How to Disclose Conflicts of Interest as a Financial Advisor

Conflicts of interest may naturally arise in your business for a variety of reasons. Just over one-quarter of advisory firms have at least one reported conflict of interest, according to an analysis of SEC data conducted by AdvisorSearch.org.¹ Compliance rules require you to notify prospects and current clients of conflicts as they arise. Your status as an advisor determines how to disclose conflicts of interest to clients.

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Understanding Conflicts of Interest for Advisors

What is a conflict of interest for a financial advisor? Simply put, a conflict of interest occurs when a personal, financial or business incentive compromises an advisor’s duty to act in the best interests of their clients.

Examples of conflicts of interest for advisors include:

• Recommending investments to earn commissions, referral fees or other financial incentives, even when those investments do not further the client’s best interests.
• Front-running, or completing trades that conflict with the client’s interests and objectives.
• Directing clients toward specific products or services that the advisor is affiliated with for the purpose of collecting a referral fee.
• Recommending proprietary products that generate higher fees, even when those products conflict with the client’s interests.

According to AdvisorSearch, the most commonly reported type of conflict involved affiliation with an insurance agent. Advisors also reported conflicts with proprietary products, private investment management, commissions and attorneys.

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How to Disclose Conflicts of Interest: RIAs and Broker-Dealers

Registered investment advisors (RIAs) are required to disclose conflicts of interest on Form ADV Part 2, which is your firm’s brochure. RIAs must deliver a copy of their brochure each time they enter into an advisory relationship with a new client, per SEC Rule 204-3(b). Advisors must also provide existing clients with an updated brochure annually.

Conflicts of interest are addressed in the following items on Form ADV:

• Item 5 – Fees and Compensation: Item 5 requires you to disclose how you collect fees from clients, including a detailed fee schedule and whether those fees are negotiable. You must explain to your clients whether you or any of your supervised persons receive commissions for the sale of investment products, and how this creates a conflict of interest. You must also detail how you address conflicts of interest and disclose them.
• Item 6 – Performance-Based Fees: If you or any of your supervised persons accept performance-based fees, these must be disclosed. You also have to disclose whether you or any of your supervised persons manage accounts that generate performance-based fees and other types of fees. If that applies to you, you’re required to disclose how that creates conflicts of interest and how you address those conflicts.
• Item 10 – Other Financial Industry Activities: If you’re dual-registered as an RIA broker-dealer or are in the process of seeking dual registration, you must disclose that to your clients. You must also disclose conflicts of interest that arise from recommending other investment advisors to clients in exchange for compensation.
• Item 11 – Code of Ethics/Participation: If you or a related person invests in the same securities that you recommend to clients, or trades the same securities you’ve recommended at around the same time you execute similar trades for clients, you must disclose those conflicts of interest. You must also disclose how you address those conflicts of interest.
• Item 12 – Brokerage Practices: Broker-dealers and dual-registered RIAs must disclose conflicts of interest related to soft-dollar benefits. These benefits occur when you receive research or other products and services from a brokerage or third-party in exchange for executing trades in client accounts. Brokers must also disclose client referrals that create conflicts of interest.
• Item 14 – Client Referrals: Item 14 deals with referral arrangements in which someone who is not a client provides an economic benefit to you for providing investment advice or other advisory services to your clients. You must detail how the arrangement works, explain the conflicts of interest and disclose how you manage those conflicts.

Form ADV must be updated annually. Your updated Form ADV, which includes any new conflicts of interest you’re required to disclose, is due within 90 days of the end of your fiscal year. So, if your fiscal year ends on December 31, the deadline for you is March 31. You’ll submit your updated Form ADV through the Investment Advisor Registration Depository (IARD).

How to Disclose Conflicts of Interest: CFP^® Professionals

If you hold the Certified Financial Planner™ credential, you’re subject to the ethical standards set by the CFP Board. The code of ethics states that you must either avoid conflicts of interest, or disclose and manage them.

According to the CFP Board, a conflict of interest arises when “a CFP® professional’s interests (including the interests of the CFP® Professional’s Firm) are adverse to the CFP® professional’s duties to a Client; or When a CFP® professional has duties to one Client that are adverse to another Client.” Information regarding a conflict of interest is material when “a reasonable Client or prospective Client would consider the information important in making a decision.” ²

CFP Board standards require you to:

• Fully disclose material conflicts of interest
• Obtain the client’s informed consent to the conflict
• Manage the conflict by adopting and following business practices reasonably designed to prevent material conflicts of interest from compromising your ability to act in a client’s best interest

Example scenarios of when material conflicts of interest may arise include rollovers from an employer-sponsored retirement plan to an individual retirement account, for which you receive compensation for moving funds to an IRA; advising clients to use assets to invest versus paying off debt; and recommending asset allocation strategies that result in increased compensation for you.

The CFP Board does not require you to disclose conflicts of interest to prospects and clients in writing. You are not required to obtain a client’s informed consent in writing either. However, it may be to your advantage to do both.

A written record of disclosures, along with a written policy for managing conflicts of interest, can demonstrate transparency to clients. It can also help prevent misunderstandings or confusion over which of your business practices may or may not lead to conflicts of interest.

How to Disclose Conflicts of Interest: Other Advisors

If you hold a professional credential other than the CFP® mark, disclosure requirements for conflicts of interest may be set by your issuing board. For example, here’s what’s required by the CFA Institute for Chartered Financial Analysts (CFAs):

“Members and candidates must avoid or 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. Members and candidates must ensure that such disclosures are prominent, are delivered in plain language, and communicate the relevant information effectively.”

Certified investment management analysts (CIMA), certified private wealth advisors (CPWA) and retirement management advisors (RMA) are held to similar standards by the Investments & Wealth Institute (IWI). If you plan to pursue a professional designation or credential to elevate your career, it’s important to familiarize yourself with how to disclose conflicts of interest and when those disclosures are required.

Bottom Line

A proactive approach to disclosing conflicts of interest can serve your business well if you’re building trust with clients while adhering to compliance requirements. Understanding what you’re required to disclose and when, and the format those disclosures must take, can help you address this key business task with minimal stress.

Tips for Growing Your Advisory Business

• If you’re starting an RIA with $0 AUM then you’ll need to explore strategies for how to drum up clients. Developing a comprehensive and consistent marketing plan can help you get your business off to a solid start. SmartAsset AMP (Advisor Marketing Platform) is a holistic marketing service financial advisors can use for client lead generation and automated marketing. Sign up for a free demo to explore how SmartAsset AMP can help you expand your practice’s marketing operation. Get started today.
• Form ADV consultants assist advisors with preparing the required documents for initial registration and annual updates. It may be beneficial to work with one of these professionals if you find Form ADV Part 2 (or Part 1) daunting or would simply prefer to have a second set of eyes review your paperwork.

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