Q:
I always live by the rule of “The Client Comes First.” But, sometimes I feel that my bosses are pushing in the opposite direction. What do I do when I feel a product or solution that is not proprietary is a better fit for my client, but my bosses are pushing me to sell our company products for the benefit of the company? I've always been a team player. But, being a team player often appears to clash with my motto of putting the client first.
A:
The question you raise and concerns you have are both legitimate and all too common in the securities industry. It's the classic push-and-pull of an industry that relies heavily on the advice of an individual who is earning a commission. Being a “team player” and “putting the client first” aren't incompatible, however.
Let's assume that you have a self-employed client in need of advice for his pension account. He speaks to you about his risk tolerance, his time horizon for investing and his prior experience in the market. After a thorough discussion, during which you've obtained all the relevant information, you research suitable investment recommendations. If there's no product, proprietary or otherwise, that addresses the specific needs of your client then your concern is a moot point. The conflict also doesn't exist if your firm does not have a proprietary product that suits your client's needs, but a suitable investment is available from an outside source.
The problem arises when you've got to choose between proprietary and non-proprietary investment products that both appear to fit your client's needs. How do you choose? NYSE Rule 405, known as the “Know Your Customer” rule, states: “Every member organization is required … to use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account …” Additionally, the rule goes on to state that every member organization is required to “supervise diligently all accounts handled by registered representatives of the organization.”
Nowhere does the rule specifically prohibit the recommending of proprietary investments over non-proprietary products. Rather, Rule 405 specifies that a registered person is required to obtain all of the essential information available about a client prior to making a determination about the suitability of an investment recommendation. Moreover, part two of the rule places a heavy burden on the firm to oversee the activity of a registered person — you — to ensure compliance with the basic tenets of the rule. So, not only are you charged with knowing and understanding the needs of your client, your firm has an equal or greater burden to “diligently” supervise the accounts you serve to ensure compliance as well.
The fact that you may want to recommend a proprietary product does not automatically make it suspect and, thus, unworthy of recommending. If that were the explicit interpretation of the rule, then you, as the investment advisor, might be severely limited in the recommendations you could offer to a client. Your firm may have a product that is just the right fit, making it unwise for you to rule out suggesting it to your client.
If you find yourself in the quandary of what to recommend when there are both proprietary and non-proprietary products available:
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Make a careful and reasoned analysis of the choices.
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If, after this analysis is conducted, you believe that your client would be best served by the non firm-sponsored investment vehicle, you have an obligation to offer that investment to the client.
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Should your decision to offer a non company product be questioned by your supervisors, you might want to provide them with the analysis that you conducted on the firm's versus outside offerings.
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Highlight for them the basis for your recommendations.
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Underscore your desire to do the right thing — both as a team player who follows the rules, thus protecting the firm, and as an investment advisor who makes sound and suitable investment recommendations for his clients.
Jeffrey S. Feinberg, Esq.
Bernstein Nackman & Feinberg,
New York City, 212-709-8229.
[email protected]
A:
If it is any comfort, the issue you raise is not new. There is a long-perceived natural tension that exists between the challenging goals of revenue production, adherence to compliance and effectively serving the customer's interests. These competing forces do not necessarily have to be in conflict. Well-run organizations and dedicated sales staffs find the correct balance, identifying proper products for the appropriate customer and generating fair returns for all of the participants to the transaction — the firm, the broker and the customer.
It is only when a party's interests are diverted from this path that problems arise. Unfortunately, there have been occasions when a broker/dealer or registered representative wandered off the path of righteousness and pursued a personal agenda to the detriment of the customer. These problems may arise as a consequence of the sales of proprietary products, such as mutual funds, annuities and private placements, or distributions in which the firm is an underwriter. Improper activities have led to regulatory sanctions against firms for tying special incentives, such as trips, cash and goods to sales of the firm's proprietary products when non proprietary products were as good, if not better and cheaper, than the product touted by the firm and the sales personnel. Sanctions have also been made against individual reps for violations of the “Know Your Customer” rule.
Under the circumstances described in your inquiry, your concerns appear to be real and justified. It will generally not suffice for you to assert that you were just following orders when you sold what is an allegedly unsuitable investment to the customer. That defense hasn't worked before NASD arbitration panels in the past, and it will probably not work in the future, either.
The customer's interests must be paramount. That much we can all agree on. Clearly, if the product were inferior, you would not sell it, and if you were hounded by management to sell it anyway, you would leave the firm. But let's proceed on the assumption that the product that the firm seeks to market is not defective in some sense. Rather, let's assume for the purposes of this discussion that the firm's product provides features, rates of return and fees and costs comparable to the competition.
If the product is truly competitive as an investment, all things being equal, there may be strong reasons why a proprietary product would best serve the interests of a customer, as well as the collective interests of the firm and broker. First, if the firm is sponsoring the product, it is expected to have an in-depth familiarity with the product and a reasonable expectation regarding how it will react to various market conditions. Since the firm stands behind the product, it will be motivated to provide a ready and stable market for it and to maintain its competitive position by dint of performance and fees. Second, unless the account is “overloaded” with any one company's products — especially product that would make the account illiquid or subject to high surrender costs — or is not properly diversified by sector, then there is no reason to avoid proprietary product. A broker who is meeting his or her duty to the customer will have offered the customer various alternatives, including the proprietary product, and can justify the recommendations made. Then, it's up to the customer to decide. I do not know what repercussions you fear, but the firm would be on very thin ice legally if it were found to have “intimidated” its brokers into pushing its product over another that was better or, worse, retaliated against a broker for acting on his conscience.
In light of your concerns, you might wish to put in writing the bases for your recommendations. Contemporaneous notes may act as an insurance policy, reflecting why a particular recommendation was made at an earlier time. This document may be valuable in the event you get into a scuffle with the firm regarding your “loyalty” or subsequently with an aggrieved customer, who attacks the recommendation because he was sold a proprietary product that failed to perform to expectations.
In the end, go with your instincts. It's your license and reputation that are at stake. Once they're tarnished, they're hard to restore. If the product isn't right for the customer, don't sell it.
Jonathan M. Harris,
Lindquist & Vennum, Minneapolis.
612-371-2492
[email protected]
The Ethical Rep is our monthly column through which more than 30 prominent securities industry attorneys, experts and law school professors answer questions you, our readers, send anonymously to us.
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