"if both gain all,
The gift doth stretch itself as ʼtis received"
All’s Well That Ends Well
In the records of Edinburgh’s older professional firms one can find photos of partners taken a century ago. They depict crusty old men – and they were invariably men - often whiskery, always grim-faced and bespeaking stern authority. Pillars of the establishment no doubt they were, but not the chaps for a knees-up on Friday night. Yet these men commanded huge respect and implicit trust. The possibility that any might succumb to a conflict of interest would have been laughed out of court. Happily, some of this respectful aura still surrounds our professional fraternity.
Other business communities today, however, enjoy a much diminished repute. Over recent years an epidemic of problems directly associated with conflicts of interest has erupted. Global business culture seems to be infested by misaligned priorities. Short-term targeting and greedy aspiration have fertilised the ground of human frailty. Popular confidence in the workings of the enterprise system has been sapped. This is no light consideration for investors.
Impropriety can arise whenever an individual (or group) has competing interests or loyalties. Personal interests are usually involved. Zuckerberg’s dilemma at Facebook, presumably, was whether to uphold the transparency principle and reveal the whole truth about the exploitation of customers’ data and risk provoking damaging criticism, or withhold it. He made the wrong choice. Not long ago he apologised to Congress.
Or take the case of the Financial Reporting Council. This is the body charged with oversight of the accounting profession. Apparently four of its 15 members are ex-partners of the Big Four accountancy firms. In the wake of Carillion’s collapse in the UK, concerns have arisen over whether the FRC’s loyalties might be compromised when it comes to inspecting a company’s audit procedures impartially.
Naturally our own focus is on the financial sector. It reveals more than its share of damage from conflicting interests. Many such conflicts crystallize in a failure to inform customers fully of factors relevant to their financial choices. Only in 2010 were banks compelled to reveal the true interest costs to customers of using credit card facilities. Before legislation effective in April last year, most insurance companies declined to reveal automatically a year-on-year comparison of premium costs. Nor did they set out reasons for premium increases. Customers tend to renew insurance premiums automatically. They might not have done so if directly confronted with cost comparisons. Similarly asset managers have been slow to reveal the full cost of portfolio management services. Regulation now requires complete disclosure of such information.
In America public company directors have sanctioned spending huge amounts to buy back their own company shares. The effect of this is to boost the profits attributable to each remaining share. Executives like this form of financial engineering because in the short term it helps lift the share price and so, very often, their bonuses. However, money spent on buying back shares is often borrowed. Gearing up a company’s balance sheet makes the business riskier. Using borrowed money to boost share prices (and bonuses) absorbs funds otherwise available for long-term capital investment. Conflicting interests cast a cloud over longer-term prospects for shareholders.
There may be particular reasons why the financial sector exhibits so many signs of conflicting interests. One may be that material damage arising from its cultural shortcomings is readily measurable; money is the sector’s stock in trade. A less obvious but more weighty factor is the part played by intermediaries in the financial service supply chain. Every intermediary wedge of activity separating customer from source weakens the tie of direct accountability. It is easier to shelter conflicting behaviour when several layers of financial activity are involved.
Yet another troubling instance of conflicting interest surfaces in the investment management sector. For their own economic reasons, management firms have simply been casting off some clients. Firms have restricted the availability of their service and confined their offer to the richest ones. This despite the fact that it is often the poorer ones who need the most help. Firms are not charities. But a clue to understanding this unattractive behaviour lies in the nomenclature. Big management firms are now commonly styled “asset gatherers”. This deplorable phrase declares to the world clients’ money is the priority target, not the development of professional relationships.
Clearly it is neither feasible nor even desirable to eliminate all conflicts of interest. The Bank of England and the National Audit Office have both said as much. Of themselves, conflicts of interest do no harm. Their impact depends on how they are dealt with. Human choices can justifiably take account of personal preference. We inherit a selfish gene. Risks of inappropriate behaviour are ever present. Hurt only arises when such personal preferences prejudice the reasonable interest of another party.
Various aids to navigation through the cross-currents are on offer. Regulation certainly has a role in redirecting priorities towards equitable outcomes. One of our regulator’s basic precepts is the requirement to “treat customers fairly”. Note the word “fairly”. It carries a sense of impartiality as between different or competing interests. That means not discriminating in favour of one side or the other. Yet achieving a fair result can still require a subjective judgement as to where an appropriate balance rests.
Virtually every public company publishes a statement of how it deals with conflicting interests. Goodness knows how much timber is lost to pages of governance guff detailing conflict avoidance procedures. Facebook’s “conflicts of interest” statement consists of 2½ pages, closely typed. Conflict avoidance measures go back a long way. Senators in ancient Rome were forbidden to enter into commercial contracts during their tenure of office. Removing the opportunity for gaining improper advantage is one way of tackling the problem.
Stakeholder pressure is another. Shareholders can collectively insist on equitable policies rather than ones which extravagantly favour the executive cadre. Many are beginning to do so.
Wider efforts are being directed at inculcating a more equitable culture. Efforts to promote transparency between engaging parties have already evened up the financial playing field. Yet human nature being what it is, change from the top down may take a pretty long time. Behavioural culture is not created by fiat. It evolves with custom and changing social priorities.
Policy statements may provide a principled framework for conflict resolution. But ultimately, success in reshaping priorities lies at the point of individual decision. It is the sum of individual choices that will characterise a culture. If it is individuals’ decisions that determine behavioural priorities, it is they who need to be enlightened and persuaded. Raw emotion stirred by David Attenborough’s Blue Planet series with its pictures of starving, agonised seabirds* touched millions of hearts. Personal priorities are shifting. A changed national psyche has moved plastic pollution to the top of the environment agenda. Individuals have begun to connect their own lives with the planet’s future.
Jan Wallander wrote a book about his extraordinary success in turning around Handelsbanken, a big Swedish bank. He concluded that individuals could best be inspired and persuaded at a local decentralised level outside the impersonal stranglehold of corporate governance. This truth is a waymark on the business path to fairness in conflict resolution. But the journey begins at another place.
It starts from awareness that many apparently differing interests need not compete at all. In professional life, clients’ preference is the provider’s too. Resolution by preferment of one interest at the expense of the other is always a failure. It indicates a shortcut to some arbitrary destination that suits the upper hand. Success is finding the means to accommodate both interests. Of course any accommodation may involve an element of short-term sacrifice for the decision maker. A financial service provider, for example, may have to consider subsidising poorer clients to build the firm’s goodwill in the longer-term. Clients’ goodwill, however, is the ultimate determinant of enduring success for any firm. It is no sacrifice to nurture it.
Imagine how the financial establishment would be faring now if it had recognised that customers’ interests were intimately bound up with its own. Dusty lawyers recognised that reality 100 years ago. One might wonder what they saw that business today does not. For sure they had figured out that reconciling clients’ interests with their own led to material rewards. But we can surmise they had discovered one other big thing: that pleasing those they served made themselves feel better too. When all stakeholders in business life today come to share that discovery, our enterprise system will be considerably more secure. So will the long-term prospects for investors. Roll on the day.
1st May 2018