The Star Producer's Outside Directorship and Referral Payments
A supervisor learns that a top-producing advisor has, for 18 months, served as a director of a small private lender that makes bridge loans to real estate developers. The advisor did not disclose the directorship on the firm's annual outside-activity attestation. The advisor also received CAD 42,000 over the period in 'referral fees' from the lender for introducing clients who then took bridge loans. Several of those clients are also advisory clients of the firm, and in three cases the advisor recommended that clients use the lender's product instead of a firm-approved alternative. The advisor says the directorship is personal, the referral fees are separate from his firm business, and the clients were happy. The firm's policy requires pre-approval of outside activities that could conflict with firm duties and prohibits unapproved referral compensation.
1. Identify the conflicts and policy breaches, and assess the advisor's 'personal matter' defense.
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The 'personal matter' defense fails on every element.
Conflicts:
- Directorship in a lending business that serves the same client base the advisor serves. The advisor has a financial interest in the lender's volume and profitability.
- Referral fees paid by the lender to the advisor create a direct incentive to steer clients to that lender, independent of what is best for the client.
- Recommendations favoring the lender over firm-approved alternatives - the conflict appears to have influenced advice.
Policy breaches:
- Failure to disclose the directorship on the attestation (a false or incomplete attestation).
- Failure to obtain pre-approval for an outside activity that could conflict with firm duties.
- Receipt of unapproved referral compensation, which the policy prohibits.
Why 'personal' fails:
- The activity is not personal when it involves the firm's clients and the advisor's recommendations to them.
- The fees are not 'separate from firm business' when they are earned by referring firm clients in the advisor's capacity as their advisor.
- Client happiness is not a defense; clients cannot consent to a conflict they were not told about, and the advisor's recommendation was tainted regardless.
Aggravating factors:
- 18 months of non-disclosure suggests it was concealed, not overlooked.
- Three documented cases where the conflicted recommendation displaced a firm-approved alternative.
2. What supervisory and remediation steps are appropriate, and how should the supervisor handle the three affected clients?
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The response should address the advisor, the clients, the lender relationship, and the control gap.
Advisor:
- Immediate restriction on the advisor's ability to recommend the lender's products, and a review of all client accounts that used the lender.
- Escalate to compliance and, if warranted, to the firm's disciplinary process. Consider whether the conduct requires regulatory notification.
- Require disgorgement or other remediation of the CAD 42,000 consistent with firm policy and applicable rules.
- Require a corrected attestation and pre-approval application for any continuing directorship - which the firm may decline.
Affected clients:
- Review each of the three recommendations against the firm-approved alternative: cost, terms, suitability. If the client was disadvantaged, consider making the client whole.
- Disclose the conflict to affected clients in plain terms: the advisor had a financial interest in the lender. Do not minimize.
- Offer the client the opportunity to review the arrangement with an independent person at the firm.
Lender relationship:
- Determine whether the firm has any business relationship with the lender that must be reviewed or terminated.
- Confirm no other advisors are receiving similar payments.
Control gap:
- The attestation process did not catch an 18-month directorship. Review how attestations are tested (e.g., cross-check against public registries, ask targeted questions) and whether the outside-activity list is current.
- Add a periodic review of advisor-affiliated entities against client transaction records.
Documentation: record the analysis, the client remediation, and the advisor outcome.