Journal of Financial Planning: April 2023
Frank C. Bearden Ph.D., CLU, ChFC, 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.
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Individuals who serve as financial advisers constantly hear about the risks of engaging a potential client who poses a conflict of interest (COI) to the adviser. We will begin the discussion that follows by first considering the nature of a COI, and then proceed to what a financial adviser can do to avoid COIs in order to further engage in and build their practice. As a sound initial thought, we should realize that a COI is an influence that cannot be resisted indefinitely and will impair professional judgment (Davis 2001). Because of this, a financial adviser who serves clients according to the fiduciary standard should carefully avoid COIs. The COI will eventually and often subtly disrupt a financial adviser’s focus and actions away from the client’s best interests, toward activities that may be ethically questionable, and place a financial adviser at professional risk. An important term to remember in this process of the influence of a COI is the word “subtly.”
The Meaning of the Fiduciary Standard
Serving a client according to a fiduciary standard of service means a financial adviser aligns the financial planning service he or she provides in the best interests of a client. This means always addressing the client’s best interests when making recommendations of products or services. If and when a financial adviser is no longer able to keep the client’s best interest as their primary focus, the financial adviser should then consider releasing the client to another financial adviser.
How Does a COI Threaten a Financial Adviser?
Engaging a potential client who poses a conflict of interest threatens the adviser’s ability to meet the fiduciary standard by appealing to the financial adviser’s interests other than those credible interests of the client. As an example, consider if an adviser is asked by a close friend to take out a large application for life insurance for the close friend, and the close friend divulges an illness that occurred two years before. As a favor, the close friend asks the adviser not to divulge the illness as it ended one year ago and should not affect the underwriting. In this request, the close friend is asking the financial adviser to violate his fiduciary responsibility by hiding the truth of the friend’s health history.
In considering this dishonest behavior, the financial adviser may accept the request from the friend, as he may be motivated by their friendship and the large potential commission incentive. In accepting this behavior from his friend, the adviser has violated his fiduciary responsibility to his friend while attempting to do his friend a favor. The financial adviser, a licensed insurance agent in this example, is bound by the insurance laws, which he will have violated. In addition, the friend’s health history will likely be discovered from the Medical Information Bureau, and the policy will likely be declined, if issued.
The reasons financial advisers should be hesitant to engage a client who poses a potential COI toward the financial adviser are based on the likelihood of violations of fiduciary responsibility the financial adviser may develop toward that client. Among the persons who may pose a COI are family members, close personal friends, a business partner in a venture, or an individual posing another type of conflict of interest (Bearden 2001).
Consequences of Failing to Control Conflicts of Interest
A financial planner may initially think they can control a conflict of interest the financial planner has and provide quality financial advice to a client. This is certainly understandable at first, and when this point of view develops, it is usually because the financial planner minimizes the active interest they have in the client, some of which is subtle. Two examples may help make the point. For the first, consider a financial planner who has a joint interest with a real estate agent in a business, such as a commercial rental property. The business relationship has been cordial between the financial planner and the real estate agent for a few years, with little disagreement.
The relationship became difficult at a point when the real estate agent partner proposed they make an investment with their cash surplus in an investment that has a very active market risk. The financial planner realized the risk involved and provided a referral to a financial planner that the partner knows who can make a more practical recommendation. The real estate agent asks why the financial planner can’t review their assets without outside involvement. The financial planner partner simply states that a financial planner unaffiliated with their firm will be more capable of making an objective recommendation. The financial planner partner then states they do not have the objectivity required to make sound investment recommendations for their firm, and this partner is correct. Finally, however, in an effort to satisfy the real estate agent, the financial planner agrees to make the purchase of the investment with active market risk, and the two partners proceed to lose almost half of their cash surplus.
A Second Example
A financial planner is asked to provide financial planning services for his father-in-law, who owns the largest auto dealership in a small town in Oklahoma. The father-in-law has had little financial planning advice while building his business and now realizes that he needs financial planning advice to maintain and grow the assets he has developed in the dealership. During the first meeting, the client father-in-law tells the financial planner some of the investment requirements he has and his desire to double his financial success at the dealership. The financial planner calmly states that gathering information to form a financial plan is the best way to begin and proceeds to ask a few beginning questions.
After a few minutes, the father-in-law interrupts the process, noting that as the planner’s father-in-law, he was certain the financial planner would simply follow his directives, as if he had become the father-in-law’s employee. At that point, this had not occurred to the son-in-law, who now sensed he had made a mistake. He should have referred his father-in-law to one of his associates in his financial planning firm who has no relationship to the father-in-law. The father-in-law, due to the relationship with the son-in-law and his wife, would probably receive a more objective quality of service by working with a financial planner not within his family. For the son-in-law who is a financial planner, the father-in-law poses a COI by being his father-in-law.
This second example tells us clearly that a personal relationship a financial planner may have with someone like a father-in-law can generate significant intellectual and emotional interference to compete with the effective relationship a financial planner needs to have to provide pertinent, useful financial planning advice and recommendations. In other words, the personal relationship a financial planner may have with a client is likely to affect the professional relationship. In this example, could an associate financial planner not related to the family provide clear and objective advice to the client? The answer is likely to be yes if there is no existing personal relationship involved. Second, could the family member financial planner serve as more of a client relationship manager for the account? The answer here could also be yes if the family member is not directly involved in the recommendations and delivery of financial planning service.
How to Avoid a COI with a Potential Client
This brings us to the question of how a financial adviser can avoid a potential COI with a potential client. The prompt answer is the financial adviser can refer the client to another financial adviser who is not attached to the client and for whom the prospective client poses no risk as a COI. Without a COI, the financial adviser referred to will be able to make recommendations aligned with the client’s best interest (Vessenes 1997). In this light, the initial financial adviser who effected this transition to the second, unattached financial adviser has provided a significant service to the client as well.
What Can We Conclude?
Conflicts of interest involve situations in which a financial adviser has interests in an individual or couple beyond potential fiduciary interests, such that those interests can readily distract the financial adviser from attending to concerns for the client’s best interests. What has been established is that this interest beyond fiduciary concerns is not an enabling fiduciary interest, but an enabling interest that counters fiduciary responsibility. As Jerome P. Kassirer, M.D., stated in the forward to Conflicts of Interest and the Future of Medicine: The United States, France, and Japan, “Needless to say, the ideal solution to financial conflicts of interest is not disclosure, but to have no conflict at all” (Rodwin 2001).
Conflicts of interest pose a hinderance to the effective work of financial planners, to the point that a financial planner may place their licenses at risk. The far better approach for a financial planner to develop their practice is to avoid the COI and seek potential clients who do not carry this serious hinderance, seeking simply financial advisory services instead.
References
Bearden, F. C. 2001. “Conflicts of Interest in Providing Financial Planning to Friends, Acquaintances and Relatives.” Journal of Financial Counseling and Planning 12 (1): 27–37.
Davis, M. 2001. “Introduction.” In Conflict of Interest in the Professions. Edited by M. Davis and A. Stark. Oxford, England: Oxford University Press: 3–19.
Rodwin, M. A. 2011. Conflicts of Interest and the Future of Medicine: The United States, France, and Japan. Oxford University Press.
Vessenes, K. 1997, December. “Avoiding Lawsuits Based on Conflicts of Interest.” Journal of Financial Planning 10 (6): 22–24.
