Fiduciary Corner

Blaine F. Aikin

Finra's call to arms to put clients first

All that's left out of regulator's new conflicts of interest report is reference to the word "fiduciary'

Jan 5, 2014 @ 12:01 am

Have you made a New Year's resolution for your business? Here's a suggestion: Worry less about what new laws and regulations are in the offing and concentrate more on how your company's culture serves clients.

In the interest of proper attribution, that suggestion is derived from a statement made by Finra chief executive Richard Ketchum during the Securities Industry and Financial Market Association's annual conference in New York in November. Mr. Ketchum was speaking about the regulatory developments that may broaden application of the fiduciary standard to personalized advice when he advised the audience to “worry less about the legal standpoint; worry more about it from a cultural standpoint.”

Mr. Ketchum and the folks at the Financial Industry Regulatory Authority Inc. clearly have been giving a great deal of thought to how fiduciary principles should apply in the broker-dealer businesses that Finra regulates. The best evidence of this comes in the form of a 44-page report on conflicts of interest released by Finra in October. At the time, Mr. Ketchum explained that the report was intended “to highlight effective conflicts management practices that may go beyond current regulatory requirements.”

It focuses on three critical areas: enterprise-level frameworks to identify and manage conflicts, approaches to handling conflicts of interest in manufacturing and distributing new products, and compensation arrangements.


Conflict management is tied directly to the “tone from the top” of the organization and an institutional commitment to “ethical decision making and fair treatment of customers.” These values “must be backed by “strong supporting structures, policies, processes, controls and training.”

In regard to conflicts associated with new products, recommended best practices include the use of pre- and post-launch product review processes to anticipate and mitigate conflicts as part of standard product development and management.

Plain-English disclosures are also highlighted, with admonishment from Finra that “firms should look beyond minimum-disclosure obligations under statute, regulation and case law to identify practices that are effective in helping customers make informed decisions.” Firms are urged to reject products and decline to engage certain product distributors when conflicts cannot be adequately mitigated or customers' best interests are not sufficiently protected.

The section on compensation starts with a stark acknowledgement that rewards (and penalties) influence adviser behavior in ways that affect customer interests. From there, the discussion turns to suggested best practices that entail major business model adjustments for many broker-dealer firms.

Firms are encouraged to avoid compensation structures that increase with sales volume, provide incentives for registered representatives to favor one investment over another, and promote proprietary products. They are also encouraged to carefully monitor adviser behavior in situations when the influence of conflicts of interest may be particularly strong, such as when thresholds for special bonuses or recognition are within close reach.

Readers of Finra's report may wonder why it assiduously avoids using the term “fiduciary” and yet is steeped in fiduciary principles. Repeated references to serving clients' best interests, the duties of care and good faith, and obligations to avoid or mitigate conflicts provide an unmistakable fiduciary overtone to the entire document. The most likely explanation is that Finra does not want to give the appearance of interfering with the work of the Securities and Exchange Commission, because Dodd-Frank authorized the SEC, not Finra, to extend the fiduciary standard more broadly to the broker-dealer community.

Why, if Finra lacks the authority, and perhaps the will, to implement a strong fiduciary standard, would it promote a culture of fiduciary responsibility?

The logical answer is that Finra and a growing number of forward-thinking brokerage firms have concluded that it is increasingly a competitive necessity, even if not yet a regulatory imperative, to embrace some form of fiduciary standard. The net migration from traditional brokerage firms to advisory practices lends credence to this explanation, as does growing investor awareness of differences in broker versus adviser accountability. Look for industry-led cultural reform to overshadow regulatory reform in 2014, and consider whether you should resolve to participate in that trend.

Blaine F. Aikin is president and chief executive of fi360 Inc.


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