Can Advisors Have ‘Zero’ Conflicts of Interest? The Legal and Regulatory Record

c. Any information about the certificant or the certificant’s employer that could reasonably be expected to materially affect the client’s decision to engage the certificant that the client might reasonably want to know in establishing the scope and nature of the relationship, including but not limited to information about the certificant’s areas of expertise.

In other words, not just any information, but material information must be disclosed.  It would be misleading under our rules for a CFP Professional to state that he/she has “zero” conflicts of interest because non-material conflicts arise frequently enough in an advisor/client relationship such that they must be distinguished from material conflicts.

The Supreme Court has, on numerous occasions, reaffirmed the traditional test of Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), that the materiality requirement under Section 10(b) of the Exchange Act is satisfied when there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as being important to his or her investment decision (including a decision to retain the security or not).”  Thus, materiality depends on the facts and is to be determined on a case-by-case basis (pp. 238-241. Basic v Levinson, et al.)

Following the Basic and TSC Industries materiality definition, it seems incredulous that Mr. Weisbluth would have suggested that he had neither material nor non-material conflicts of interest since by definition some non-material or material fact will always exist in every advisory relationship.  Although an advisor may have no material conflicts of interest, it does not follow that he has “zero” – a standard that is, for all intents and purposes, unachievable. 

Ultimately, every CFP Professional and Investment Advisor has an ongoing obligation under our Practice Standards to disclose material conflicts of interest. In view of the ongoing nature of the obligation to disclose material conflicts and the fact that, as every financial adviser knows, and history has shown, material conflicts can arise at any time during a client-planner relationship, it is simply inappropriate for a CFP® professional to say to a client that he/she has zero conflicts of interest. Here, a question of materiality comes into play.

As mentioned above, CFP Professionals have a duty to disclose material conflicts of interest to clients.  The more difficult question is: “How much disclosure is enough?”  In a 2010 settled enforcement action, the SEC suggests that disclosure of material facts alone may not be sufficient, and that more explicit disclosure is needed when investment advice may result in additional compensation to the adviser.  The case is Matter of Valentine Capital Asset Management.

The SEC’s administrative order found that the advisor “fail[ed] to fully and adequately disclose a material conflict of interest” by not informing its clients that the advisor would receive an additional commission if its clients accepted its recommendation to switch from one series of a managed fund to another series in that same fund.  The SEC reached this conclusion despite the fact that the advisor fully disclosed all commission costs to its clients.

Despite disclosure of the fees, the SEC found that the advisor was required to make “full and clear disclosure” about any conflict of interest in recommending the exchanges, and that it “failed to disclose to clients that [it] would receive additional commissions” if clients followed the advice.  Consequently the SEC found that the advisor breached its fiduciary duty.  The SEC charged the advisor with failing to tell clients that he would receive additional commissions if they switched from one series of a fund to another; the case settled with a censure, disgorgement of approximately $395,000 in commissions, and a $60,000 fine for the advisor’s president.

In a release publishing recent amendments to Form ADV, the SEC addressed this type of conflict issue. The SEC noted that Item 5 of the amended form requires that advisers receiving compensation, such as commissions, attributable to the sale of a security or other investment product, disclose the compensation as well as “the conflict of interest it creates, and … how the adviser addresses this conflict.”

Valentine should serve as a cautionary tale for all CFP Professionals. Not only is there no such thing as “zero” conflicts of interest but the nature of “material” is subject to change.  Be careful and diligent.  Keep abreast of regulatory developments and the latest literature. Many traps lie in wait for the careless or uninformed CFP Professional, including those regarding “material” conflicts during the client-planner relationship.