Other Economic Issues

This section of the blog will address other economic interests and examine whether they do or don’t count for COI purposes.

“Type 2″ Conflicts of Interest, Risk Assessment and “Inner Controls”

In his comprehensive taxonomy of conflicts of interest in the financial services industry ,  Professor Ingo Walter of New York University distinguishes between the kind of conflicts  that a firm has with its clients (“Type 1” conflicts) and conflicts between a firm’s clients (“Type 2″ COIs).   Because the coverage of the COI Blog is not focused on this (or indeed any) industry we have  devoted little attention to the latter.  However, last week the UK’s Financial Services Authority imposed, in a Type 2 case, what is evidently its largest COI-related fine ever against a firm (Martin Currie), and this seems a good occasion to discuss these sorts of conflicts.

As briefly described in this article  the firm “caused one client to enter into an ill-advised transaction which rescued another client from serious liquidity concerns…  Both of the two … clients focused on making investments in the China market and were managed by Martin Currie from its Shanghai office. In April 2009, Martin Currie caused the rescued client fund to invest around £15m in an unlisted bond issued by an offshore Chinese firm, the FSA said. Martin Currie failed to ensure that the bond’s valuation or the rationale behind the investment were properly scrutinised at the time of the transaction and it proved to be a poor investment for the client, whose fund halved in value over the next two years. While the investment was detrimental to that fund, it had significant advantages for the other client in question, which was facing serious liquidity concerns due in part to its exposure to illiquid investments in a single offshore Chinese entity.”

Note that Type 2 conflicts pose risks not only for financial services firms.  They can also arise in law firms (where such COIs are far more common than are the Type 1 variety), and other contexts, too – e.g., consulting firms that do not fully disclose how commercial relationships with one client can impact the advice given  to others (such as in technology  procurement).

Indeed, it may be non-obvious Type 2 COIs that create the greatest risk for some organizations precisely because they have not been spotted.  And even where these are known they may not be fully appreciated,  because the self interest in Type 2 COIs may be less obvious (though no less real) than in Type 1 conflicts; i.e., those faced with the former may be particularly at risk due to the relative absence of “inner controls.”  For these reasons, all sorts of organizations should at least consider in their risk assessments whether Type 2  COIs could be an issue for them.

CEOs’ COIs

F. Scott Fitzgerald famously said that “The rich are different than you and me,” and, along the same lines, CEO conflicts of interest can be pretty different than those involving people like you and me.  Consider this story – which likely would not have taken place with anyone other than a CEO – about what in going on at Chesapeake Energy.

As background, the company permits its CEO, Aubrey McClendon, to take personal stakes in the wells it drills.   By itself this arrangement – while unusual and controversial – does not, in my view, inherently involve a COI.  Indeed, one could argue that by investing side by side with the company, the CEO aligned his interests with those of the company’s shareholders.

However, “[i]n order to pay for stakes in new wells, McClendon borrowed money — using his stakes in existing wells as collateral — from a group that Chesapeake was trying to sell assets to. Investors complained that the arrangement raised a conflict of interest. They worried that Chesapeake might have sold its assets to the firm because the firm agreed to lend McClendon money, and not because the terms of the deal were the best Chesapeake could have received.  The arrangement was not previously disclosed to shareholders.” Or, as noted in another (more bluntly written) account:  “The overlapping relationship has led many analysts to say that there was at least the appearance of a conflict of interest since Mr. McClendon could give his lenders a sweetheart deal in exchange for a preferential interest rate on his loans.”  (Perhaps some of these analysts recall the harm caused by the tangled personal financial dealings of then CEO Bernard Ebbers at WorldCom.)

Where was the board – which included a former governor of Oklahoma and former US Senator – when this was going on? According to this story, Chesapeake’s general counsel initially claimed that the board “was fully aware of the existence of the loans” but the company soon reversed course on this.   As described by Ben Heineman, a former General Electric Co. general counsel who teaches corporate governance and business ethics at Harvard: “the Chesapeake board, in effect, is declaring that it would ‘rather just look ill-informed and negligent than complicit in McClendon’s deals.’”

Adding to this turmoil – a story has now surfaced of an undisclosed financial tie between the CEO and a director  (albeit one dating back several years).  And, the Securities and Exchange Commission has opened an internal  investigation.

What does all this mean for the shareholders (i.e.,  people like “you and me”)?  Many have apparently lost faith in senior management and the board, which has led to a massive loss in their investments in the company. This is, of course, entirely predictable when a CEO creates an apparent COI of this magnitude and the board – the only meaningful check on a CEO – is either negligent or complicit.

CEO conflicts really can be unique, not only in terms of what they are but also the impact they can have.

 

 

Conflicts of Interest in the News – 012112 edition: Did Al Gore Have a COI at Apple?

Once again, conflicts of interest were much in the news this week – most prominently concerning payments to health care professionals by life science companies.     But potentially the most intriguing story for COI aficionados was entited: “Did Al Gore Violate Apple’s Business Conduct Policy?”

The piece, by Fox News, reported that “the National Center for Public Policy Research is urging Apple shareholders to vote for shareholder proposal # 4 in Apple’s 2012 proxy statement. The proposal, submitted by the National Center for Public Policy Research, asks Apple to determine if board member Al Gore violated the company’s Business Conduct Policy. At issue is whether Gore played a role in Apple’s 2009 decision to end its membership in the U.S. Chamber of Commerce as part of an effort to pressure the trade group to stop opposing greenhouse gas regulations. Several companies, including Apple, ended their relationship with the Chamber over the trade group’s aggressive opposition to the Waxman-Markey cap-and-trade bill and EPA regulation of carbon emissions. Gore’s significant personal investments in renewable energy and related technologies would have benefited from these greenhouse gas regulations.”

From another article, we also learn that  the “Apple board issued an accompanying statement recommending shareholders vote against the request, arguing such a disclosure is ‘not necessary nor a useful undertaking to foster transparency or accountability at the Board level’… Apple already has ‘a robust set a of policies’ in place to deal with any potential conflicts of interest, so the goal of the request has already been achieved in their view. ‘The decision in 2009 did not ‘harm Apple’s business interests in other policy matters’, nor does the Board believe it will in the future,’ the company said. Just a few weeks before resigning from the Chamber, Apple launched a vigorous new ‘green’ policy intended to make its product line more climate-friendly and energy efficient. It was that policy which led to the company’s decision, the board said, not ‘undue influence by any member of the board.’”

Comment: while COIs at the board level can, of course, be harmful, it is difficult (at least based on these public reports) to see the basis for the claim here, which is questionable on two levels. First, it seems to assume without any basis that Gore failed to disclose the investments in question; indeed, his investing heavily in this sector was evidently a long standing matter of public record at the time of the events in question. Second, the proposal also seems assumes that public companies may not as an ethical (and possibly legal) matter pursue socially responsible efforts; if true, this would come as a shock to the countless corporate board members and executives (of all political persuasions) who have undertaken clean energy and other socially responsible measures for their companies.