In recent years, conflicts of interest have been a hot topic for regulators. Not only are actual conflicts of interest troubling, but the perception of a conflict of interest can be just as concerning. Typically, these are situations in which personal interests conflict with professional interests and an advisor’s fiduciary responsibilities. Outside business activities are a particular area where conflicts of interest may arise. Those in a fiduciary capacity are particularly susceptible to a conflict because of the inherent nature of the financial services industry.
Advisers are obligated to disclose actual and potential conflicts of interest as well as material arrangements, financial or otherwise. Generally, employees must not engage in an outside business activity that could create an actual or potential conflict of interest. Outside business activities must not interfere with the individual’s job function, compromise the responsibilities to the firm or the firm’s customers, or be viewed by the public as part of the firm’s business.
Advisers engaging in an outside business activity may present a conflict of interest to the firm and/or client by creating an incentive for the adviser to breach their fiduciary duty and not act in the best interest of the client (e.g., recommending a product/service that is not in the clients’ best interest and receiving compensation for doing so).
Firms are required to establish and maintain a system to adequately supervise and monitor outside business activities in accordance with the securities laws and regulations. Supervisory practices for assessing conflicts and mitigating risk include creating, implementing, and maintaining an effective Code of Ethics and Compliance Program.
Establishing written supervisory policies and procedures to identify and manage conflicts of interest are a critical component for preventing and detecting improper conduct and behavior that may create reputational and regulatory risk. This may include: written prior consent, employee attestation, reporting and tracking mechanisms. Additionally, there are also preventative best practices to protect firms against regulatory scrutiny relating to undisclosed outside business activities such as conducting internet and social media searches. The use of a third-party vendor can be a useful tool to assist with the supervisory obligation.
Training and educating employees on the Firm’s written policies and procedures regarding conflicts of interest and outside business activities is another significant component to effective oversight.
The management and enforcement of a workable supervisory system will mitigate risk to the employee, the client, and the Firm, as well as prevent unnecessary and costly legal action.