BLAW 480 Quiz on CFPC&S-A5. Conflicts of Interest

A.5. CS1. Regarding Bruce’s duty to disclose conflicts of interest, which of the following is the best response?

• Bruce has no Material Conflict of Interest because Heather understands that Bruce will be paid for his services.

• Bruce satisfied his disclosure obligation when he disclosed his fee for managing the IRA.

• Bruce did not fully disclose to Heather the Material Conflict of Interest that his recommendation presented.

• Since Bruce sincerely believed that his recommendation was in Heather’s best interest, he was excused from making

  full disclosure to Heather.

Answer explanation

A CFP must make full disclosure of all Material Conflicts of Interest with the client that could affect the professional relationship. That includes providing the client with sufficiently specific facts so that a reasonable client would be able to understand the conflict and the business practices that give rise to the conflict, and either give consent to or reject such a conflict.

Here, Bruce has a Material Conflict of Interest that could affect his professional relationship with Heather because of how he is compensated for his services. To provide sufficiently specific facts for Heather to understand his Material Conflict, Bruce must explain that he will receive an ongoing fee for managing Heather’s assets only if she accepts the recommendation and the assets are invested in an IRA; Bruce will receive no compensation if Heather keeps the assets in the account in the 401(k) plan because he will not be providing Financial Advice on those assets. A reasonable Client, like Heather, would consider that information important to making a decision whether to follow or reject Bruce’s Financial Advice. Because Bruce did not fully disclose that information to Heather, he did not satisfy his duty to disclose Material Conflicts of Interest.

A.5. CS2. Emma analyzes David’s investment time horizon and concludes that the commission she would receive on the purchase of a REIT investment would be less than the management fee she would earn if the assets remained in David’s investment account. The account that would hold the REIT would not pay Emma a management fee. What should Emma do?

• Explain to David that, in her professional judgment, he should not invest in the REIT.

• Fully disclose to David her Material Conflict of Interest, obtain informed consent to the conflict, and provide David

  with her advice.

• Explain to David that she must decline to provide David the advice he is seeking. Emma has a Material Conflict of

  Interest because she will earn more compensation if David keeps the assets in the investment account than if David

  invests in the REIT, and Emma cannot provide disinterested Financial Advice.

Answer explanation

A CFP must make full disclosure of all Material Conflicts of Interest with the Client that could affect the professional relationship. The Duty to Disclose Conflicts of Interest requires the CFP to provide the Client with sufficiently specific facts so that a reasonable Client would be able to understand the Material Conflicts of Interest and the business practices that give rise to the conflicts, and to either give informed consent to such conflicts or reject them. One Conflict of Interest occurs when the CFP's interests (including the interests of the CFP’s Firm) are adverse to the CFP’s duties to a Client. Information is Material when a reasonable Client or prospective Client would consider the information important in making a decision. A CFP must make full disclosure and obtain the Client's consent before providing any Financial Advice regarding which the CFP has a Material Conflict of Interest.

Here, Emma has a Material Conflict of Interest because she will earn more compensation if David accepts her recommendation. The fee that Emma would receive if she continued to manage David’s investment account will be greater than the commission she would receive if he purchased the REIT. Emma must make full disclosure to David of the compensation conflict before or when making the recommendation and obtain David’s informed consent to the conflict.

As a best practice, CFP Board recommends that Emma disclose the Conflict of Interest to David in writing before or when providing the Financial Advice, even though written disclosure is not required.

A.5. CS4-Q1. Which of the following are NOT material conflicts of interest under the CFP Board's Code and Standards?

• Frank’s contract with Old Jersey requires Frank exclusively to offer Old Jersey products to his Clients.

• Frank and Margaret met while serving on the Board of Trustees of their children’s school.

• Frank receives compensation only for providing Financial Advice on the sale of insurance products.

• The premiums of permanent life insurance are higher than the premiums for term insurance, which means that Frank

  receives more compensation when he sells a Client permanent life insurance than when he sells a Client term life

  insurance.

Answer explanation

Response B is not a Conflict of Interest. The fact that Frank met Margaret while serving on the Board of Trustees at the school does not make Frank’s interests adverse to his duties to Margaret.

A.5. CS4-Q2. What must Frank do to address these Material Conflicts of Interest?

• Frank must disclose his Material Conflicts of Interest to Margaret, obtain her informed consent, and manage the

  conflicts in Margaret’s best interests.

• Frank must obtain Margaret’s informed consent to any Material Conflicts of Interest in writing.

• Frank should not disclose his Material Conflicts of Interest to Margaret because this gig is about making MONEY!!

Answer explanation

Here, one way that Frank may make full disclosure of all Material Conflicts of Interest would be by providing Margaret with the following information:

1. That his agent agreement with Old Jersey requires him exclusively to offer Old Jersey products, even if other products available in the marketplace might have a lower cost or have features that would make them a better fit for Margaret’s circumstances.

2. That he only is authorized to sell insurance products and that he receives compensation only on the sale of insurance products, and that this provides him with a financial incentive to recommend insurance products even if other types of products that he is not permitted to sell might be a better fit for Margaret’s circumstances.

3. That there is a difference between permanent and term life insurance, and explain that difference.

4. That Margaret will pay higher premiums for permanent life insurance, and that Frank will receive more compensation for the sale of permanent life insurance, and that this provides Frank with an incentive to sell permanent life insurance.

5. That Frank expects to earn more compensation over the term of certain insurance products than others, and the types of products that will pay him more compensation.

6. That this provides him with a financial incentive to recommend those insurance products over others where he will earn a lower aggregate amount of compensation.

For Frank to sell Margaret the policy, Margaret also must provide her informed consent to the Material Conflicts of Interest. Margaret’s informed consent may be inferred if Frank’s disclosures are sufficiently specific.

Frank also must manage the Material Conflicts of Interest by adopting and following business practices that are reasonably designed to prevent the Material Conflicts of Interest from compromising his ability to act in Margaret’s best interest.