This isn’t a note about insider dealing. It’s a note about independence and situations in which that might be compromised by an independent or external person becoming so vested in a firm that they become part of the home team rather than being a true outsider. This won’t always be the case. But there’s a risk that, at some point in a relationship, the line is crossed and an outsider becomes an insider in ways that are subtler than the usual conflict of interests situations.
This is relevant to all organisations but it can be particularly important to regulated firms and that’s what I’m focusing on in this note.
1 Who are ‘outsiders’? – in broad terms, they’re the people who should be independent and objective.
- Independent non-executive directors (INEDs).
- Auditors – external, and any internal auditor appointed under an outsourcing arrangement.
- Professional advisers appointed by, and acting for, the firm – law firms; consultants; investment bankers; tax advisers.
Independence and objectivity should be part of the value outsiders bring to the firm.
2 How can independence and the outsider’s perspective be compromised? – there are various ways in which this can happen and these can alter over time. Consider the following situations.
- An INED is in post for seven years and has seen a firm through good times and tough times too. They consider that they’ve contributed to the success of the firm and they feel a little prickly when a new INED or anyone from outside the firm suggests that things could be done differently.
- Professional advisers seek to build long-term relationships with clients and that’s often presented as a selling point in pitches and proposal documents. The risk, though, is that the relationship reaches a point where the external adviser doesn’t want to deliver bad news – something the firm or its CEO doesn’t want to hear – for fear of losing the client and the prospect of future work. This can happen over a period of years or could be baked into the relationship at an early stage if there’s the prospect of a large piece of work in the near-future – e.g. a group reorganisation; setting up a new business line; purchase of another company; an IPO; a refinancing or investment round.
3 Isn’t this just about conflict of interests? – there might be a conflict of interests but the issue here is more about subtext and mindset, subtle points that aren’t nearly as clearcut or as easily identifiable as a conflict, and which often emerge gradually.
- For long-serving INEDs, a good test of independence and objectivity is often whether there’s sufficient challenge of management or whether the INED has become more aligned with management and the business.
- In other cases, the test is usually whether the same decision or recommendation would have been made, or if the same advice would have been given, if it weren’t for the prospect of future gain or future work.
4 Conflicts of interests still matter – think of the outside/insider point as supplementing conflict of interest. It doesn’t replace it.
5 Why does this matter from a regulatory perspective? – regulators expect firms to have robust governance in place and that includes having thoroughly independent INEDs, where INEDs are on the board, and receiving uncompromised and thoroughly independent advice from professional advisers.
6 What should firms and boards do? – both firms and boards need to be alert to risks of being told what they want to hear. It’s a tricky situation because being told what you want to hear is reassuring and validating and doesn’t create problems. However, firms might want to pay particular attention to the following situations.
- An INED has been on the board for more than five years. This is less than the periods of six, seven and nine years often mentioned but, based on what I’ve seen in practice, five years is likely to be the point when an INED is less likely to become independent (if that’s going to happen) and is also the point at which an INED would indicate that they’re willing to serve beyond six years. And, in general, keep INEDs on the board for no more than six years.
- There’s the (explicit or implicit) prospect of a future piece of large work for professional advisers, advice you’ve received is pretty much in line with the optimal position that’s been outlined to the advisers and you’re not getting challenge. In these cases, ask for challenge. Make that the part of the scope of work and the advice process.
This article 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.