Preventing conflicts of interest

Earlier this year, PwC was heavily fined by New York’s Department of Financial Services for “improperly altering” its sanctions and anti-money-laundering report for Bank of Tokyo Mitsubishi. This recent “whitewashing” case has reopened the ethical question concerning the way in which independent consultancy firms can work with their clients and their objectivity of findings and recommendations.

Whilst cases like this may seem harsh to some, it highlights the challenge of putting trust in voluntary disclosure of such relationships. 

Here we will examine examples of how such conflicts of interest can arise and what can be done to mitigate them from three perspectives: the client, the consulting firm and the regulator.

The ease at which conflicts of interest can arise

There are a number of scenarios that can heighten the risk of conflicts of interest for independent consultancy firms when providing services to clients.

Appointing a firm as both the internal and external auditor is one example. For client firms, there is a view that undertaking an internal audit makes an auditor more knowledgeable about a client, and therefore a better external auditor. Additionally, firms may perceive that the time taken to deal with multiple teams from different organizations is reduced.

On the other hand, this also has the potential to cause conflicts of interest. Internal auditors answer to management, as opposed to external auditors who report to shareholders. As such, having the same professional services firm for an internal and external audit can often reduce the effectiveness of internal controls and impair the management of risk. There is, therefore, an ongoing need to preserve a segregation of duties as consultants should never be in a position where they are reviewing their own advice.

We recently saw another example in the U.K. A number of accounting firms were accused of using insider knowledge gained from staff seconded to the Treasury, to help their clients avoid paying U.K. taxes. Whilst this situation is different to the PwC/Bank of Tokyo Mitsubishi case, it shows that there is a similar fine ethical line which can be crossed. This can not only cause financial and reputational damage to the firms involved, but may also make the general public more suspicious of the way the financial services industry operates and deter investors.

Another example of where conflicts may occur is when a professional services firm advises a company in its preparation for listing, whilst at the same time undertaking regulatory remedial projects of sensitive client nature, such as mis-selling. While most professional firms would argue that effective Chinese walls are in place, staff may ultimately know of the business relationships elsewhere in the firm. The solution would clearly be to avoid such conflicts by appointing another independent service provider.

Remaining objective – an ongoing challenge for firms

Whilst there is a requirement by consulting firms to be transparent and honest when delivering services to clients, this can compete at times with an overwhelming sense of a need to ensure that the client relationship is not compromised. This leads to some consultancy firms potentially being reluctant to challenge or criticize a client. It is imperative that consultants be as transparent, factual and robust as possible in their findings to avoid any ambiguity; equally, clients should also encourage their consultants to be challenging and the clients should be open to findings and recommendations so that the business issues are resolved effectively.

Another example is where commercial interests could compromise auditors in their ability to confront senior management on difficult issues. This situation can arise where audit firms are employed to provide consultancy services to management at the same time as undertaking an independent audit on behalf of the shareholders.

Where consultants are asked to amend reports in a way they feel uncomfortable with, the consultant must show integrity and be firm and courageous under pressure. We recommend that all firms have a clear internal reporting and governance process in place to consider unusual client requests. Ultimately, the consultant should not make short-term decisions that endanger the impartiality of a report as this will increase exponentially the risk of long-term personal and firm reputational damage.

A client’s view: The value of getting the real picture on regulatory and compliance matters

Firms should also understand that they would benefit more from having an objective report. They are paying for professional services which require time and budgetary investment. If the produced report does not enable the firm to resolve the issues that drove the appointment of the consultant in the first place, then the firm will likely face further regulatory intervention on the same topic some months or years later. This is costly, not only in terms of the fees that have to be paid, but also in terms of the impact on senior management and staff time. Where any issues involve public regulatory scrutiny, the reputational impact can be even more severe.

For clients and consulting firms, there is the additional possibility of regulator-enforced business restrictions. This was seen in the PwC/Bank of Tokyo Mitsubishi case where PwC was suspended from accepting consulting engagements for financial institutions, regulated by the New York State Department of Financial Services, for two years. The industry has also seen a number of firms and individual directors banned from taking on specific assignments or holding directorships as a result of regulatory action as well.

Business restrictions can be avoided, however, if the issues are resolved at the first hearing and an objective, independent report is drafted to allow the client to resolve its issues and move forward.

Culture

The inherent risk is that acceptance of conflicts of interest becomes embedded in the culture of the client firm, resulting in compromised findings becoming the norm rather than the exception. Furthermore, if financial services firms see that their consultants accept a culture of compromising the opinions in their reports, this does not help to encourage best practice and transparency in the clients themselves.

A clear and well-executed training and development program for staff in ethics and conduct is crucial in both the regulated sector and their professional advisors (many of whom are recognized professional bodies themselves). The training delivered may differ between firms, but at its core, a culture of compliance and integrity needs to have an understanding of the danger of conflicts of interest and an underlying confidence in staff of all grades to feel comfortable challenging (and escalating where appropriate) perceived unethical behavior and damaging behavior driven by conflicts of interest.

The role of regulators

Regulators also have a key role to play. They can challenge the relationships between the professional services firm and its client. This requires the professional firm to sign an undertaking confirming that there is no conflict in the relationship with its client, prior to taking on a regulatory commissioned review. As more niche consultancies enter the market, financial services firms are becoming more comfortable engaging specialist consultants, who have less to gain from conflicting interests, and are therefore in a position to be as transparent and objective as possible.

We see this debate re-occur from time to time as regulators review the dominance of larger firms in some markets. One response has been for some regulators around the globe to engage more deeply with a range of larger and smaller specialist consulting firms, including allocating work to a wider pool of experts.

There is a fine line between regulators being supportive yet firm with consultants in order to ensure and improve the quality of the reports as opposed to opening enforcement procedures. Whilst enforcement clearly is a deterrent for further “whitewashing” of reports, the regulators have a responsibility to work with all the consultants to determine best practices and ensure the integrity of their reports maintain the highest standards.

The actions in New York bring to light the issue of conflicts of interest for professional services firms. There is therefore a need for professional services firms and their clients to remain objective and transparent. Ultimately, there may be cases where bigger is not always better and a range of consultancy firms could be used to avoid conflicts of interest.

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Monique Melis

Monique specialises in regulatory advice and over the last 20 years, has worked with investment firms and asset managers. Monique’s areas of expertise include senior management systems and controls, market monitoring issues, global procedure manuals for the banks, large investment firms, regulatory investigations, transaction reporting, expert witness reports and regulatory due diligence. Monique is also involved in resolution of regulatory investigations issues and has on numerous occasions spoken at industry seminars and written articles on regulatory change and transaction reporting.

Monique joined Kinetic Partners from the Cayman Stock Exchange where she was Head of Market Regulation and Business Development. Monique previously managed the Transaction Monitoring Unit in the Markets and Exchanges Division of the FSA. She transferred to the FSA from the Securities and Futures Authority where she worked in the Surveillance Department.  Monique is a member of the Kinetic Partners Executive Board.
 

Monique Melis
Member
Consulting – Regulatory Compliance
Kinetic Partners
London, UK


T: +44 20 7862 0837
E: monique.melis@kinetic-partners.com
W: www.kinetic-partners.com 

 

Kinetic Partners

Kinetic Partners is a leading provider of tailored consulting, advisory and assurance services to clients within the asset management, investment banking and broking industries, who value our global approach and expert advice.

Established in 2005, we have built a multidisciplinary team of industry recognised experts, drawn from regulators, financial institutions, asset management firms and leading professional services firms around the world. We have gained an excellent reputation for the quality of our service delivery and we currently advise over 1,200 clients across our eight global offices in London, Dublin, New York, Grand Cayman, Geneva, Hong Kong, Luxembourg and the Channel Islands.

Future planned expansion sees us opening in additional jurisdictions in response to the changing needs of our clients, who rely on our ability to operate seamlessly across borders, a crucial requirement given the global nature of our industry. 

 

Kinetic Partners
London
Dublin
Grand Cayman
New York
Geneva
Hong Kong
Luxembourg
Channel Islands


T: +44 20 7862 0837
E: monique.melis@kinetic-partners.com
W: www.kinetic-partners.com