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Codes of conduct make it easier to handle matters related to conflict of interest. Photo: iStockphoto
Codes of conduct make it easier to handle matters related to conflict of interest. Photo: iStockphoto

Book extract: Who Cheats And How?

Conflict of interest is about impropriety more than corruptionfor instance, the ability to influence company decisions that may benefit you directly or indirectly

Cyberfraud, insider trading, tax avoidance—there are any number of examples of companies and executives who have succumbed to the temptation of short cuts in business. In Who Cheats And How? Scams, Fraud And The Dark Side Of The Corporate World, Robin Banerjee, managing director of Caprihans India Ltd, which manufactures PVC film, draws on these examples to talk about how they can be checked and what shareholders can do to protect their interests.

In a section, “Who Bothers About Conflict Of Interest?", Banerjee asks questions about whether it’s okay for a reporter to own shares in a company s/he writes about or for a board member to ask the company to provide him its services for free. Edited excerpts:

The corporate world is replete with conflicts of interest. Auditors’ fees are paid by the companies’ that are audited, the rating agency’s fees by the organisations that are rated, the courts earn their fees by companies filing cases with them—such instances are legion.

A Merrill Lynch broker recommended that Infospace stock should be held on to in spite of its falling share price, without disclosing that the company would acquire Go2Net of which Merrill was the financial advisor. In another case, Airgas Inc., a large machinery company, sued the legal firm Cravath, Swaine & Moore, which was advising Airgas on finance-related issues, and a little later advised its rival company to make a hostile bid for Airgas. SEC (Securities and Exchange Commission) found instances where key credit rating agency analysts were taking part in discussing the fees of clients, which they would ultimately rate. These are all conflicts of interest prevalent in our business world.

For example, Mr X is the chairman of ABC Co. and wants to appoint XYZ Consultants as the company’s management consultants. Mr X is a partner in XYZ and has a conflict of interest in the proposed appointment of the consultancy firm, since he holds decision-making powers and office of profit in both the organisations. Therefore, when the board of ABC Co. decides on XYZ’s appointment, Mr X should disclose his position in the consultancy firm, since he is likely to benefit financially from its revenues, and abstain from the decision-making process when ABC puts its vote to its board on its decision.

Conflict of interest is often difficult to surmise. What if the board member is not likely to benefit, but an action will benefit his business associate or a relative? How does one know the extent of the likely benefit?

Let us assume that a board member of a facility company asks it to repair the toilets at his home. This is a facility that is not normally provided by the company’s charter to its board members or to its employees. While the cost involved could be small or the work carried out a part of the routine task of the facility company, should the board member disclose the conflict of interest? What happens if he does not? These are challenging questions on corporate ethics and it is difficult to determine the nature of penalty levied on the board member concerned. The answer is, under good corporate governance, such situations need to be disclosed.

In real life, board members or top management often keep shareholders in the dark about developments that may involve themselves and make it impossible for the latter to discover existence of conflict of interest. Conflict of interest is not necessarily corruption, although in some cases it could be. However, it is impropriety. The difference is thin and often hazy. It amounts to poor governance and bad ethics in corporate management.

What constitutes conflict of interest and what does not is often left to the concerned individuals, and it is up to them to disclose the genesis of any possible conflict.

Sections of the legal community are sometimes of the opinion that if conflict of interest is disclosed, the interested person can even discuss or vote on the resolution concerned. However, more often than not, it is not good practice to participate in the decision-making process when one can directly or indirectly benefit from the decision taken.

Since conflict of interest necessitates judgement and self-disclosure, companies need to have codes of conduct that make matters easier to handle. A robust code of conduct should state upfront that the concerned board member should neither participate in the decision-making process nor vote, and should refrain from the decision-making procedure on the matter that could directly or indirectly benefit him or her. A code of conduct, however, does not supersede prevalent regulations or the law on the matter. It only helps to fulfil the law and prevent a potential problem from taking place.

The New York Times once summed up the challenge to determine conflict of interest very well—‘in many cases potential conflicts can be identified by using the “sniff" test. If it smells bad, don’t do it’.

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