Incentive Structures Possible Conflict of Interest 10:16, November 16, 2016

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Incentive Structures Possible Conflict of Interest

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Earlier this year, the US Department of Labor (DOL) passed a rule about handling retirement accounts. While the new rule is pretty technical, it provides a simple example of a conflict of interest that affects everyday people and internal incentive structures.

People invest in IRAs and 401(k)s for their retirement. An administrator manages those accounts and has a fiduciary duty to act “solely in the interest” of the people with these accounts (you and me). This is a strict duty of care that requires administrators to put our interests above theirs. If the account holder doesn’t take control of investing, part of the administrator’s duty is selecting where our money gets invested, who invests it, and how the investment is performing.

Where’s the conflict of interest? It’s potentially with the person recommending the investment to the administrator or participants. Imagine a broker-dealer or financial adviser who makes an investment suggestion. If the administrator decides to invest, the broker-dealer will usually get compensated through commissions, fees and/or bonuses.

The allure of compensation creates the conflict of interest. A broker-dealer may suggest an investment that is not in the best interest of the participant, like a risky investment, because the personal payoff would be greater than a low-risk investment. No one is saying this is intentional; rather, the DOL weighs retirement accounts more heavily than risk associated with investment advice.

So, the DOL’s new fiduciary rule forces a fiduciary duty onto these broker-dealers and financial advisers to put “their clients’ best interest before their own profits,” according to the DOL’s Conflicts of Interest FAQs released in October 2016. This impacts compensation incentives, which must be “reasonable” under the circumstances, and communication, which includes disclosing conflicts of interest and certain fees and costs to the participant. ERISA and the Internal Revenue Code, complex federal laws, govern 401(k)s, IRAs, and other retirement-type accounts.

Having a stable retirement account is something we can all understand. But understanding personal and professional motivations, even with regulations like the fiduciary rule, are more complicated. For example, doctors are encouraged to disclose medical conflicts of interest, such as a doctor sincerely recommending a patient to undergo a certain procedure that the doctor had a hand in developing (and licensing). And we can all implement conflict of interest policies to reduce the risk of harm to the business and customers.

Disclosing is important, but something needs to compel people to disclose in the first place. “When it comes to reporting, there are barriers that might prevent one from disclosing ethical transgressions.” Financial or family pressures, a sense of loyalty, and ambition are all potential barriers to doing the right thing. Fortunately, there are tools that help us engage in ethical action by breaking down these barriers.

LawRoom (powered by EverFi) delivers online compliance courses to help your business meet compliance requirements both dynamically and scalably. In addition to our award-winning online courses, LawRoom delivers a robust, cloud-based learning management system to help you easily deploy and track our growing library of ethics, anti-harassment, data security and employee conduct courses.

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Douglas Kelly
Douglas Kelly is EverFi's lead legal editor. He writes on corporate compliance and culture, analyzing new case law, legislation and regulations affecting US companies. Before joining EverFi, he litigated federal and state employment cases and wrote about legal trends. He earned his JD from Berkeley Law and BBA from Emory University.

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