Conflicts in the financial industry occur if the client and the financial advisor have different interests in their contractual relationships. In such instances, the responsibilities of financial advisors differ with their private interests (Conflicts of Interests). Clients seek financial advice to identify potential risks, investment objectives, and time horizons in their projects. The clients usually state restrictions and investment limitations they may be facing to obtain appropriate information from financial advisors to deal with these constraints. The advisors have discretionary authority to decide on behalf of their clients. However, financial advisors can misuse this privilege for their own financial or material gain.
Conflicts of Interests
The source of the fee is a significant cause of conflict of interest in financial advisory relationships. Fee-based advisory firms are affiliated with insurance agencies or registered broker-dealers. These firms earn a commission for selling investment or insurance products of these agencies (Burke et al. 3). The conflict of interest arises when financial advisors recommend their clients to purchase the products of a particular insurance or investment agency to increase the commission that the former earn. For example, a financial advisor may recommend their client to buy common stocks of a specific company through a given brokerage firm to increase its commission. The suggested products or services may not be aligned with the financial goals or interests of a client.
Also, some financial advisory firms have their own investment companies, which they use to deceive clients. The advisors act as sale representatives of their investment companies instead of providing independent financial advice to their customers (Burke et al. 3). For instance, some financial advisory firms serve as insurance brokers and can recommend their clients to buy some insurance products from their companies, which may be registered using different names. Fraudulent advisors conceal their identities because clients cannot buy their products if they discover the truth ((Burke et al. 4). Such advisors do not provide their clients with trustworthy and competent advice.
Moreover, conflicts of interest occur when financial firms advise clients to choose particular products to increase the organization’s gains. For example, these firms may recommend clients to buy common stocks instead of fixed income products. They give such suggestions because they will earn a higher commission in managing equity products in comparison with other financial products (Burke et al. 3). As a result, the advisors expose their customers to excessive risks as they seek to increase personal profits.
Relations with problems in Royal Commission
Conflict interests are related to the issues that are addressed by the Royal Commission. The government of Australia formed the commission after realizing the rising cases of greed among the players in the financial sector that exposed customers to financial risks and losses (Royal Commission). The Royal Commission has the power to investigate complaints raised in the financial industry by conducting public hearings and verifying the necessary documents (Royal Commission). Most of these complaints emanate from dishonesty, negligence, and greed of the players in the industry. Complaints also emerge from practices such as consumer lending, wealth management, financial planning, and brokerage. For example, the management of the ANZ bank admitted before the Royal Commission that it had engaged in dishonest practices of not checking loan applications that were received through brokers in March 2018 (Hutchens). Similarly, the commission found the CBA guilty of engaging in misconduct in regards to responsible lending, add-on insurance, and offering financial credit to its customers. In all these cases, financial institutions displayed conflict of interests by working with other investment companies to make financial gains at the expense of their customers. Therefore, there was a conflict between the financial goals of the financial institutions and the objectives of their clients.
Firstly, financial advisors can avoid these problems by disclosing their interests at the beginning of their engagements with their clients. Financial advisors have to disclose potential areas of conflict of interest. Although some do not do so, upholding this law will play a critical role in minimizing conflicts of interest. Secondly, financial firms can avoid conflicts of interest by separating the operating functions of their business (Burke et al. 32). They can distinguish their advisory role from other investment divisions such as selling financial products to generate profit. The distinction will ensure that their investment interests do not conflict with their clients’. Professional boundaries enhance the objectivity, independence, and accountability of financial advisors in their operations to safeguard the interests of their clients (Burke et al. 32). Finally, financial advisory firms need to uphold the fiduciary principle in their services (Burke et al. 33). This principle requires registered investment advisors to have a fiduciary obligation of acting in the best interests of their clients. Financial advisors have to provide the most useful advice to their clients irrespective of their fee structures.
Many financial advisory firms engage in practices that raise conflicts between their interests and those of their clients. These conflicts occur when financial advisors recommend customers to buy certain products to increase their commission or fee without disclosing their interests. Other firms also run investment companies where they advise clients to purchase certain products or services. The Royal Commission was established to deal with complaints related to conflict of interests. Disclosing the interests to customers and complying with the existing laws can enable financial advisory firms to avoid these conflicts.
Burke, Jeremy, Hung Angela, Clift Jack, Garber Steven, and Yoong Joanne. “Impacts of Conflicts of Interest in the Financial Services Industry.” Working Paper, 2015, 1-60.
Conflicts of Interest. CFA Institute. 2020. https://www.cfainstitute.org/en/advocacy/issues/conflicts-of-interest.
Hutchens, Gareth. “ANZ admits not checking key details of loan applications made via brokers.” Guardian Australia. 2018. https://www.theguardian.com/australia-news/2018/mar/19/anz-admits-not-checking-key-details-of-loan-applications-made-via-brokers.
“Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services Industry.” 2019. https://financialservices.royalcommission.gov.au/public-hearings/Pages/default.aspx.