Identifying Conflicts of Interest

• VINCIA CLOETECONFLICTS of interest abound at all levels of the organisation, particularly at board level.

Regardless the type of entity, nearly every director has an outside level of interest in the organisation’s business. Recent media reports have been fraught with cases of conflicts of interest. Identifying conflicts propels the board to manage and mitigate actual or perceived conflicts, while it clarifies public discernment of board actions.

Conflicts are defined in many ways.

For example, a conflict of interest occurs when a director’s direct or indirect personal interest interferes in any way, or appears to interfere, with the interests of a company as a whole. Put differently, it is a transaction or arrangement that benefits an officer, board member, or employee on a personal level improperly.

It denotes any financial or other interest which actually or potentially impairs a director’s objectivity and his ability to act independently or which creates an unfair advantage for, or in favour of, any third party by virtue of an existing relationship with the conflicted director.

The underlying element of any definition is the tension between multiple competing interests, whether personal or pecuniary. This often manifests in the entanglement of the private and professional interests of an individual. These conflicts may be actual or perceived.

The perception of a conflict is influenced by whether an independent observer might question whether a director’s professional actions were motivated or incited by a potential personal financial gain. The existence of a conflict is, however, not necessarily an indication that an impropriety has occurred.

Conflicts of interest generally apply only to current interests – not to interests that have expired or which no longer exist or to interests that cannot reasonably affect the director’s current behaviour, for instance a previous directorship of a company unless the parting was hostile. Conflicts of interest also do not apply to interests that may arise in future.

There are different tiers (illustrations) of conflicts of interest.

A tier 1 conflict is an actual or potential conflict between a board member and the company. The principle is that a director should not take advantage of his or her position. The most fundamental duty of any board member is to act in the best interests of the organisation. Board members must be able to say that the board decisions were made equitably and independently. A conflict of interest is where a board member puts his/her personal interests ahead of the interests of the organisation.

Major conflicts of interest could include, but are not restricted to, salaries and perks, misappropriation of company assets, self-dealing, appropriating corporate opportunities, insider trading, and neglecting board work (perhaps because of multiple directorships).

Tier 2 conflicts arise when a board member’s duty of loyalty to stakeholders or the company is compromised. This would happen when certain board members exercise influence over the others through compensation, favours, a relationship, or psychological manipulation.

Under particular circumstances, some independent directors form a distinct stakeholder group and only demonstrate loyalty to the members of that group. They tend to represent their own interest rather than the interests of the companies.

A tier 3 conflict emerges when the interests of stakeholder groups are not appropriately balanced or harmonised. Shareholders appoint board members, usually outstanding individuals, based on their knowledge and skills and their ability to make good decisions. Once a board has been formed, its members have to face conflicts of interest between stakeholders and the company, between different stakeholder groups, and within the same stakeholder group.

When a board’s core duty is to care for a particular set of stakeholders, such as shareholders, all rational and high-level decisions are geared to favour that particular group, although the concerns of other stakeholders may still be recognised.

Tier 4 conflicts are those between a company and society and arise when a company acts in its own interests at the expense of society. The doctrine of maximising profitability may be used as justification for deceiving customers, polluting the environment, evading taxes, squeezing suppliers, and treating employees as commodities. Companies that operate in this fashion are not contributors to society. Instead, they are viewed as value extractors.

The materiality of conflicts remains an important area of judgement and should be assessed both from the perspective of the company and the individual. In exercising that judgement, the director considers the guidelines that are available, bearing in mind that there is no single measure of whether something is material or not.

Conflicts cannot always be avoided, but they must be identified and action must be taken to ensure that the conflict situation is mitigated effectively. Managing conflicts of interest effectively is crucial to good corporate governance, and is the responsibility of the individual director. The director must address the appearance of conflict of interest as well as the actual conflict of interest.

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