Conflict Of Interest Under The Microscope — Again


Assessing and monitoring conflict of interest in financial matters has never been a slam dunk. A new rule published by the Securities and Exchange Commission (SEC) indicates this continues to be so.

The rule sets tightened standards for Nationally Recognized Statistical Rating Organizations (NRSROs), which are essentially credit rating agencies.

The conflict of interest section pertains to those firms, not to advisory practices or procedures. Still, certain provisions in this section provide a kind of heads-up on regulatory thinking on conflict of interest matters, particularly in the area of “influence.” Regulatory thinking has a way of migrating, after all.

The pertinent provision not only prohibits sales and marketing persons at NRSROs from participating in or monitoring credit ratings or developing/approving rating procedures or methodologies, as may be expected. It also prohibits NRSROs from issuing credit ratings when employees who make the credit determinations also participate in the NRSRO’s sales and marketing or are influenced by sales or marketing considerations.

The language on this gets more technical, but that’s the gist of it.

The goal is easy enough to grasp: To ensure impartiality by preventing the money-making side of the organization from tainting the thinking and actions of the employees who are charged with rendering independent analysis and decisions.

But the “influenced by” section is troubling to at least one regulator — SEC Commissioner Michael S. Piwowar.

In a dissent posted on the SEC website, Piwowar maintained that the influenced by stipulation “sets an impossible standard for compliance and has no limiting principle. Any NRSRO that grows its business in any asset class could be suspected of having the ratings determination process ‘influenced by’ sales and marketing considerations.”

It’s not just management motives that could be questioned, Piwowar continued. “Every NRSRO employee, including those involved in ratings determinations has an interest in the success of the enterprise. Could the efforts of an NRSRO to increase, or even maintain, its market share and presence, and therefore support its workforce, be seen as ‘influencing’ employee conclusions about ratings?”

These questions go to the heart of the struggle over not only defining conflict of interest in a business setting but also coming up with a fair and objective way to regulate in that area. One could argue that virtually everything one does, and does not do, influences thinking and decisions, so where are the boundaries?

In the fees-versus-commissions debate, the conflict of interest issue pertains to financial professionals. The issue grows hot when conversation turns to which standard of care is best — fiduciary or suitability.

Fee proponents frequently complain that commission-based producers, who are subject to the suitability standard, may tend to (or be tempted to) recommend products that pay the highest commission, even if another product paying a lesser commission would be just as suitable.

Commission proponents complain that fee-based advisors, who are subject to the fiduciary standard, may tend to (or be tempted to) recommend investments that will quickly ramp up the assets under management upon which the fee is based, even if comparable options entail less cost and/or volatility.

There are plenty of other complaints, on both sides, and regulators are wrestling with them all. But what if regulators now sweep in the issue of “influence”? Will the profit motives of the advisors’ organizations be deemed as an influence that adversely impacts advisor recommendations? Will a special campaign to generate business from targeted buyers or to sell targeted products and services be so deemed? If so, under what circumstances? What is undue influence in this setting, and what is not?

If “influenced by” thinking surfaces in advisor-related proposals, a thorough airing of the matter would seem essential. As Piwowar commented, in reference to the NRSRO influenced by provisions, “had we [the SEC] posed focused questions about these issues at the proposing stage, perhaps the public could have suggested better ways to achieve the same objectives.”



Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Connect with Linda →

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