Ask the Ethicist: How can advisers best disclose conflicts of interest related to compensation?

Q: I provide financial planning and investments as a dually-registered person with an insurance company. I offer financial planning advice as an investment adviser representative of the insurance company affiliated registered investment adviser. I offer investment products for implementation as a registered representative of the insurance company owned broker-dealer. These are sometimes proprietary products manufactured by the insurance company but often include investment choices from outside firms. Some of the proprietary funds are managed by these same outside firms. When my clients need insurance products, I act as an agent for the insurance company. In all of these roles, I earn commissions whenever a client chooses to implement their plan through me.

How should I deal with the conflicts of interest in my practice?

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A: You have already taken the first step, and that is to recognize that conflicts exist in your relationships with your clients. A conflict exists when your business or personal interests (or those of your firm) differs from those of your client, and that difference may impact your ability to offer impartial, objective advice. Conflicts can sometimes be minor, like when your client wants to meet in the evening at their home and you prefer to meet in your office during the day; or, they can be more substantive, such as when one product offers a hefty commission and another doesn’t. An important part of identifying and naming the conflict is recognizing that the conflict in itself is not bad. Instead, it is how we choose to handle it that can have a negative effect. When we know that a conflict exists, we can deal with it appropriately.

The first step is to avoid the conflict, if at all possible. This can mean organizing our business in a way that reduces the potential for your interests to clash with those of your clients. For example, publishing clear policies that client meetings are held on certain days and between certain hours on your website lets any clients with different needs know that you are not the right provider for them. The conflict is avoided. Inherent in this first step is to let your client know of likely conflicts. You cannot assume that clients will recognize a conflict or its impact. You know the products and services you offer and understand how they may clash with the interest of clients. Your client does not possess the knowledge or expertise about what you do and how you do it. Fairness requires that you inform them of likely conflicts up front and in a straightforward manner.

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Some conflicts are unavoidable. In your situation, the way you are paid is a good example. You cannot change it, and your only control is by choosing which products and services to offer. Your client wants to pay as little as possible for a solution that helps them achieve their goals, and you want to earn as much as possible while helping them do that. In a perfect world, clients would receive exemplary services at no cost, but the financial world is far from perfect. You need income to run and sustain your practice. Whether you earn commissions, or charge advisory fees based on assets under management or some other mechanism, this conflict will still exist. It cannot be avoided in our imperfect world. Instead, you need to look for ways to mitigate and/or minimize the conflict. The best way to start that process is to make sure that both you and your client fully understand the conflict and its ramifications. What are the costs to implement? Are there other choices that would accomplish the same goal at less cost? Is there a simpler, less costly solution that is likely to work just as well?

Thinking this through and sharing that information with your client helps your client understand that you evaluated the alternatives in a way that respects their needs. Since the conflict can only be managed and not eliminated, ultimately it is your client’s informed consent that is required.

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Dan Candura is founder of the education and consulting firm Candura Group. Write to him to submit a question. All submissions will be treated confidentially.