A conflict of interest arises when a financial professional's personal financial interests, relationships, or other incentives conflict — or could appear to conflict — with their duty to act in a client's best interest.
Common conflicts of interest in financial services:
| Type | Example | |---|---| | Compensation-based | Rep earns higher commission for selling proprietary products vs. equivalent third-party funds | | Principal trading | Firm sells securities from its own inventory to clients (potential markup conflict) | | Soft dollars | Directing client trades to brokers who provide research, not necessarily best execution | | Dual hatting | Acting as both adviser and broker on the same transaction | | Referral fees | Receiving compensation for referring clients to other professionals | | Investment banking | Analyst faces pressure to rate favorably companies the firm does investment banking for | | Front-running | Trading ahead of client orders |
Regulatory requirements to manage conflicts:
- RIAs (fiduciary standard): Must disclose all material conflicts of interest in Form ADV Part 2A; must mitigate conflicts that cannot be eliminated; must never put personal interest ahead of clients' interests.
- Broker-dealers (Reg BI): Must identify and disclose material conflicts; establish policies to mitigate conflicts that create an incentive to recommend products not in clients' best interest.
- FINRA Rule 2010: General standard of commercial honor; undisclosed conflicts are prohibited.
Disclosure vs. elimination: Disclosure alone may not be sufficient for serious conflicts — some must be eliminated (e.g., a fiduciary cannot simply disclose they are front-running client trades).
> Exam tip: Disclosure is the first step, but for fiduciaries, disclosure alone is not always enough — some conflicts must be mitigated or eliminated. Know the difference between Reg BI's conflict management (mitigate) and the fiduciary standard (eliminate or manage with client consent). Tested on Series 65, Series 66, and CFP®.