Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, May 21, 2012

Ketchum Addresses Conflicts of Interest at FINRA Conference

Richard G. Ketchum, FINRA's Chairman and Chief Executive Officer, emphasized identifying conflicts of interest and placing the customer's interest before the firm's in his speech before the FINRA Annual Conference on May 21:

First, I call on you to do a better job of assessing—and disclosing—your conflicts. We've heard a lot in the last couple months about the culture at large firms through various media reports and the conflicts that are part of the day-to-day operations. However, I don't think the conversation should just be about the culture at one firm or another. We understand that conflicts exist in the financial services industry. We need to take a step back, acknowledge that there are risks and look at how we handle those conflicts.

Nine years ago Stephen Cutler, who was then director of the SEC's Division of Enforcement, asked firms to undertake a top-to-bottom review of their business operations with the goal of addressing conflicts of interest of every kind. I would like to see such a concept review become a standard part of operating procedure. You should be assessing whether your business practices place your firm's—or your employees'—interests ahead of your customers. What I can promise you is that, particularly with respect to the large integrated firms, we will look to have a focused conversation with you about the conflicts you have identified and the steps you have taken to eliminate, mitigate or disclose each of them.

 Second, I call on you to ensure that the products you sell are appropriate for each investor. We have often reminded firms of their obligation to assess the potential risks associated with products that raise specific investor protection concerns. One of our concerns is the sale of complex products, and in January we published guidance in the form of a Regulatory Notice.

We've brought a number of enforcement actions involving complex products where we found firms didn't adequately supervise the sale of the products, the recommended products were unsuitable for the investors, or the sales material were misleading. We recognize the challenge you face when managing compliance oversight at a time when more customers are searching for yield and financial advisors are looking for products to meet these requests. Nevertheless, the suitability rule remains in effect, and it is the obligation of every firm to take steps reasonably designed to ensure that the suitability issues related to complex and other products are adequately addressed.

Before recommending a complex product to a retail customer, your financial advisers should be discussing the features of the product, how it is expected to perform under different market conditions, and the product's risks, potential benefits and costs. This means describing the circumstances under which the customer could lose money, not just those under which the customer would earn money. It also means explaining carefully the direct and imputed costs your client will incur and, where applicable, the fact that your firm or an affiliate is on the other side of the transaction. For this disclosure to work effectively, it will be equally important that you increase the training provided to your financial advisers to ensure that they fully understand the assumptions underlying the product and what can go wrong as well as right. 

Finally, before any complex product is offered to a retail client, your financial adviser should be able to write down on a single page why this investment is in the best interests of your client. This does not have to wait until you find out the details of any fiduciary rulemaking the SEC may make. Being able to articulate why an investment is in the best interests of your client is fundamental to what the securities industry must be about if it is to deserve the trust of investors.

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