Journal of Financial Planning: August 2019
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.
All too often, conflicts of interest are treated intellectually, as if the main challenge a financial planner faces is understanding them. While a conceptual understanding is important, it provides little benefit if the planner does not know how to implement her or his understanding.
The purpose of this column is to discuss an essential first step toward being able to implement what we know about conflicts of interest. This is the ability to recognize a likely conflict of interest when a financial planner is considering an engagement.1
A conflict of interest is similar to any other conflict in some ways, but different in one important way. The similarity is a conflict of interest will be a distraction from our focus when exercising judgment in a client’s best interest, much like any other conflict. The distinctive quality of a conflict of interest is the level and persistence of the distraction. A conflict of interest is not wondering how our favorite sports team will do in an upcoming game, because we can easily stop our wondering. A conflict of interest is much harder to put out of our thoughts and can be of influence, impairing judgment on behalf of a client even when we do not realize it.
Consider a few types of situations that could be conflicts of interest. The situation that is mentioned most frequently is a financial conflict, which means a person or entity with whom or which the financial planner has a strong financial interest. Another situation is a personal conflict, which can involve an individual with whom the financial planner has a strong personal relationship. Within each of these types of conflict of interest are a number of variations. A third situation involves the prospect of receiving professional recognition if a financial planner makes a given decision regarding a client, even if the decision is not in the client’s best interest.2
Situations to Consider
What follows are four examples of situations a financial planner might encounter in practice. Consider each one carefully and ask yourself if the financial planner is likely to have a conflict of interest if she or he accepts the engagement.
Situation 1: an engagement with the president of the planner’s alumni association. Mary is a financial planner with an active practice and strong involvement with her university alumni association. She had an exceptional experience academically and socially during her undergraduate studies and feels the experience was a major influence upon the person and professional she has become. She has been an active member of her university alumni association since graduation.
John is the president of Mary’s university alumni association. He is the principal in a large high school in the same city where Mary and her family live. She has met John, but does not know him well. He was referred to Mary by another alumni who serves on the alumni board. The referring individual knew Mary as a student and thinks highly of her. John has called Mary’s office to ask for a pre-engagement appointment. John wants to review his and his wife’s retirement and estate planning.
Do you think Mary is likely to have a conflict of interest in exercising her fiduciary responsibility with John and his wife, given John’s position with the alumni association?
Situation 2: an engagement with the financial planner’s father. Will was raised by his his father, Fred, as his mother died when Will was 10. Will has not agreed with his father a number of times, but he has maintained regular communication with his father weekly and sees him at least once a month. One of their points of contention was Will’s engagement and subsequent marriage to his wife, Jennifer. In recent years, Fred has developed a cordial relationship with Jennifer. Will has grown to care greatly for his father.
Fred is an active, prosperous attorney with a general law practice in an adjoining suburb to Will and his family. He is concerned about the management of his investments and has asked Will for an appointment to discuss an engagement to help with his retirement planning.
Do you think Will is likely to have a conflict of interest in exercising his fiduciary responsibility with Fred, given their familial relationship?
Situation 3: an engagement with the owner of the building that houses the financial planner’s office. Four years ago Ron and his two junior partners, Susan and Mark, moved their offices to a new office building located in a new business area of the city where they practice. Ron and his partners were able to secure a very attractive lease, as they were the first tenants in the building. When Ron needed to add an office for a paraplanner, Ron was able to do so at the same cost per square foot as the original lease.
Norris, the senior partner of the building, recently contacted Ron to ask about a meeting to discuss the management of his financial investments for his retirement. Norris is within 15 years of his planned retirement and has done well with his real estate business and his stock and bond investments. Norris’ enterprises are well-known in the city, where he has a reputation for innovation and fairness. Ron is excited about a financial planning engagement with Norris, thinking such an arrangement may be what is needed to take his practice to the next level.
Do you think Ron is likely to have a conflict of interest in exercising his fiduciary responsibility toward Norris, given his relationship with Norris as his tenant?
Situation 4: an engagement with a referral from a prominent client. Sarah is an established financial planner in a large city in the Southwest. For several years, she has had an active engagement with a well-known cardiothoracic surgeon in the city, Dr. Marsha Wells. Recently Dr. Wells hired an associate cardiothoracic surgeon, Dr. Laura Walker, who has just completed her final residency. Dr. Wells contacted Sarah and told her she would be referring her new associate to her for preliminary financial planning for her investments and debts.
Dr. Walker has contacted Sarah for a pre-engagement appointment. She expressed active interest in managing current and future investments, as well as her indebtedness incurred while in her medical studies. Sarah has expressed her thanks to Dr. Wells for referring Dr. Walker, and is very interested in helping her develop an investment policy statement and debt management plans.
Do you think Sarah is likely have a conflict of interest in exercising her fiduciary responsibility toward Dr. Walker, given her current professional relationship with Dr. Walker’s supervisor?
Responses to the Situations
The responses I would provide for the situations are:
- Situation 1: not likely
- Situation 2: yes, likely
- Situation 3: yes, likely
- Situation 4: not likely
For Situation 1, although Mary has a strong affinity with her university alumni association, I do not think that relationship is sufficiently strong as to interfere with her providing financial advice to John that she believes is in his best interest.
For Situation 2, Will has a relationship with his father in which they have both gone through significant difficulty together, with the death of Will’s mother. They have had their differences, although Will talks with Fred weekly and sees him monthly. I think Will will have difficulty making recommendations he thinks are in his father’s best interest, if he thinks his father may disagree. This looks like a likely conflict of interest to me.
For Situation 3, the office space Ron’s firm is leasing from Norris is important for his practice. I do think that could inhibit him from making a recommendation to Norris he believed was in his best interest, if he thought Norris would strongly disagree.
For Situation 4, while I’m sure Sarah is well aware of her financial planning relationship with Dr. Wells, I do not think that would sufficiently inhibit her from making a recommendation to Dr. Walker that Sarah thought was in her best interest.
What Can We Conclude?
Conflicts of interest are often difficult to determine, and that determination depends on complete honesty with yourself.3 When unsure if you are considering a conflict of interest, confer with a trusted peer. Remember, the key characteristic of a conflict of interest is pervasive influence strong enough to inhibit fiduciary responsibility. There will be some variation of consideration among financial planners, as judgment certainly is involved. As noted earlier, some types of relationships are more likely to be conflicts of interest than others.
What to Do when Facing a Likely Conflict of Interest
Clear disclosure is a minimum requirement if you believe you can honor your fiduciary responsibility throughout the engagement (see the CFP Board Code of Ethics and Standards of Conduct effective October 1, 2019, for standards governing CFP® professionals).
Sometimes disclosure alone may be inadequate, as damage from the conflict of interest can occur even with the client’s knowledge and acceptance of the engagement.4When possible, referring a client posing a conflict of interest to a respected peer can be a useful course of action.
For clients, the stakes with conflicts of interest are high. Impaired judgment can lead to significant consequences of financial loss and more. The objectives of client financial choices may have to be foregone, such as a paid college education or a well-funded retirement.
Financial planners have their consequences as well for failing to clearly disclose a likely conflict of interest. These can involve professional sanction, loss of professional credentials, and litigation from the client. Knowing how to recognize a likely conflict of interest is the first step toward avoiding these consequences.
Endnotes
- See “Recognizing and Addressing Conflicts of Interest,” by Arthur Siegel and Susan McGrath in the April 2003 issue of The CPA Journal (archives.cpajournal.com/2003/0403/nv/nv1.htm), and “Recognizing Conflicts of Interest in Financial Planning: A Sequential Study,” by Frank Bearden in the spring 2018 issue of the Journal of Personal Finance (journalofpersonalfinance.com).
- See “Conflicts of Interest in Medicine: Should We Contract, Conserve, or Expand the Traditional Definition and Scope of Regulation?” by Marc A. Rodwin in the Journal of Health Care Law & Policy (vol. 21, issue 2) (digitalcommons.law.umaryland.edu/jhclp/vol21/iss2), and “CPAs and Conflicts of Interest: A Recap of Recent AICPA Guidance,” by Quinton Booker and Kayla Booker in the August 2016 issue of The CPA Journal (cpajournal.com).
- See “How to Decide When Facing Ethical Conflicts of Interest?” by Colin West and Chen-Bo Zhong in the March 2019 issue of Organizational Dynamics (sciencedirect.com), and “Conflicts of Interest: How Money Clouds Objectivity,” by Richard Smith in the Journal of the Royal Society of Medicine (vol. 99, issue 6)
(ncbi.nlm.nih.gov/pmc/articles/PMC1472724). - See “Conflicts of Interest in Financial Planning Practice,” by Frank Bearden in the February 2002 issue of the Journal of Financial Planning.