Thursday, October 17, 2013

FINRA's Conflict of Interest Report

By Tim Dulaney, PhD, FRM and Tim Husson, PhD

On Monday, the Financial Industry Regulatory Authority (FINRA) published their Report on Conflicts of Interest (PDF)  "to better understand how [a number of a large firms] manage conflicts of interest and to identify effective practices to manage those conflicts."  The report details observations made in connection with FINRA's targeted examination letter in July 2012 as well as in-person meetings resulting from that letter.

The report makes it clear that a well-defined framework is necessary for effective management of conflicts of interest.  Staff should understand their responsibility to identify conflicts of interest, and compensation packages should be structured so as to minimize potential conflicts of interest.

As new products develop, so to does the potential for new conflicts of interest.  FINRA notes that firms "at the forefront of financial innovation are in the best position, and are uniquely obligated, to identify the conflicts of interest that may exist at a product’s inception or that develop over time."  FINRA hit the nail on the head here since, in our experience, new products tend to breed the most egregious conflicts of interest.

The report also suggests augmenting a firm's code of conduct to include a "best-interest-of-the-customer" standard.  Such a standard, if uniformly implemented, would go a long way toward increasing investor protection.

FINRA seems content with the progress made by broker-dealers so far, but notes that "[i]f firms make inadequate progress [to address conflicts of interest], FINRA will evaluate whether conflicts-focused rulemaking is necessary to enhance investor protection."

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