The Regulators’ Conflicts of Interest

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A new SEC rule (Regulation Best Interest or “Reg BI”) that takes effect June 30 will encourage the acceptance and transmission of conflicts of interest. This rulemaking is a historic, giant step backwards in securities regulation. It turns principles of advice in the client’s best interest on its head. It is certain to undermine trust in financial advisors.

Trust and honesty are crucial not only in finance, but to any relationship in which one party (dependent) entrusts to another party (trustee) power over the dependent party itself or over its interests.

Conflicts of interest by the trustee corrode this trust relationship and reliance, in which dependents must rely on another. If the dependent suspects that the trustee has conflicting interests, they might withdraw from the relationship. However, in many cases the dependents do not know of the conflicts of interest that caused their loss and may discover the cause too late. The dependents’ loss can affect not only their well-being but the fortunes of the country.

Every trustee may be faced with conflicting interests – those of the dependent party and those of his or her own. The holders of entrusted power can be a government official, judge, lawyer, physician, teacher (who has the power to grade) or a financial adviser or broker. All can be exposed to conflicting interests. Conflicts can range from personal sympathy to the financial interests of the entrusted person. Hidden conflicting interests can arise in many situations. For example, a broker, who receives from a lucrative client an order to sell certain stock, which is too volatile, may try and persuade another, less lucrative, client to buy the stock, even though the other client, as well, is concerned, but less knowledgeable, about volatility.