As fiduciaries, financial advisors are required to disclose any conflicts of interest that exist between themselves and their current and potential clients. The conflicts themselves can range from compensation models that impact how much money an advisor might earn as the result of a recommendation (such as specific product recommendations for advisors compensated on commission and 401(k) plan rollover recommendations for AUM-based advisors) to less direct conflicts such as ‘soft dollar’ benefits provided by custodial platforms that could incentivize advisors to recommend one platform over another.
But no matter the size or directness of the conflict, it still needs to be disclosed to clients, at a minimum on the advisor’s Form ADV Part 2A brochure. And given the sheer number and scope of potential conflicts that do exist in the advisory industry (where a wide range of providers seek to incentivize advisors to recommend their products and services to clients), there’s a vanishingly small number of RIAs that don’t have at least some form of actual or potential conflict to disclose.
However, despite the large number of potential conflicts that exist for advisory firms, much of the financial media and the general public tend to focus specifically on the conflicts caused by commission-based fee models. Which, in turn, has led a small but growing number of RIA firms to describe themselves as “conflict-free” on their websites and advertising materials as a way to distinguish themselves from other firms that may have more directly conflicted business models.
But the downside to using the “conflict-free” label was put into sharp focus recently, when the SEC announced that it had fined several RIA firms for violating its Marketing Rule. Specifically, the firms had all used some form of “conflict-free” to describe themselves on their website, while at the same time, each firm’s Form ADV Part 2A described multiple conflicts of interest – or in other words, the firms’ claims of being “conflict-free” were directly contradicted by their own required conflict of interest disclosures!
At a high level, the SEC’s cases illustrate that it can be highly problematic for an advisory firm to call itself “conflict-free”, since doing so violates the Marketing Rule’s prohibition on making any material statements that the advisor can’t substantiate when the firm really does have conflicts that it discloses in its own regulatory filings. And given that almost every firm has at least one conflict to disclose, there are almost no firms that could accurately (or compliantly) describe themselves as “conflict-free” – meaning it really might be best for advisory firms to avoid the label altogether.
If an advisory firm wanted to highlight its distinction from the commission-based compensation model, it could, in theory, use a more technically accurate term like “commission-free”. However, in a landscape where the number of fee-only, fiduciary advisory firms has grown – making “commission-free” less of a differentiator for any one firm – it’s worth questioning whether it makes sense for firms to describe themselves in terms of their relative lack of conflicts of interest at all. Because doing so shifts the client’s focus away from the advisor’s expertise and the value they provide, and instead draws attention to how their conflicts of interest compare with those of other advisors.
The key point is that with the sheer number of potential conflicts of interest in the advisory business, it’s better for advisors to be transparent about their own conflicts (and how they work to minimize them) than to downplay their conflicts in comparison to others in the advisory industry. Not only does this help them stay compliant from a regulatory perspective (as the recent SEC cases showed for firms that called themselves “conflict-free”) but it also helps build a foundation of trust with their clients – who are ultimately more interested in how their advisor can solve their financial problems than in questioning which practices pose more of a conflict of interest than others!
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