FINRA has announced its intention to conduct a targeted examination (or sweep) of its members’ practices relating to the identification and management of conflicts of interest. The importance of this effort cannot be overstated. Conflicts of interest in the securities industry are particularly troublesome because customers usually do not stand in an arm’s-length, caveat emptor relationship to their broker. Instead, most customers trust and rely upon their broker’s superior knowledge and skill, assuming that their adviser is acting in their best interests and unaware of the myriad opportunities for conflicts of interest to work against them. The industry’s pervasive conflicts of interest present the broker with opportunities to betray that trust that can be irresistible.
Conflicts of interest come in many forms. For example:
- The broker earns a commission only when recommending a transaction.
- The broker recommends his firm’s own products rather than potentially better or less expensive products that accomplish the same objective.
- The broker is paid more to sell a proprietary product.
- The broker recommends a security because his firm has an investment banking relationship with the company.
- The broker-dealer is a counter-party in a client transaction.
- The broker-dealer trades ahead of (front runs) a known pending customer order.
- The broker recommends margin borrowing because his firm earns money on the interest spread.