while the conflicts report addresses duty of loyalty.
With the release of the conflicts report, another regulator is jumping into the debate over the standard of care for retail clients, according to Matt Kitzi, a partner at Armstrong Teasdale LLP.
Last week, an advisory group at the Securities and Exchange Commission urged the SEC to move ahead with a rule that would impose a uniform fiduciary standard for retail investment advice.
“There's some building of momentum behind these discussions of disclosure, and dealing with conflicts of interest and working in the client's best interests,” said Mr. Kitzi, a former Missouri securities commissioner.
Firms likely to take hint
Although the Finra report doesn't create any new requirements for firms, it is likely that brokerage firms will take the hint and start to implement some of the practices, experts said.
“I wouldn't be surprised to see more-detailed frameworks that firms are going have to use to identify and remedy conflicts,” said attorney Patrick Mahoney.
He is watching for changes in how brokers are paid.
“Broker compensation is at the heart of these conflicts of interest,” Mr. Mahoney said.
But one observer said that Finra's guidance doesn't have the teeth to make a real difference in how firms manage conflicts.
“The report is overdue,” said Jonathan G. Heller, president of JGHeller Private Wealth Advisors Inc. “I don't think it goes as far as it needs to to create significant changes in the industry. What it identifies are things that have been talked about within management circles for many years.”
The report does, however, show that Finra is thinking about best-interests standards.
“Finra continues to test the waters, but given the SEC's responsibility in this area, it can't go further with the F word,” Mr. Thompson said. “If Congress were to consider a [self-regulatory organization] in the future for investment advisers, one can say that Finra has certainly polished its résumé in this area.”
Doug Schriner, president of FA Risk Management Inc., also sees “mission creep” in the Finra conflicts report, following the demise of legislation last year that would have established an adviser SRO.
“If you can't bring the [registered investment advisers] to Finra, you bring Finra to the RIAs,” he said.
In the report, Finra identified dozens of potential conflicts outlined by broker-dealers that the regulator surveyed, ranging from managers who spend more time on revenue-generating activities than supervision, compliance staff subjected to sales pressure, and registered representatives recommending fee-raising transactions without regard to their suitability for clients.
“While many firms have made progress in improving the way they manage conflicts, our review reveals that firms should do more,” Finra chairman and chief executive Richard G. Ketchum said in a statement. “To help firms analyze the conflicts they face and implement a conflicts management framework appropriate to the size and scope of their business, we are publishing examples of how some large broker-dealer firms address conflicts.”
In the report, Finra called compensation a “major” source of conflicts of interest.
“The rewards firms offer associated persons may influence their behavior in ways that affect customer interests,” the organization said, adding that it focused on four specific areas that it said could “create, exacerbate or mitigate compensation-related conflicts of interest.”
The areas included compensation for brokers, surveillance and supervision of registered representatives as they approach compensation thresholds, compensation for supervisory personnel, and deterrents to poor conflicts management.
Finra's suggestion that firms cap the amount of revenue from a mutual fund or variable annuity fund that can be credited to a broker didn't sit well with Mr. Schriner.
“That strikes me as anti-competitive and ignorant of pricing models used in the industry,” he said.
New funds have to pay bigger commissions to increase exposure.
“That [marketing] has to be compensated,” Mr. Schriner said.
Trevor Hunnicutt contributed to this story.