Corruption can take many forms, but its root cause could and often does include a conflict of interest of some sort and possibly collusion.
OECD states, Conflict of interest occurs when an individual or a corporation (either private or governmental) is in a position to exploit his or their own professional or official capacity in some way for personal or corporate benefit.
The most commonly known fraud involving collision is bribery – something given to influence a specific act to happen – whether given after an act has been performed or made to obtain a future benefit or information. Where there is collusion there may also be a conflict of interest. While this type of fraud doesn’t necessarily involve a distinct third party, it does involve the employee in a role other than as an employee.
This is where an employee colludes with another party (whether from outside or inside the business) to use his role as an employee to obtain a personal benefit.
Frauds that involve collusion usually occur off the books. That is, usually no activity needs to be concealed or hidden in business records.Based on the above, it should be obvious that conflicts of interest can present significant fraud and other risks for corporations, government agencies, fiduciaries, customers and suppliers.
The following ICC Guidelines and a consultation with an experienced fraud examiner can help in fighting wrongdoing.
Recently, the ICC released its Guidelines on Conflicts of interest. As will most guidelines these should be viewed as a tool and can be applied to all organizations – public, private, and not for profits.
The International Chamber of Commerce (ICC) recommends that enterprises closely monitor and regulate actual or potential conflicts of interest, or the appearance thereof, of their directors, officers, employees, agents and representatives and make sure they don’t take advantage of conflicts of interest of others.
Section II of the Guidelines provide among other things a definition of a conflict of interest, with explanatory notes and a description of three types of conflicts with examples. I also provide you with a definition from the New York Stock Exchange’s Corporate Governance Rules below. I suggest reading both.
There is also discussion in Section III of the Guidelines on communication and training, evaluation of a policy on conflicts of interest (with a description of the key elements of a policy), and how to prevent, manage and mitigate conflicts.
The publication concludes by describing four “dilemma” scenarios that can be used as a training aide.
Inherently, conflicts of interest schemes are one of the most difficult areas of fraud to detect, investigate, and obtain adequate evidence. Improper investigations can create counterclaims and civil actions against organizations and professionals.
Common conflicts of interest schemes include:
Purchase schemes, which involve the over-billing of a company for goods or services by a vendor in which an employee has an undisclosed ownership or financial interest
Sales schemes, which involve the underselling of company goods by an employee to a company in which the employee maintains a hidden interest
When it comes to detecting conflicts of interest schemes, it’s usually a the failure to disclose because:
Employees, directors, or others don’t understand the potential seriousness of having a conflict of interest or the company’s policy relating to it.
The employee, director, or other party is deliberately trying to conceal or hide the conflict. There shouldn’t be any reasons for employees and others not declare conflicts of interest, assuming they have read the policy and are made aware of their responsibilities.
Other Risks and Activities
Leadership that is controlling or domineering can operate with a long-term view, in alignment with others’ interests.
There can be several risks from controlling or domineering leadership, including the potential for conflicts of interest and abusive related-party transactions that are often difficult to detect, assess, and investigate.
Why? Because many people have a difficult time avoiding conflicts of interest, they are usually secretive, and the financial or other benefits more often than not are hidden, albeit sometimes in plain sight, but nonetheless can put the individuals involved and their company at risk of regulatory scrutiny and reputational harm.
The New York Stock Exchange’s Corporate Governance Rules defines conflicts of interest as the following:
“A conflict of interest occurs when an individual’s private interest interferes in any way ̶ or even appears to interfere ̶ with the interests of the corporation as a whole. A conflict situation can arise when an employee, officer or director takes actions or has interests that may make it difficult to perform his or her company work objectively and effectively. Conflicts of interest also arise when an employee, officer or director, or a member of his or her family, receives improper personal benefits as a result of his or her position in the company…. The company should have a policy prohibiting such conflicts of interest, and providing a means for employees, officers and directors to communicate potential conflicts to the company.”
I have found the types of activities that can create a possible conflict of interest include:
- Nepotism is the practice of giving favors to relatives and close friends, often by hiring them
- Cronyism is the appointment of friends and associates to positions of authority, without proper regard to their qualifications
- Self-dealing is a situation in which someone in a position of responsibility in an organization has outside conflicting interests and acts in their own interest rather than the interest of the organization
The ICC Guidelines have some examples in Section II that I suggest you review too.
For those subject to SOx, in addition Sections 302, 906, and 404, several other sections of SOx relate to internal controls and corporate governance.
Section 406: code of conduct and ethics Section 406(c) requires all US-listed companies to maintain a code of conduct applicable to all directors, executives, and employees with the definition of “code of ethics” as stated in this section. The NYSE Corporate Governance Rules (Provision 10) also require a company to adopt and disclose its Corporate Governance Guidelines and Code of Business Conduct and Ethics.
The code of conduct must be publicly available and must define conflicts of interest, illegal and improper payments, anti-competitive guidelines, and Foreign Corrupt Practices Act (FCPA) compliance, as well as acceptable dealings with employees, suppliers, customers, investors, creditors, insurers, competitors, auditors, and so forth.
Conflicts of interest can be problematic if not understood and managed appropriately.
Conflicts of interest increase the risk of bias and poor judgment because of the obligation to two or more competing interests and usually never end well for those that have consciously avoided the company’s business practices and ethics.
When it comes to fraud risk management, compliance and internal audit need to understand conflicts of interest and address them accordingly.
All conflicts of interest must be documented in writing! This really helps if there is ever an issue, because you can show the regulators the company is proactively dealing with these issues.
I welcome you thoughts, comments, and suggestions.
Jonathan T. Marks, CPA, CFF, CFE