Journal of Financial Planning: September 2018
Frank Bearden, Ph.D., is an adjunct professor for graduate degree programs at the College for Financial Planning. He has published articles, given presentations, and conducted qualitative and quantitative research regarding conflicts of interest.
Financial planners and other professionals hear a lot about conflicts of interest from professional publications, at professional meetings, and in their professional codes of ethics. As just one example, CFP Board’s Code of Ethics and Standards of Conduct, effective October 1, 2019, under Duties Owed to Clients, has Section 5 dedicated to disclosing and managing conflicts of interest. Why are conflicts of interest so important? To gain an understanding of this, we should start with consideration of a common conflict, the kind we experience every day, and then consider how a conflict of interest is different. This will help us understand why conflicts of interest are important and should be avoided in professional practice if possible.
What Is a Common Conflict?
A common conflict is a personal interest that periodically distracts us from our focus when exercising professional judgment on behalf of a client. Fortunately, the distraction we experience from a common conflict can be resisted, so that professional judgment can still be exercised at an acceptable level of competence, serving the client’s best interest. The fact that the distraction from a common conflict can be effectively resisted is the key point to remember.
Example: A financial planner forgets to tell her husband that she has a deadline to meet for a client, requiring her to work late. After a little frustration from forgetting, she calls her husband with the news. This results in some changes for supper for her husband and their children, but the omission does not hinder the financial planner’s ability to resume her work at an acceptable level of competency.
How Is a Conflict of Interest Different?
A conflict of interest is like a common conflict, but the interest that generates the conflict is stronger, so the interest is unlikely to be effectively resisted. Professional judgment is likely to be impaired and exercised at an unacceptable level of competence, which is not in the client’s best interest. The key difference lies in the strength of the interest, the resulting distraction, and the quality of professional judgment exercised on behalf of the client.
Example: A financial planner decides to form a financial planning engagement with a business partner, with whom the financial planner owns a real estate venture. In preparing for the summary and recommendations interview, the planner has trouble preparing the insurance related section. He notices the new client has insufficient life insurance to provide for his wife and three children in the event of an unexpected early death.
He begins the life insurance needs analysis, but remembers his new client stating, “I hope you don’t recommend additional life insurance for me, as I am counting on our real estate investment growing in value to provide for that.” The financial planner’s first thought is to include the needs analysis and recommendation for additional coverage, as the need was obvious. However, he does not, fearing he would upset his client.
The real estate venture with his new client provides almost half of his income, which he does not want to jeopardize. Instead, he places a footnote under life insurance, noting the client’s comment that the appreciation of the real estate venture will provide the needed funding.
What Are the Risks from a Conflict of Interest?
The example shows that the first risk of a conflict of interest is to the client, when a financial planner does not exercise acceptable professional judgment on the client’s behalf. What could result from the example? The client’s wife and three children could lose the ability to maintain their current standard of living at the client’s death.
The second type of risk relates directly to the financial planner, when he compromises his professional integrity in failing to exercise his best professional judgment. A third risk also involves the financial planner, who could be at risk of litigation and possible loss of his professional credentials if an unexpected death occurred to his client.
When we think about common conflicts and then conflicts of interest, they do not seem much different at first. This is an additional risk to both the financial planner and his client. A conflict of interest is often subtle, and thus, may not be obvious at first. To avoid exposing a client or ourselves to such a risk, we should recognize an important point: some professional engagements are not a good idea if they involve persons or situations of high interest to us. The high level of interest, whether financial or personal, will compete with our interest in exercising quality professional judgment, and at some point, may win our attention, impairing our professional judgment and the resulting service to the client.
What Should We Do?
The damage from a conflict of interest can be practical as well as theoretical, meaning clients may be done actual financial harm, and financial planners can face professional, regulatory, and financial repercussions. For these reasons, we should think about conflicts of interest practically, as well as theoretically. This means asking ourselves if we can do all that may be appropriate for a potential client, including providing difficult financial conclusions and recommendations.
If we’re uncertain about our capability, we may benefit from confidentially conferring with an associate for her or his opinion. If we conclude that we can serve in a prospective client’s best interest, then proceeding with the engagement is probably a good decision. If we conclude otherwise, consider a referral to a respected planner.