The way in which finance and financial services firms manage their conflicts of interest is something that keeps coming back time and time again as a regulatory issue.
Over the last few years, the Financial Services Authority and the Financial Conduct Authority (FCA) have both levied substantial penalties against firms for failing to implement systems and controls to manage conflicts. Towards the end of 2012, the FSA even went as far as requesting attestations from some investment management firm CEOs, that their controls around conflicts management were suitably robust. (See last week’s blog post to learn more about attestations).
And this week, it’s happened again, with a major fund manager being fined for failings in its controls around conflicts management.
I don’t intend to look at this case specifically, but it has got me thinking about why actions like this continue to be taken, despite copious warnings being provided by the regulators on the repercussions of not managing conflicts properly.
What is a conflict?
It’s probably best to start with defining what a conflict of interest is. There are a number of technical definitions but in plain language, it is when an individual or a firm has two roles or tasks to carry out which conflict with each other to the extent that neither can be fulfilled properly. This means that one will benefit at the expense of the other.
In asset management firms, these conflicts can have an impact on customers or groups of customers, some of whom will benefit from a particular course of action where other will lose out. In accountancy firms, conflicts can arise, for example, where a firm acts on both sides of a corporate finance deal (such as a merger or an acquisition), the risk being that one firm benefits at the expense of the other in the deal.
The fact about conflicts is that in our industry, they will always arise – it’s how we manage them that counts.
Prevention is better than cure
This is the mantra that regulators have been going by for years. It’s always better to have the controls in place to prevent the conflicts arising in the first place rather than dealing with then after they have happened.
This is where the control functions, such as risk and compliance come in. Their job is to advise senior management on how to implement the relevant controls to identify potential conflicts at the first possible opportunity and then mitigate them as far as they possibly can.
Set out your stall
For many firms, there is a regulatory requirement to produce and maintain a conflicts of interest policy, which sets out where it believes its conflicts are, what steps it takes to prevent them, and where conflicts to arise, what steps it takes to minimise them as far as possible.
The point with this document is that it’s not just something to show to customers. It’s the document that focuses minds in the firms about what steps it actually takes to stop conflicts from arising.
But the inevitable can happen
Despite the best efforts of firms’ management, their control functions and front-line staff, conflicts can arise. And when they do, the question is what to do about it. Especially when the situation has arisen too late to fix.
The best course of action in many cases is to make a full disclosure of the situation to the affected parties, giving them enough information to decide whether they are comfortable to continue the business relationship.
However, the expectation from regulators is that firms should have sufficiently robust systems and controls to prevent this situation arising save for exceptional circumstances.
A pattern emerges
As you can see, all of these issues lead back to the same thing. The strength of the firm’s control environment; the thing that is ultimately used by regulators to determine whether enforcement action needs to be taken.
You might think that the thrust of this post is to say that firms need to strengthen their controls, but, there is one thing that is even more fundamental than the control environment (well, actually, two things).
Knowledge and understanding
That’s right. Because without a thorough understanding of what conflicts are, how damaging they can be, and what individuals can do to identify and manage them, there’s a risk that even the strongest of control frameworks will ultimately fail.
And it doesn’t just apply to those at the top. Take a look at these examples.
Yes, senior management, and particularly approved persons, need to understand the importance of conflicts management, the strength of their conflicts policies, and the regulatory risks if they don’t deal with this issue, for which they will be accountable.
But beneath them, you have:
Control functions. Risk and compliance need to understand what the regulators are looking for, what the conflicts are that could arise in the firm, and help the business implement the right controls.
And then you’ve got the people in the front line. Whether it’s relationship managers in private banking firms or traders in asset managers, for example, everyone has to understand what conflicts are, to be vigilant for their occurrence, and when they do arise, to know what course of action to take.
Ultimately, all of this only happens when people are trained on the subject of conflicts. And this training can take many forms – internal and external.
Many firms will undertake internal training programmes as a means of educating staff “en masse” about conflicts and how to disclose them. But for senior management, those in control functions and those carrying out specialised technical front-office functions, often something more dedicated or bespoke may fit the bill better.
The good news is that a number of regulatory-based training courses cover this area as part of their programmes.
So if you feel that the control environment on conflicts needs some more focus, and you want to start by looking at bringing knowledge and understanding up to scratch, start with Industry Events Online.
By Martyn Oughton a Professional Member of the International Compliance Association (ICA). Martyn now writes a regular blog for Industry Events Online focusing on the importance of training in all aspects of compliance. Read Martyn's other publications at Martyn's Writers' Residence website.
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