Referrals to family and friends: Issues that could turn sour

INVESTORS in Singapore do discuss money matters and investments with their spouse, as well as close personal friends and work colleagues. Typical subjects include investment goals, performance, market news and what to invest in next. In the course of a chat, it is not uncommon for one party to recommend a particular professional. It is also not uncommon that friends, family and associates seek recommendations on professionals who could potentially help with investment plans.

A word of caution, though. The practice of recommending someone may work for most people. But one needs to be cognisant of relationships turning sour, especially if risk assets underperform. Should a professional be recommended to investors, pertinent issues such as potential conflicts of interest and referral fees, if any, need to be addressed before proceeding with an investment arrangement to prevent a potentially unpleasant situation in the future.

Disclosure of conflicts standard

CFA Institute is the global association of investment professionals that sets standards for professional excellence and credentials. Its Disclosure of Conflicts Standard requires finance professionals to make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity, or interfere with their duties to their clients, prospective clients and employer.

To be effective, disclosures must be prominent and must be made in plain language and in a manner designed to effectively communicate the information. Best practice is to avoid actual conflicts or the appearance of conflicts of interest.

Conflicts of interest often arise in the investment profession. Conflicts can occur between the interests of clients, employers, and the investment professional’s own personal interests. Common sources for conflict in a referral arrangement include relationships and referral fees.

Nevertheless, once there is full disclosure, clients and prospective clients will have the information needed to evaluate the objectivity of the investment advice, action taken on their behalf and any recommendation.

Ethics in action

This case is based on and adapted from a CFA Institute Professional Conduct enforcement action. As a guide, the desired ethical behaviour required is based on the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards).

Joyce works as a research analyst at a private equity firm. Her personal investments are managed by her brother Neville, who works as a financial adviser. One day over lunch, Joyce’s colleague, Roger, mentions to Joyce that he is looking for a financial adviser and asks Joyce who she uses to manage her investments. Joyce tells Roger that Neville is her investment adviser, but she does not disclose that Neville is her brother.

After meeting with Neville, Roger hires him to manage his considerable assets. Neville regularly pays a $5,000 referral fee to his current clients who recommend new clients to his firm. Neville offers to pay his sister the $5,000 referral fee. Joyce was unaware of the potential referral fee and refuses to accept the money from her brother given their relationship. Did either Joyce or Neville violate the CFA Institute Standards of Professional Conduct?

This case potentially involves the CFA Institute standards related to conflicts of interest, which is the Disclosure of Conflicts Standard. Does Joyce or Neville have a conflict that needs to be disclosed to Roger? It is possible that Joyce has recommended Neville because he is a close family relation, and not solely because of his abilities as an asset manager. But she may also not not want Roger to feel pressured to hire Neville just because he is her brother.

The discussion between Joyce and Roger was personal rather than professional in nature. Roger is neither a client nor a potential client for Joyce. Rather, they are colleagues having a friendly discussion over lunch.

But even though Joyce’s actions in this particular scenario do not violate Disclosure of Conflicts Standard, it may be prudent for Joyce to make such a disclosure at the outset. If Roger learns of the sibling relationship, he may feel that Joyce withheld important information from him. She could potentially still find herself on the receiving end of a complaint, especially if things later sour between Neville and Roger.

Another aspect to look at is the CFA Institute Referral Fees Standard. This standard requires professionals “to disclose to their employer, clients, and prospective clients any compensation, consideration, or benefit received from or paid to others for the recommendation for products of services”.

Neville had a referral fee arrangement in place for his current clients when they referred his services to others. But Neville’s sister Joyce was unaware of the payment and turned down the referral fee when it was offered. So, Joyce was not influenced by a referral fee. If the fee had been paid to Joyce, Neville would have had to disclose this fact to Roger.

This column has been adapted from content by CFA Institute. The writers are CFA charterholders who volunteer with the Singapore chapter on advocacy issues.