Bad-Actor Conflict Review
Expose hidden conflicts by testing what a bad actor could exploit
- Difficulty
- Moderate
- Time to result
- ~weeks to results
- Steps
- 6
- Confidence
- 93%
The review inventories the firm's relationships, payments, products, authority, and disclosures, then compares what the business can do with what clients have been told. Instead of assuming employees will act properly, an objective reviewer asks how a bad actor could exploit each incentive or discretionary power and what client harm could follow. Each conflict is then classified: eliminate arrangements that are inherently improper, mitigate those that can be controlled, and disclose the conflict and mitigation clearly enough for a client to understand. This mechanism counters the blindness produced by familiarity and good intentions. It also turns conflict review into an operational exercise based on actual capabilities rather than a moral judgment about the current team.
Origin
Extracted from Masters in Business during a discussion of SEC examinations, fee disclosures, affiliated investments, and why good intentions prevent advisors from recognizing exploitable conflicts.
Core principles
- 01Good intentions do not eliminate structural conflicts
- 02A conflict must be identified before it can be mitigated or disclosed
- 03Disclosure resolves many conflicts but not every conflict
- 04Some arrangements are inherently improper
- 05An objective reviewer sees risks insiders normalize
How to run it
- 1
Inventory relationships and incentives
List affiliated entities, products, revenue sources, referral arrangements, fee discounts, compensation, and decision rights. Include indirect economic benefits.
Pro tip Trace who pays whom and who can influence each recommendation.
Watch out A conflict can exist even if no one has exploited it.
- 2
Compare practice with disclosure
Read agreements, Form ADV language, marketing, and operating practices side by side. Flag contradictions, omissions, and vague descriptions.
Pro tip Test fee disclosures against real client invoices and exceptions.
Watch out Aspirational language may be misleading when practice is more complicated.
- 3
Install the bad actor
Imagine that each discretionary role is occupied by someone willing to maximize personal benefit. Identify what the structure would permit that person to do.
Pro tip Ask an objective outsider to run the scenario.
Watch out Do not stop because current employees are trusted.
- 4
Measure potential harm
Describe how each exploit could affect client cost, allocation, advice, service, privacy, or choice. Rank severity and likelihood.
Pro tip Use concrete client scenarios instead of abstract compliance labels.
Watch out Low historical incidence does not prove low structural risk.
- 5
Eliminate the improper
Remove conflicts that cannot be made consistent with applicable duties, even through disclosure. Redesign products, fees, or authority where necessary.
Pro tip Separate revenue streams when being on both sides of a transaction creates unacceptable incentives.
Watch out Disclosure is not a universal waiver.
- 6
Mitigate and disclose
Add controls for permissible conflicts and disclose both the conflict and the material effect plainly. Assign monitoring responsibility.
Pro tip Explain how the firm benefits, not merely that a conflict may exist.
Watch out Boilerplate disclosure can remain misleading if clients cannot understand the incentive.
In the wild
An advisory firm owns a venture fund and considers recommending it to clients. The review maps advisory fees, fund expenses, ownership upside, and allocation authority, then asks how an abusive manager could steer assets toward the fund. The firm excludes impermissible arrangements and adds controls and clear disclosures for any relationship it retains.
→ The firm distinguishes manageable conflicts from arrangements that disclosure alone cannot cure.
A firm discloses that its fee is one percent but routinely grants discretionary discounts. The review compares invoices with Form ADV language, identifies which clients or services drive exceptions, and evaluates whether incentives or inconsistent descriptions create conflicts.
→ Fee practices and disclosures are revised to describe the real arrangement accurately.
Common mistakes
Equating good intent with no conflict
A structural incentive exists independently of whether current employees intend to abuse it.
Trying to disclose everything away
Some conflicts remain improper regardless of the amount of disclosure provided.
Reviewing documents in isolation
Conflicts often become visible only when disclosures, agreements, payments, and actual practices are compared.
Is it for you?
Best for
It is best for fiduciaries reviewing fees, affiliated products, compensation, disclosures, and discretionary authority.
Not ideal for
It is not a substitute for jurisdiction-specific legal analysis of whether a particular arrangement is prohibited.
From the transcript
“What we do to mitigate that conflict or eliminate that conflict is another issue. But we have to call out the conflict and disclosure.”
“mostly, but it doesn't resolve at all. Right, And some conflicts are are simply improper, right, you simply can't can't disclose them away.”
“just imagine for a moment there was a bad actor, right, could we do this?”
From the episode
Brian Hamburger on Surging Merger Business in RIAs
Brian Hamburger