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Compliance Concepts

Culture, Conflicts of Interest and Ethics is ‘So Last Year‘

May 12, 2017

This post was supposed to rejoice the financial services industry, which strives to be a ‘beacon of righteousness’. Conflicts of interest are frowned upon, if not deemed illegal, and failure to disclose relevant facts and conflicts of interest are cause for significant fines and sanctions.


FINRA Rules 2241 and 5121 refer directly to Conflicts of Interest, as they pertain to Research Analysts, Research Reports, and Public Offerings of Securities. [FINRA Rules]


In November 2016, FINRA announced that VALIC Financial Advisors agreed to pay $1.75 million to settle charges that it had failed to prevent conflicts of interest in its compensation policy and for other supervisory failures related to variable annuity sales.  [FINRA News Release]


The SEC’s Office of Compliance Inspections and Examinations (OCIE) notes that, “as a fiduciary an investment adviser has a duty to make full and fair disclosure of all material facts, including all material conflicts of interest that could affect the advisory relationship. Examiners will assess the conflicts of interest that a registered adviser or supervised person may have. Particular attention will be given to conflicts that may exist with respect to financial arrangements (e.g. unique products, services, or discounts) initiated by supervised persons with disciplinary events. [SEC Announcement]


In announcing enforcement results for fiscal year 2016, the SEC refers to a $267 million settlement with JPMorgan wealth management subsidiaries over their failure to disclose conflicts of interest to clients – and the firms even admitted wrongdoing!  [SEC Press Release]


And then, we were going to refer to FINRA’s 2016 Regulatory and Examination Priorities Letter, that kicked off with the issue of “Culture, Conflicts of Interest and Ethics.”


While firms may have their own definition of "firm culture," we use it here to refer to the set of explicit and implicit norms, practices, and expected behaviors that influence how firm executives, supervisors and employees make and implement decisions in the course of conducting a firm's business.


In 2016, FINRA will formalize our assessment of firm culture while continuing our focus on conflicts of interest and ethics. Firm culture has a profound influence on how a firm conducts its business and manages its conflicts of interest. FINRA does not seek to dictate firm culture, but rather to understand how it affects compliance and risk management practices at firms. That understanding will inform our evaluation of individual firms and the regulatory resources we devote to them. In our assessments, FINRA will focus on the frameworks that firms use to develop, communicate and evaluate conformance with their culture. We will assess five indicators of a firm's culture: whether control functions are valued within the organization; whether policy or control breaches are tolerated; whether the organization proactively seeks to identify risk and compliance events; whether supervisors are effective role models of firm culture; and whether sub-cultures (e.g.,  at a branch office, a trading desk or an investment banking department) that may not conform to overall corporate culture are identified and addressed.


A firm's culture is both an input to and product of its supervisory system, including its approaches to identifying and managing conflicts of interest and ensuring the ethical treatment of customers. This means that firms should take visible actions that help mitigate conflicts of interest, and promote the fair and ethical treatment of customers. For example, material breaches of firm policies and procedures should not be tolerated, and compliance functions should be equipped with necessary resources to help firms navigate a complex and changing regulatory and market environment. In this regard, FINRA's focus on firm culture is closely related to another area of focus for 2016: supervision. As discussed in our 2015 letter, a firm's supervisory, risk management, and control systems are essential safeguards to protect and reinforce a firm's culture.


LITERALLY AND FIGURATIVELY, “CULTURE, CONFLICTS OF INTEREST AND ETHICS” IS ‘SO LAST YEAR’!    The financial services industry appears to be at a crossroads in 2017. The industry could continue to seek virtue in the name of ‘investor protection’. Alternatively, it could take its cue from the Trump administration, where new revelations of conflicts of interest (‘COIs’), whether they’re disclosed or undisclosed, along with Alt News, are as common as … - well, as common as daily occurrences.


Here it is, in May, and we’re just learning that Jared Kushner, Trump’s son-in-law and senior adviser, failed to provide a lot of financial disclosure – like, the fact that he’s currently in business with Goldman Sachs and billionaires George Soros and Peter Thiel. Turns out that Kushner is a part-owner of real estate finance firm Cadre, which matches investors with real estate projects (and Cadre’s other investors include Goldman, Soros and Thiel). [NYPost and WSJournal


One week later, we learn that the Kushner family – in particular, Jared’s sister Nicole Meyer - used a sales pitch to Chinese investors that came “very, very close to solicitation of a bribe,” according to Richard Painter, who was an attorney for President George W. Bush and is now a professor at University of Minnesota Law. He further remarks: “This is corruption, pure and simple.”


Yet, what will become of these incidents, or any of the countless other COI’s in this administration. NOTHING.  Fact is, COIs are BADGES OF HONOR. Carl Icahn has proposed changes to the market for trading biofuel refining credits that would benefit certain refiners, including CVR Energy, in which Icahn holds a controlling stake. According to Reuters, CVR built a large short position in renewable fuel credits, or RINs, positioning the refiner to profit if the price of the credits fell. Prices dropped shortly after Icahn made his proposal.


WHERE FINANCIAL SERVICES GOES FROM HERE.    Perhaps the answer for the financial services industry will be decided by the republican-led executive and legislative branches of government, which seem hell-bent on ‘defanging’ financial regulations and chopping the budgets of federal regulators – for better or for worse. On yet another flank, the judicial branch of government continues to issue rulings that question the constitutionality of SEC Administrative Proceedings and the in-house judges.


On a more proactive mode, financial services firms and individuals might opt to fight tooth and nail’ against attempts by regulators to issue fines and sanctions that pertain to conflicts of interest. There is, after all, plenty of present-day precedent to support some level defiance. And it might save help protect the careers, financial resources and reputations of many financial players.  


[Note: In making such a statement, Financialish in no way suggests or endorses that penalties for other violations – e.g., market manipulation and unsuitable sales to senior investors – be eliminated or reduced in severity.]