Monday, February 23, 2009

Conflict of Interest

Conflict of Interest is something that few people consider in their day-to-day lives that absolutely must govern the conduct of a financial services adviser, such as a mortgage broker, yours truly.

There are any number of ways that a conflict of interest may arise for a mortgage broker, any of them significant to the potential victim of the conflict of interest.

I will define a conflict of interest as follows, "A confict of interest is the result of an imbalance of power created by an advisor's ability to gain the trust of a client, when in the present of that trust, the client relies on information provided to the client that fails to disclose relevant information known to the advisor but not to the client, such information causing potential harm to the interests of the client."

Another way to put this, is to say that, "anything known which may have a tendancy to cause a client not to engage in a contract, must be disclosed prior to the client completing the contract. This is particularly true when an advisor acts as an agent for the client, and using superior knowledge or skill on a client's behalf."

For brokers there is certain information they are expected to provide as a part of their normal due diligence, and while the precise information required depends upon the specific details of a given mortgage arrangement, due diligence is required of a broker. It is not enough for a broker to say, "I didn't look, so I therefore didn't know."

In the day-to-day lives of mortgage brokers there are several situations which commonly occur, particularly when a broker is representing a borrower and a lender in the same transaction. It is a rule of ethics, and of law, that the broker fully disclose any compensation he is receiving from either party to the other party, and that there be no secret commissions or compensation, as the party not in possession of this information may conclude that the broker is being influenced by such an undisclosed payment.

There are other potential conflicts of interest, such as when a borrower client tells a broker confidential information, which if disclosed to a lender would result in a mortgage loan being declined, such as information that the borrower is just about to lose a job. In such a situation, where the right to confidentiality of one party potentially violates the right of the other party to full disclosure the broker may very well find himself in a position of having to withdraw entirely from the file and cancel the application for the mortgage prior to completion, as this situation would result in an improper outcome if the information is withheld. On the other hand the borrower has a legitimate right to have his or her confidentiality preserved.

In such a no-win scenario a broker has no choice but to withdraw from the transaction altogether because there is no way he can legitimately balance the rights of both parties.

Many times a potential conflict of interest arises because the lender is paying the broker's commission or finder's fees while the broker is simultaneously acting for the borrower. This is the most common conflict of interest experienced by mortgage brokers acting to place mortgages with institutional lenders such as the banks, who generally pay all of the broker's fees. Just because the bank is paying the freight does not mean that the broker has no obligation to the borrower, on the contrary. The broker must balance his duties to the two parties carefully, to ensure that he fulfills his fiduciary responsibility to his borrower while at the same time ensuring full disclosure of all relevant information to the lender.

In most provinces there is legislation mandating specific forms of disclosure of this last type of conflict of interest, which allows the broker to deal with the potential confict of interest, and the harm it could cause a borrower, by fully disclosing that conflict of interest in the course of the transaction.

Although much more could be written about the potential conflicts of interest arising out of a brokers responsibilities to both borrowers and lenders, the bottom line is full disclosure of all material information to both parties at the time of any transaction. Any deficiency in disclosure, either statutory or ethical, is unacceptable as it has the potential to harm the financial interest of either the lender or the borrower.

Ultimately, both lenders and borrowers (ie: investors) need to accept personal accountability for their own lending and borrowing decisions, something only possible if they are in possession of all relevant information.

There are severe potential financial, legal and regulatory consequences for the financial advisor who does not takes his duty of disclosure seriously or his obligation to his clients to balance fairly the interests of both the borrower and lender.

In the context of investing in mortgages or mortgage investments generally it is critical that investors read the disclosure documents closely whether the Mortgage Investment Disclosure Form as defined by the Form 9 in British Columbia, or by an Offering Memorandum for an investment in a mortgage investment corporation. It is extremely important to review all documents provided by your broker or other investment advisor in order to satisfy yourself that everything needed for you to make a decision is present.

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