Conflicts of interests are relevant to all regulated firms in a number of ways. This note looks at conflicts of interests in the context of boards of directors.
To begin, why do conflicts matter? Directors have a duty to shareholders to act honestly and in good faith. There’s an underlying principle that directors should not treat a company as though it exists for their own personal benefit and reward and this extends to avoiding conflicts of interests. It can be hard for a director to disregard a conflict and there’s a risk that the director doesn’t act in good faith, even if the director manages to avoid any personal benefit or reward.
Conflicts can arise in various situations, for instance:
- A director of a firm is also a director of a company the firm is considering doing business with – perhaps, lending to; entering into an outsourcing arrangement; providing IT, consultancy or other services.
- A family member of a director is a key employee at an investor that has a small team.
- A director also has a significant shareholding in the company.
- A director has been appointed by the parent company or as the investor director, intended to report to the organisation that’s appointed them.
- A merger is proposed between the firm and another organisation and a director is on both boards.
Also, be aware that regulators – the Financial Conduct Authority, as well as the Prudential Regulation Authority – pay close attention to board conflicts of interests, at authorisation and on an on-going basis.
Here are some points to consider.
1 Expect regulatory scrutiny of board conflicts of interests – in connection with authorisation applications, regulators usually ask what conflicts of interests the applicant has identified and how those conflicts will be managed. This includes board conflicts. It’s good to address this in the application materials to show that you – as the applicant – have recognised the importance of the point and that appropriate consideration has been given to identifying conflicts and finding effective ways to address them. That’s about more than just managing them. Resolving a conflict of interests appropriately might involve eliminating a conflict because it can’t be managed effectively and that might require changes to governance and/or board structure, including replacing directors. In spite of proposals to reduce the regulatory burden, I don’t expect this to alter – it’s too fundamental to good governance and governance remains on the regulatory agenda.
2 Expect regulators to pay close attention to founders’ rights and influence – regulators’ concern is that founder directors, who are usually executive directors, will have disproportionate influence on the board, partly as a result of their role as founders but also because of the shareholdings they have, in combination with their management role. The usual response is to embed safeguards to address this within the governance structure – for instance, that there’ll be a majority of independent non-executive directors on the board; that there’s an experienced Chair of the board. The challenges for firms are to ensure that these safeguards work in practice and that they continue to work. As an example, will the INEDs challenge management (including the founder executive directors) consistently in practice and challenge them effectively? Expect a degree of scepticism because regulators will have heard the usual analysis many times before.
3 Investor-appointed NEDs can add significant value but conflicts can arise – NEDs appointed by investors provide a different perspective which can be extremely valuable but conflicts can arise if an investor wants a regulated firm to go in a particular direction to protect its investment. My experience is that conflicts are generally managed appropriately and fairly but there can be glitches, usually in crisis situations when investor directors might need to be excluded from discussion on anything relating to the investor and its investment – for instance, a proposal to reschedule debt. In extreme cases, an investor director might need to resign. More generally, the success or failure of investor-appointed NEDs on a regulated board comes down to the particular NED and relationships built with other board members.
4 Parent-appointed NEDs present a particular type of conflict – with investor-appointed NEDs, scope for conflicting loyalties is clear. With parent-appointed NEDs, the conflicts can be swept under the carpet on the basis that we’re all part of the same group. However, legal and regulatory analysis works by company, not by group. Each entity needs to be considered separately, not on a group basis, and that’s when any conflicts should become clear. Most of the time, this won’t be a problem but here are two situations to consider.
- Where there’s a difference of views between the company and its parent. For instance, the parent might expect faster diversity of product or target market than the regulated firm considers prudent, set a higher budget or refuse to prioritise funding for transition to a new IT system. There could be a requirement to transition to a new IT platform being introduced for the group that the regulated subsidiary isn’t happy with. Or the parent might require a dividend to be paid but the regulated subsidiary considers it appropriate to retain profits to support the business. One solution is for parent-appointed NEDs to be excluded from discussions where they would, or might, be conflicted and not to be included in the quorum or any vote. My experience, though, is that there’s often resistance to this – on the part of the parent and the NEDs it’s appointed and on the part of the subsidiary board that doesn’t want to upset the parent.
- Parent-appointed NEDs should avoid becoming merely messengers from the parent. Providing a view from the parent’s perspective is probably fine, although consider how the message is given and whether there’s any breach of confidentiality owed to the parent.
5 Managing a conflict of interests doesn’t mean it no longer exists – there’s a difference between (i) managing the effects and impact of a conflict and the circumstances that give rise to it and (ii) eliminating a conflict of interests. I’ve come across a number of cases where firms and their boards have thought that managing a conflict means that it disappears and no longer has to be reported or considered. The conflict is still there, although managed, and care is needed to ensure that the steps taken to manage it remain effective and appropriate.
This note is intended to provide general information about current and expected topics and perspectives that might be of interest. It does not provide or constitute, or purport to provide or constitute, advice relevant to any particular circumstances. Legal or other professional advice relevant to any particular circumstances should always be sought.