Conduct of Business - Business Essay Example

Conduct of Business

A principal is the major investor in a financial transaction, who buys and sells his/her own shares - Conduct of Business introduction. In a financial services firm, an agent holds assets in trust for a beneficiary and will have to fulfil his/her fiduciary duties towards the beneficiary organization. An agent is also referred to as a broker or a financial consultant. As per law, the agent will have an obligation to ensure that the interests of the principal are intact. An instance of conflict of interest can occur between a principal and an agent in a financial services firm can occur due to fraud, malpractice or unjust dealings.

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This essentially means that an agent must, at all times, maintain the confidentiality of the client and his/her personal information and business transaction details. When the information possessed by an agent about a principal is used against the principal’s benefit, it constitutes a conflict of interest. The agent should not maintain secret profits under any circumstances. Brokerage agents must abstain from receiving soft commissions and bundled brokerage commissions, and should maintain transparency in financial transactions. Soft profits or commissions are given to a brokerage agent by the FM, whereas the support services are actually performed by a third party agency governed by a business level agreement. An agent should not make false claims or exaggerate IPO prices before its issue. This practise is commonly known as laddering and is done to convince the principal investor to obtain better allotment.

When dealing with more than one principal, the agent should not have any bias and exercise the highest degree of impartiality. The agent should also bear in mind that directly or indirectly favouring one client over another with respect to keeping the customer updated on new investment ventures and impartial investment allotment can result in a conflict of interest due to prejudicial treatment. A conflict of interest can also arise when an agent helps one client to obtain cheaper shares in return for explicit favours at the cost of another client. This practise is also referred to as spinning and is followed by brokerage firms to promote their relationship with bigger clients.

Bundling of orders into one is known as aggregation to attract bigger players. Bundled brokerage commissions do not have an explicit agreement and are often in-house commissions. However, this can lead to a conflict of interest if one client gets an undue advantage over another or when it is done without the prior notification to the clients. Any brokerage agency has to enforce a system to ensure that such conflicts of interest do not crop up. However, if a conflict of interest is identified, it must be entirely disclosed at the earliest, bearing the client’s best interests in mind.

There are certain COB rules that have to be followed while mitigating conflict of interests, in order to promote fair transactions. While dealing with a discretionary customer, a brokerage firm must not offer advice unless it takes regulatory steps. One such measure is to enforce Chinese Walls, which is nothing but the ability of a firm to create rules to restrict information from flowing to other departments or firms involved in the same line of business[1]. However, adequate monitory measures need to be put in place to ensure that the walls are safe, in order to avoid abuse of information.

The FSA has issuing certain guidelines to carry out investment research. Before the issue of the market research results, a firm is not permitted to directly deal on it own account. However, an exception can be made if the firm happens to be a market-maker. The firm can also directly deal on its own account if it satisfies a customer order which is unsolicited. FSA requires the published research to completely unbiased and to incorporate measures to mitigate conflicts of interest. The firm will also be required to issue its disclosure along with the publishing of investment market research. The disclosure must be accurate and must clearly elucidate the fact that agreement has been effected to eliminate certain fiduciary duties of the firm. The disclosure must also ensure that the client is fully aware of the consequences of the agreement and not misguided by distorted information. However, specific disclosure is required when the firm intentionally effecting a conflict of interest, due to unethical reasons. It is also needed when the agent gains undue advantage or when principal in the transaction is the firm itself.

A customer’s order can be executed either as an aggregated order or as a single order. However, the execution of the order in investments must be fair and square. The execution of the order in a designated investment must within a reasonable timeframe[2]. The firm must also maintain proper records of both single and aggregated orders that it has executed. It should also keep records pertaining to client details, allocation order and the type of client relationship involved.

Recently, the term “best execution” has come under a lot of scrutiny. It is quite essential to spread the meaning of the term and its relevance among the customers. Irrespective of the nature of execution of the order, the execution of the deal must be at the best price. This practice is known as best execution and be sustained only through continuous monitoring. This can be achieved by comparing various prices from different sources, while neglecting commission charges. However, best execution cannot be enforced in collective investment and life policies.

References

J.R. Midgley, ‘Confidentiality, Conflicts of Interest and Chinese Walls’ (1992) 55 Modern Law Review  822

J. Macey and M. O’Hara, ‘The Law and Economics of Best Execution’ (1997) 6 Jnl of Financial Intermediation 188

[1] s.147 FSMA
[2] COB 7.6.4

 

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