2011 Issue 9
BoardWorks International
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Recognising and Handling of Conflicts Of Interest

Conflict of InterestFew people in governance roles do not occasionally encounter a conflict of interest situation. While as board members we have a fundamental obligation to act in good faith and in the best interests of the entity on whose board we sit, this can sometimes conflict with our personal interests or obligations. Whether we think we have a conflict is not the issue. Someone else’s perception there could be a conflict is enough. Having a well-thought-out framework for dealing with conflicts of interest is, therefore, a fundamental requirement of good governance. This is as much for the benefit of the individual’s reputation as for that of the organisation.

When does a conflict of interest exist?

A conflict of interest exists if it could seem that a director or a person or group associated with that director might benefit undeservedly through the misuse of their position.

Neither the perception nor the actual existence of a conflict of interest means that someone has done something wrong or that it will cause problems. An actual or potential conflict not identified and managed appropriately can undermine trust and damage relationships, altering the dynamic within the board and between board and staff. Organisational, board, and personal reputations can be affected in ways that may never be fully recovered.

Sources of conflict

Potentially conflicting interests or duties tend to arise from one or more of the following sources:

  • A director’s own financial affairs.
  • A relationship or other role that the director has (including a legal duty, for example, as a director or trustee, to act in the best interests of another entity).
  • Something the director has said or done that might suggest, for example, bias or predetermination.

Recognising conflicts of interest

There is a variety of pragmatic tests that can be used by individuals and boards to identify potential conflicts or perceptions of conflicts. For example:

  • The ‘sniff test’ – does this ‘smell’ right?
  • The ‘trust test’ - would others trust your judgment and have confidence in your integrity if they knew you were in this position?
  • The ‘headline news test ‘- how readily would you be able to defend your position confronted by media and public scrutiny?

The answers to these types of questions should help alert those concerned to whether…

... a reasonably informed objective observer would infer from the circumstances that the director's judgment is likely to be influenced to the detriment of the company's best interests.

(Institute of Directors (2007). The Four Pillars of Effective Board Governance. Wellington. p.35)

The core issue, therefore, is whether it might be thought that the independent judgment a director is expected to apply in performing his/her duties could be compromised.

Managing conflicts of interest

The following are indicative of the range of different approaches a board has available to manage the various risks associated with conflicts of interest.

  1. Policies and procedures

    Well designed policies and procedures will help boards and their members identify and deal with conflicts of interest. These can provide clear guidelines for simple and predictable situations and establish a process for dealing with the more difficult ones. The seriousness of some situations will be a question of degree or materiality and not easily managed by a ‘hard and fast’ rule.  For example, sometimes the existence of a conflict of interest will not outweigh the value of an, at least, partial contribution by the conflicted individual to the board’s deliberations.

  2. Determination of the desired board culture

    There is value in a board engaging explicitly in the deliberate development of a desired board culture. An effective governance culture is likely to be based on characteristics such as professionalism, capability, accountability, independence, trust, diligence and candour.  Candour and trust are particular characteristics of the context within which conflicts of interest need to be handled.

  3. Induction

    The effective induction of new board members is an important adjunct to the development of appropriate policies and procedures.  New board members must be under no misunderstanding about the organisation’s expectations of how its governors will behave when their personal interests may conflict with those of the organisation. Ideally, an existing conflict or potential for a conflict of interest should be declared and the ramifications discussed prior to election or appointment to the board. In some cases the appointment should not proceed.

  4. Ongoing Training and Development

    It is also important for existing board members to have an opportunity to update their knowledge and understanding of matters like the handling of conflicts of interest. Thinking about the best way to handle conflicts of interests is constantly changing as a consequence of public controversies, judicial decisions and statements of best practice released by regulators and professional associations.

  5. Disclosure and recording

    Having an effective process of disclosure is central to any board’s ability to continuously assess the seriousness of an actual or potential conflict of interest. Each board should have an interests register, updated at least annually and as necessary (as a result of changes in directors’ circumstances) during the year. Depending on the agenda to be covered at each board meeting directors should make further declarations about possible conflicts that might arise during the meeting.  A potential conflict may also arise between meetings. The director concerned should raise this with an appropriate person (often the chairman, or possibly the chief executive) as soon as the risk is identified.

The onus of declaration is on the individual. It is invariably awkward and embarrassing when a board has to ‘call’ one of its members on a failure to declare an interest. A declaration should be made as long as possible before the matter in which a director has an interest, is discussed. If any doubt remains, the matter should be treated as a conflict. If necessary, legal advice should be taken and all disclosures should be recorded in writing. Disclosure should be thorough enough to allow the board to make an informed decision when assessing an actual or perceived conflict of interest.

Mitigation options

Simply declaring a conflict of interest is unlikely to be sufficient in many situations. The action required should be determined by the board. It should assess the substance and seriousness of the conflict of interest and the practicability of any options for avoiding or mitigating the conflict.  Typically, mitigation options involve some degree of withdrawal or exclusion of a conflicted director. For example, the conflicted director:

  • has restrictions placed on his/her access to information (e.g. does not receive relevant board papers);
  • is excluded from a committee or working group dealing with the issue prior to the board’s consideration;
  • withdraws from discussing or voting on a particular item of business at the board meeting;
  • has certain tasks or duties reassigned to another person (e.g. to another director if the chair is the director conflicted);
  • relinquishes the interest that creates the conflict; or
  • takes leave of absence from the board for the period while the conflict exists.

When in doubt, the default position should be that a director interested in a decision or transaction is completely removed from discussion, deliberation and decision making in relation to the matter.

If the board’s decision making has already been compromised by a director’s failure to declare a conflict, it may be necessary to abort a decision or restart a process (e.g. a tendering process).

If none of these steps are sufficient protect both the director and the organisation a resignation from the board may be the only remaining option.

Ethical obligations and good practice require directors to ensure that the board is informed of any dealings that could give rise to perceptions of preferential treatment or misuse of position. While the onus is on the individual director to declare his or her interests this does not, however, absolve a board from the broader obligation to be vigilant and proactive. Boards should be asking:

  • How well do our policies and practices for conflict of interest disclosure and management meet ‘best practice’ standards?
  • If there appears to be a shortcoming in how we approach conflict of interest matters, is that justified by our situation, or are we running unnecessary risks?
  • What steps, if any, should we take to strengthen our performance in this area?

At a recent workshop a participant questioned whether his board colleagues were being too precious about the handling of conflicts of interest. Experience would suggest that many boards are not precious enough.

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