How to Respond to Conflicts of Interest
Securities legislation requires all registered
firms to identify and respond to material conflicts
How do you respond to a conflict of interest?
Clearly, you must do so in the light of your
obligation to deal fairly, honestly and in good faith
with clients. The proper response in a given case
depends on the type of conflict involved.
Possible responses are:
1. avoiding the conflict of interest
2. disclosing it to the client
3. taking steps to control it and disclosing it to the client
Response 1 – Avoiding a Conflict of Interest
Avoiding a conflict of interest means not
proceeding with the course of action that would
give rise to the conflict. You must avoid a conflict
of interest when:
• the related course of action is prohibited by law, or
• it is so contrary to the interests of the client
that no other response is reasonable
When Prohibited by Law
Avoidance is the only proper response when
the related course of action is prohibited by law.
For example, exempt market dealers and their
representatives are prohibited from lending money,
extending credit or providing margin to a client. The
prohibition is intended not only to limit your credit
risk but also to prevent conflicts of interest.
When Contrary to the Interests of the Client
A conflict of interest should also be avoided
when it is so contrary to the interests of the client
that avoidance is the only reasonable response.
Let us look at two examples.
The first example involves the sale of complex
products. You know of a product that pays a high
commission, and it is clearly in your interests to
sell it. However, the product is complex, opaque
and extremely risky. You carry out a due diligence
exercise on the product and conclude that it would
not be in your clients’ interests to own it.
In this situation, the only reasonable response
may be to avoid the conflict of interest by refraining
from selling the product to your clients.
Borrowing from Clients
The second example involves borrowing
from clients. Exempt market dealers and their
representatives are not expressly prohibited
from borrowing money from clients. However,
this course of action inevitably colours the
relationship between you and the client and
creates a conflict of interest.
How can you possibly make
recommendations with the requisite objectivity
and serenity when you are indebted to the client,
particularly if payments of principal or interest
Response 2 – Disclosing a Conflict of Interest
If you decide to avoid a conflict of interest,
you have effectively eliminated it and there is
no need to disclose anything to the client. On
the other hand, if you decide to proceed with a
course of action that involves a conflict of interest,
you must disclose the nature and extent of the
conflict whenever the client would reasonably
expect to be informed.
Disclosure must be made before or at the time
of providing the service to the client. This enables
the client to decide with full knowledge of all relevant
facts whether to go ahead with the transaction or not.
In some cases, disclosure on its own is
sufficient. The dealer’s remuneration for selling a
product constitutes a good example. Most clients
will agree that you must be fairly paid for your
work. However, within the bounds of fairness,
the client will want your remuneration to be lower
whereas you will want it to be higher.
This conflict of interest is addressed through
disclosure. As part of the relationship disclosure
information, dealers are required to provide to their
clients a description of the remuneration they receive
in connection with the different types of product that
they sell. The disclosure is made at the beginning of
the relationship with the client and whenever there is
a significant change in the information.
Response 3 – Disclosing and Controlling a
Conflict of Interest
There are cases when disclosure on its own
is not sufficient. In such cases, disclosure must be
accompanied by measures to control the conflict
Earlier, we discussed the issues when a dealer
or a representative borrows money from a client.
If a representative is allowed to borrow money
from a client, it may be possible for the dealer
to control the conflict of interest by assigning a
different representative to service the client.