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This file was generated by Descript 

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Samantha: Hello, this is Samantha Shares.

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This episode covers Understanding
Conflicts of Interest in Asset Management.

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The following is an audio
summary version of that document.

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This podcast is educational
and is not legal advice.

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We are sponsored by Credit Union
Exam Solutions Incorporated, whose

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team has over two hundred and
Forty years of National Credit

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Union Administration experience.

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We assist our clients with NCUA
so they save time and money.

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If you are worried about a recent,
upcoming or in process NCUA

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examination, reach out to learn how
they can assist at MarkTreichel.com.

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Also check out our other podcast called
With Flying Colors where we provide tips

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on how to achieve success with NCUA.

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And now the OCC summary.

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Today we're diving deep into conflicts
of interest in asset management.

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Even though this guidance is
primarily directed at banks, these

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principle-based guidelines provide an
excellent framework for credit unions

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as well when managing conflicts in
their asset management activities.

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Managing conflicts of interest properly
isn't just about checking regulatory

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boxes—it's fundamental to maintaining
trust with your clients and protecting

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your institution's reputation.

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Let's start by understanding what
exactly constitutes a conflict

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of interest in asset management.

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According to the OCC handbook, "Conflicts
of interest arise whenever a bank

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engages in self-dealing and in any
situation where a bank's ability to act

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in the best interests of its account
beneficiaries or clients is impaired."

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The handbook explains that "Self-dealing
occurs when a bank, as fiduciary,

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engages in a transaction with itself
or related parties and interests."

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At the heart of fiduciary responsibility
is the duty of loyalty, which the handbook

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describes as "the most fundamental
duty owed by a fiduciary to the

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beneficiaries of a fiduciary account."

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This involves administering the
trust solely in the interest of the

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beneficiaries and avoiding transactions
that involve self-dealing or that

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create conflicts between the trustee's
fiduciary duties and personal interests.

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So what are some common examples
of conflicts of interest?

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The handbook identifies several
scenarios where conflicts may arise:

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When a bank or its affiliate engages in
a transaction with a fiduciary account.

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For example, when a bank exercises
investment discretion and places

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fiduciary funds in an obligation
of the bank or an affiliate.

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Or when a bank places fiduciary assets
in a proprietary investment product

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managed by the bank or an affiliate.

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Another common scenario is when a bank
exercises investment discretion and

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allocates fiduciary brokerage business
to an affiliated broker-dealer, or

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delegates investment discretion to
organizations from which the bank receives

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a direct or indirect financial benefit.

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The handbook also mentions that
conflicts arise when a bank doesn't

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deal fairly with customers or collects
fees that aren't disclosed, aren't

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authorized, or are simply unreasonable.

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Even employee compensation plans
can create conflicts if they give

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employees incentives to act against the
best interests of fiduciary clients.

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Let's talk about the specific types of
risks that conflicts of interest present.

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The handbook identifies four main
categories: compliance risk, operational

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risk, reputation risk, and strategic risk.

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Compliance risk is obvious—conflicts
of interest in fiduciary activities

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are prohibited by numerous
laws and regulations, except

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under certain circumstances.

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Improper conflicts can result
in regulatory sanctions

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and costly litigation.

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Operational risk stems from potential
misconduct by directors, officers,

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and employees who administer
asset management activities.

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This includes improper use of inside
information, improper transactions between

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related parties, improper acceptance of
gifts, or acceptance of co-fiduciary fees.

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Reputation risk is particularly
damaging for fiduciaries.

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As the handbook notes, "A bank's
reputation can be negatively affected

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if the bank engages in, or appears
to engage in, improper conflicts of

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interest or self-dealing with respect
to its asset management activities."

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The expectation that a fiduciary acts in
its beneficiaries' best interest is at the

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core of the business, and damaging that
trust can have far-reaching consequences.

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Finally, strategic risk occurs because
improper conflicts can undermine a

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bank's growth and income strategy.

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Many institutions rely on fee-based
asset management as a stable

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source of revenue, which depends on
maintaining a satisfied customer base.

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Now, let's talk about what proper risk
management looks like when it comes

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to handling conflicts of interest.

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The handbook outlines
several key components.

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First, effective board and
management supervision is essential.

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The board of directors should
adopt and promote an appropriate

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corporate culture, including a code
of ethics that sets expectations

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for ethical behavior and compliance
with banking and securities laws.

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Second, institutions need comprehensive
policies that address various

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types of conflicts of interest
that might occur in their specific

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asset management activities.

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These policies should reflect the
bank's strategic direction, risk

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tolerance levels, and ethical culture.

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For example, banks are required to adopt
policies addressing brokerage placement

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practices, use of material inside
information, and methods for preventing

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self-dealing and conflicts of interest.

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They also need policies for fair and
equitable allocation of securities

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when receiving orders for the same
security at approximately the same time.

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Third, an institution needs robust
processes to implement these policies.

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This includes processes for identifying
potential conflicts in advance,

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analyzing whether such activities are
properly authorized, and monitoring

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for relevant changes in circumstances.

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The handbook emphasizes that "Even
when authorized by applicable law, the

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sale or transfer of an asset from a
fiduciary account to a related party or

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interest poses significant reputation and
litigation risks to a bank fiduciary."

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Such transactions should be
approved by the board of directors

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or a committee responsible for
overseeing fiduciary activities.

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Fourth, personnel need to be
qualified and properly trained.

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Management should recruit, develop,
and retain qualified staff and

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provide sufficient training and
oversight to ensure employees

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understand their obligations
regarding conflicts of interest.

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And fifth, effective control systems
like audit and compliance functions are

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necessary to assess the effectiveness of
processes to manage conflicts of interest.

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These systems should provide timely,
accurate, and relevant information

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about the nature and scope of
actual and potential conflicts.

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Let's discuss some specific scenarios
that often create conflicts of interest

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and how institutions should handle them.

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One common situation involves
self-deposits of fiduciary funds.

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The handbook notes that "The
primary supervisory concern with the

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self-deposit of fiduciary funds is
that a bank may fail to fulfill its

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duties of undivided loyalty and care
to fiduciary account beneficiaries

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if the bank's interests conflict
with those of its fiduciary clients."

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While regulations permit self-deposit
of funds awaiting investment or

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distribution, banks must set aside
collateral to secure deposits in

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excess of FDIC insurance coverage.

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Another important area involves
proprietary investment products.

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When a bank fiduciary invests in
mutual funds or other products

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sponsored or managed by the bank or
an affiliate, there's an inherent

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conflict because the bank benefits
from fees generated by these products.

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The handbook advises that "Before
investing assets of a particular

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account in a proprietary investment
product, a bank fiduciary should

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ascertain that all such conflicts
are properly authorized and disclosed

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in accordance with applicable law."

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Brokerage allocation is
another sensitive area.

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The handbook states that "Allocating
fiduciary business to a broker based

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on the broker's deposits or other
relationships with the bank, including

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business referral arrangements, is an
impermissible conflict of interest."

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The handbook also addresses soft
dollar arrangements, where a bank

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receives research and brokerage
services from broker-dealers in

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exchange for directing client
transactions to those broker-dealers.

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This creates a conflict because the bank
is using client assets to benefit itself.

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The handbook advises that such
arrangements must comply with the

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safe harbor provisions established
by securities laws and regulations.

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Employee conduct is another critical
aspect of managing conflicts of interest.

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Banks should implement policies
and procedures designed to prevent

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employees from improperly benefiting
from the bank's fiduciary activities.

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This includes prohibitions on accepting
gifts or bequests from fiduciary

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clients and proper oversight of
personal securities transactions.

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Let me highlight a few key principles
for handling these conflicts:

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First, authorization.

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Many conflicts of interest are permissible
if properly authorized by applicable law,

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which can include federal, state, or other
jurisdictions' laws, the terms of the

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governing instrument, or a court order.

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The handbook emphasizes that "Mere
authorization of a conflict of interest

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by applicable law does not make a
particular decision by a fiduciary

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appropriate, prudent, or in the best
interest of the fiduciary account."

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Second, disclosure.

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Even when conflicts are
authorized, full disclosure to

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interested parties is essential.

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As the handbook notes, "Even if not
required by applicable law, full

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disclosure of conflicts of interest and
fees related to investments in funds from

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which a bank receives fees is considered
a safe and sound banking practice."

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Third, fairness and reasonableness.

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Any fees charged must be reasonable,
and transactions must be fair to

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the fiduciary accounts involved.

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For example, when discussing fees,
the handbook states that "if a bank's

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compensation for acting in a fiduciary
capacity is not set or governed by

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applicable law, the bank may charge
a reasonable fee for its services."

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And fourth, best interest of the client.

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All decisions must ultimately be made with
the best interest of the client in mind.

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The handbook emphasizes that "A bank
fiduciary exercising investment discretion

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that makes a long-term investment in a
self-deposit is engaged in prohibited

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self-dealing unless the investment
is authorized by applicable law."

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Let's talk briefly about proper
oversight of conflicts of interest.

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Banks should conduct thorough due
diligence before entering into any

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arrangement that could create a conflict.

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The handbook advises that "Before
entering into such arrangements, the

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arrangements should be reviewed by
legal counsel and approved by the

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committee of the board of directors
responsible for fiduciary oversight."

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Ongoing monitoring is equally important.

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The handbook states that "These
arrangements should be reviewed

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periodically to ensure that they are
properly authorized under applicable

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law, disclosed in accordance with
applicable law, and do not impair

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the bank's ability to properly
exercise its fiduciary duties."

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Effective management information
systems are also essential.

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According to the handbook, "A bank's
MIS and related processes should provide

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adequate information to alert staff
to potential and actual conflicts of

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interest and self-dealing activities
and ensure that exceptions to applicable

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law, including bank policies, are
reported to the appropriate officers,

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employees, and supervisory committees."

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And of course, a robust audit program
is vital to ensuring that controls

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and processes are working properly.

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The board of directors must assess
whether audit programs are adequate

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to determine if conflicts of interest
are managed in accordance with

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applicable law and bank policies.

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So what happens when a bank identifies
a potential conflict of interest?

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The handbook advises that "A bank's risk
management processes should require that

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exceptions to bank policy or exceptions
that are in excess of the bank's risk

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appetite are identified and escalated
to a designated committee of the board

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of directors responsible for fiduciary
oversight or a designated senior

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manager for resolution or approval."

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Before we wrap up, I want to emphasize
that managing conflicts of interest

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effectively is not just about complying
with regulations—it's about maintaining

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trust with your clients and protecting
your institution's reputation.

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The handbook acknowledges this when it
states that "A bank's reputation as a

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fiduciary or provider of asset management
services may also affect deposit accounts,

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loan relationships, corporate clients,
and other banking relationships."

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Improper conflicts of interest
can undermine client trust and

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have far-reaching consequences
for your entire organization.

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In conclusion, conflicts of interest are
inherent in asset management activities,

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but they can be managed effectively
with proper authorization, disclosure,

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oversight, and a commitment to acting
in the best interest of clients.

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By implementing robust policies,
processes, and controls,

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institutions can navigate these
complex issues successfully.

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This concludes the summary.

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If your Credit union could use assistance
with your exam, reach out to Mark Treichel

00:13:17.771 --> 00:13:20.521
on LinkedIn, or at MarkTreichel.com.

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This is Samantha Shares and
we Thank you for listening.