The 2022 fiscal year saw regulatory bodies across the globe taking significant action against unethical and unlawful actions arising from conflicts of interest. In the UK, the Financial Conduct Authority (FCA) drove a 55.2% increase in new enforcement cases (194 - up from 125) for its 2021/2022 reporting period, compared to the previous period. The US Securities and Exchange Commission (SEC) also filed 760 enforcement actions with fines totalling a record-breaking US$6.4 billion for its 2021/2022 reporting period.
Wealth management firms are particularly at risk when it comes to conflicts of interest because they have influence and responsibility over financial outcomes for their clients. As such, they are also at heightened risk of individuals using the information and resources of their organisations for personal and professional gains.
How then can they act to avoid harsh penalties, reputational damage, and even criminal punishments by managing and minimising conflicts of interest?
Customer suitability
Every investor has a unique makeup of personal and financial factors. As a result, wealth managers have the crucial responsibility of helping clients navigate investment decisions.
A conflict of interest may be at play, however, when financial advisers push one solution over another, fail to disclose associated costs, or provide advice that does not correctly address their clients’ needs.
To ensure customer suitability obligations are being met and reduce the risk of conflicts that can negatively impact a business and reputation, the following processes should be in place:
• Well-documented sales procedures and customer suitability best practices.
• Watch lists and restricted lists that identify known and potential employee conflicts of interest.
• Visibility of outsourcing, such as research, analytics, or marketing that could influence financial advice to clients.
• Regular monitoring and analysis of suitability for all transactions.
• Defined rules for suitability, specific to your firm’s requirements.
• A fast and effective way to verify compliance reporting requirements are being met.
• Easy production of complete audit trails of all transactions should potential conflicts of interest need to be examined, or when regulatory bodies require information.
• Employee disclosure and monitoring of personal transactions that could give rise to conflicts of interest.
When personal trading becomes insider trading
Conflicts of interest arise in personal trading when an individual directly or indirectly gains an unfair advantage when dealing in securities transactions. Insider trading makes use of material non-public information (MNPI) to anticipate changes and either profit or avoid losses from that trading activity.
It is vital that employees in any financial organisation understand the severe consequences of insider trading. In late 2022, for example, former Tesla Director Kurt Schlosser pleaded guilty to two counts of insider trading. Schlosser’s trades totalled a profit of only AU$28,883.53. The result, however, is a potential 30-year term of imprisonment.
Any firm can, however, proactively manage personal trading activity and reduce risk by taking these steps:
• Have robust policies and procedures in place: Clearly define how to monitor, regulate, and report on securities trades, with particular note of directors, executives, management, and anyone with access to MNPI.
• Communicate with, and train employees: Communicate trading policies and provide guidelines for reporting conflicts through continuous training mechanisms. Employees should also understand blackout periods and any pre-clearance processes for the approval or denial of personal trades.
• Record, maintain, and monitor: Employee personal trading policy should mandate the disclosure of any conflicts of interest (such as possession of MNPI). There should be a system for recording additions and changes to potential conflicts, and it should be made a part of processes to monitor personal trading activity.
• Putting the spotlight on moonlighting: Outside Business Activity (OBA) is where employees undertake work other than what they produce for their primary employer under contract, AKA ‘moonlighting’ or a ‘side hustle’. When employees fail to communicate their moonlighting activities to their employers, conflicts of interest can arise.
Steps to more effectively manage OBAs include:
• Define policies that address the firm’s requirements and processes around OBAs. Consider whether some OBAs can be approved automatically and if others should be denied.
• Communication of documented OBA policies to all employees.
• Foster a company culture of openly discussing potential conflicts and how to avoid them.
• Regularly update attestations of OBAs to identify new or changed activity that should be flagged.
• Have the appropriate technology that lets employees easily declare OBAs and interests.
Gifts, entertainment, and hospitality
Wealth management firms need clear policies and procedures around gifts, entertainment, and hospitality to help reduce the risk of conflicts of interest arising. For example, employees must know the difference between inviting a client to an event (entertainment) or giving event tickets to a client (a gift) and when such actions are appropriate.
Policies and other critical actions taken as part of processes should include the following:
• Definitions of gifts, entertainment, and hospitality that will help wealth managers and other employees understand your policies.
• Maintenance of a central register to make it easy to declare and track all activities.
• Periodic reviews of gifts and entertainment records to detect any irregularities or policy breaches.
Cultivate an ethical business environment
Decisions are ultimately made by individual employees who may or may not be fully aware of potential conflicts of interest. By driving a culture that supports and promotes ethical decision-making a firm can help employees gain a deeper understanding of conflicts of interest.
It helps to actively communicate conflict of interest policies (and the reasons they exist), provide training, and foster open communication where questions and concerns can be raised in a safe, supportive environment. When employees are encouraged to make ethical decisions on their own, a firm stands to reduce the risk of potential conflicts becoming larger problems.
The vital role of technology
Regulators around the globe have placed increased scrutiny on conflicts of interest in recent years. Simply having systems in place to monitor conflicts is no longer enough. Proper technology plays a vital role in helping a firm more efficiently manage and minimise conflicts of interest.
Technology should:
• Make it easy for employees to declare conflicts and provide attestations.
• Be adequate and capable of proactively flagging suspicious activity.
• Enable compliance teams to effectively analyse and confirm or disprove assumptions of wrongdoing.
• Cater to and support processes specific to a firm.
• Quickly produce detailed reporting required by regulators upon examination.
This article is from The Wealth Mosaic’s APAC WealthTech Landscape Report 2023. Access the full report here.
