Disclosure of conflicts of interest

by The CFA Society Singapore Advocacy Team
The CFA Institute's disclosure of conflicts standard requires finance professionals to make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with duties to their clients, prospective clients, and employer.

What are conflicts of interest? And more importantly, why do they matter? Conflicts of interest may arise when an individual stands to benefit from decisions made in his or her official capacity. For instance, in Singapore, a manager who is contemplating selling a US office building for the S-Reit she works for may accept a lower-than-fair-valuation on the property should the buyer turn out to be a family member of the manager. If this were the case, the manager’s employer and unit holders would be shortchanged.

Nevertheless, conflicts of interest are sometimes not avoidable, or at least impractical to avert. In the case of the depressed office sector in the US, there may be practically no alternative buyer in the market. So, for the transaction to take place, there must be safeguards. One such safeguard is disclosure of conflicts of interest to employers, retail investors and stakeholders, which finance professionals must adhere to.

The Disclosure of Conflicts Standard
CFA Institute is a not-for-profit organisation and the world’s largest association of investment professionals. The organisation’s goal is to create an environment where investors’ interests come first, markets function at their best, and economies grow. As such, the institute has laid down the Disclosure of Conflicts Standard to guide finance professionals for the benefit of society.

The standard requires finance professionals to make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer.

Disclosure of conflicts to employers may be appropriate in many instances. When reporting conflicts of interest to employers, finance professionals must give their employers enough information to assess the impact of the conflict. By complying with employer guidelines, finance professionals allow their employers to avoid potentially embarrassing and costly ethical or regulatory violations.

Reportable situations include conflicts that would interfere with rendering unbiased investment advice and conflicts that would cause a finance professional to act not in the employer’s best interest, like in the hypothetical case of the sale of the US building.

The same circumstances that generate conflicts to be reported to clients and prospective clients also would dictate reporting to employers. Ownership of stocks analysed or recommended, participation on outside boards, and financial or other pressures that could influence a decision are to be promptly reported to the employer so that their impact can be assessed and a decision on how to resolve the conflict can be made.

Appearance of a conflict of interest
The mere appearance of a conflict of interest may create problems. Therefore, many of the conflicts previously mentioned could be explicitly prohibited by an employer.

For example, many employers restrict personal trading, outside board membership and related activities to prevent situations that might not normally be considered problematic from a conflict-of-interest point of view but that could give the appearance of a conflict of interest.

Best practice is to avoid actual conflicts or the appearance of conflicts of interest where possible. Conflicts can occur between the interests of clients, the interests of employers, and the finance professional’s own personal interests. Common sources for conflict are compensation structures, especially incentive and bonus structures that provide immediate returns for finance professionals with little or no consideration of long-term value creation. When conflicts cannot be reasonably avoided, clear and complete disclosure of their existence is necessary.

Ethics in action: practise, practise, practise
Today’s case is adapted from a case written by Tanuj Khosla, CFA. As a guide, the desired ethical behaviour required is based on the CFA Institute Code of Ethics and Standards of Professional Conduct.

Case study: Disclosure of conflicts of interest
Ali is an investment adviser who began his career as a portfolio manager at SR Wealth Management (SRWM). One of his accounts at SRWM was the joint investment account of a young couple. When Ali leaves SRWM to join YC Capital, a competitor, the couple’s account is assigned to another adviser at SRWM. Two years after leaving SRWM, Ali bumps into Linda, who with her husband were his former clients, at a social event in Tanjong Pagar. She tells Ali that she and her husband are separated and in the process of divorcing. She also shares that she has been unhappy with the new adviser SRWM assigned to manage the couple’s joint account after Ali left because it has performed poorly, and the fees seem to have increased substantially.

Ali offers to look over the couple’s SRWM account and statements. He is shocked to see that the investments are not in line with the information in the couple’s Investment Policy Statement, and that there seems to be a high level of turnover in the account. Ali asks Linda to dinner and shares his thoughts about the issues with the couple’s account.

In the weeks thereafter, Ali and Linda start dating. Shortly after beginning the relationship with Ali, Linda withdraws the bulk of the assets from her and her estranged husband’s SRWM account. She opens a personal account at Ali’s new firm, YC Capital, with Ali as the portfolio manager. Ali does not disclose to his employer that he and Linda are in a relationship. Are Ali’s actions acceptable?

This case relates to disclosure of conflicts of interest. CFA Institute Disclosure of Conflicts Standard requires the finance professional to make full and fair disclosure of all matters that could reasonably be expected to interfere with their duties to clients or employers. In this case, Ali’s personal relationship with his client is a potential conflict that should be disclosed to his employer because he may have an incentive to neglect other advisory clients in favour of Linda’s account as a way to enhance their relationship.

Ali is not violating confidentiality or any duty to his former employer by examining the investment records of his former client because the client provided those records to him. Ali did not access them inappropriately. He does not have a duty of loyalty to Linda’s husband, a former client, because he is no longer his investment adviser. Presumably, Ali understands that Linda is using joint marital assets to open a personal account, without the consent of her estranged husband. If Ali knows that Linda is acting in contravention of the law or a court order or is perpetrating a fraud against her husband in using those assets to open the account, Ali would also be violating another CFA Institute standard, which prohibits finance professionals from engaging in any professional conduct involving dishonesty, fraud, or deceit.

Without further information indicating any fraud, deceit, or dishonesty, Ali’s actions are unacceptable because he violates his duty to disclose the conflict of interest situation by failing to inform his employer about his personal relationship with Linda.

The writers are CFA charterholders who volunteer with CFA Society Singapore on advocacy issues with a view to promoting financial literacy among retail investors and improving overall standards and integrity in the industry. Should you have comments and feedback, please write to the CFA Society Singapore Advocacy Committee: [email protected].

Source: The Business Times