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The Actuary The magazine of the Institute & Faculty of Actuaries

Conflicts of interest

he fall from grace of American companies such as Enron, WorldCom, Global Crossing, and Tyco reflects the fact that the stakes have risen when it comes to the negative consequences of conflicts of interest. While conflicts of interest have been a feature of economic and political life for centuries, in the recent past they have conspired to destroy the credibility of, and undermine trust in, the advice of professionals.
The publication of the Penrose and Morris reports has helped to cement conflicts of interest in the actuarial consciousness. From reading these reports and the comprehensive media coverage of the issue, it is clear that actuaries should proactively address the issue of conflicts of interest. Perhaps we can learn from the other professions in how they have addressed this thorny issue. Therefore, I have chosen the examples of the accountancy profession, which has been particularly affected by conflicts of interest in recent years, and the legal profession, which by its nature will have significant expertise in this area. However, conflicts of interest are by no means limited to these professions. They also permeate other areas of business, including medicine and even academic research.
Ultimately, although legislators in many countries have provided regulation on conflicts of interest through, for example, the Sarbanes-Oxley Act, the failure or success of the professions in dealing with conflicts of interest rests on the integrity of the individual members of those professions. The accountancy and legal professions address issues related to conflicts of interest through codes of ethics. Formulated in a similar manner to our guidance, these codes of ethics may be more or less prescriptive and their violation usually carries strict censure for the individual professional or firm.

The accountancy profession
In the UK, the Financial Reporting Council sets the standards for both the actuarial and accounting professions.
The Institute of Chartered Accountants of England and Wales devotes a section of its guide to professional ethics specifically to provide guidance in the area of conflicts of interest. The guidance broadly centres on best practice in tackling two main situations.
The first of these is where a conflict exists between the interests of a member and that of his client. In this situation, considerable emphasis is placed on identification of the conflict of interest with the onus falling on firms to have in place procedures to enable them to identify if a conflict exists or is likely to arise in relation to new assignments.
Furthermore, according to this guidance, if a conflict between the interests of a member and that of their client is identified then the question to ask is: ‘Would a reasonable and informed observer perceive that the objectivity of the member is likely to be impaired?’
Interestingly, even if this question receives a positive response, the member is allowed to act if they can satisfy themselves and the client that the conflict can be managed with available safeguards. Only when the firm believes that a conflict cannot be managed with the safeguards should disengagement occur.
Among the listed safeguards are:
– disclosure of circumstances of the conflict;
– obtaining the informed consent of the client to act;
– advising the client to seek alternative independent advice in certain situations;
– establishing Chinese walls;
– disengagement.
A cautious approach to Chinese walls is advocated because the courts have suggested that they may be ineffective.
The second situation that the guidance addresses is the scenario where a firm may have two or more clients whose interests may conflict. As an actuary, this is the more common scenario that comes to mind. For example, what issues must the pension scheme actuary consider in advising both trustee and sponsoring employer? Or how does the life actuary fulfil his respective responsibilities to both policyholders and shareholders?
From the accounting perspective this conflict of interest relates almost exclusively to the safeguarding of confidential information only because their advice to the individual clients with conflicting interests is unlikely to be different owing to the existence of the other client. Actuarial advice in this situation may well differ depending on the role the actuary is fulfilling. Therefore the guidance outlined by the accountancy profession under the first conflict situation described above will be most relevant from an actuarial viewpoint.
Finally, there is also an ethics advisory service available to members where they can discuss issues relating to conflicts of interest.

The legal profession
The UK Law Society devotes a full chapter of the guide to the professional conduct of solicitors to conflicts of interest. It is hardly surprising that, from the outset of the guidance, the Law Society has given in-depth consideration to the issue. The thrust of the guidance is to prevent the individual solicitor from getting into a situation where his or her objectivity in representing their client comes under scrutiny. The wording of guidance is specific in going about achieving this goal.
In general, a solicitor is prohibited from acting in cases where there is a conflict of interest. However, a solicitor is permitted to act with clients’ consent in defined circumstances of conflict subject to suitable safeguards. There may be situations where, despite peripheral or potential conflict, it may be in the clients’ best interests for a solicitor to act for two or more clients but only with their informed consent. Of particular interest to actuaries is the situation where the clients have a ‘common interest’ and where it would be disproportionate, for example in terms of cost, to require them to instruct separate solicitors.
It is left to the individual solicitor to determine in each case whether there is a ‘common interest’ and whether it is appropriate to act. The areas of conflict must be substantially less important to the clients than their common purpose. Safeguards include:
– keeping differences between clients under review;
– only acting in limited areas where there is no conflict; and
– separate advice on areas where there is conflict.
In acting under one of these exceptions the onus is placed on the individual solicitor to demonstrate why it was reasonable to act for all clients at the time the instructions were accepted. Solicitors are urged to keep a written record of all discussions with clients on the implications of the solicitor acting for them. Written consent from the clients is always required before a solicitor can act under these exceptions.
As in the case of accountants, solicitors are warned to be cautious in accepting instructions where there may be a possibility of future conflict.

A specific actuarial guidance note?
The guidance of the accounting and legal professions have different approaches to managing conflicts of interest. At one end of the spectrum, the legal profession’s guidance is to prohibit members from giving advice where a conflict of interest exists or could exist. At the other end perhaps reflecting practical or commercial realities in the accounting profession there appears, once a conflict of interest has been identified, to be a tolerance towards members or firms operating in situations where conflicts of interest exist, with the proviso that certain predefined safeguards are in place.
Within the accounting guidance, there is perhaps an overreliance on disclosure as a means of mitigating conflicts of interest. This is not as costly and disruptive as other options like disengagement but it does rely on the assumption that it enables clients to make better decisions.
As a first step, a specific guidance note in this area would help to give the subject the emphasis it deserves. This would give more scope to deal with issues such as the identification and classification of the main types of conflicts of interest. Detailed advice could be provided to actuaries on the various tools available to them and the appropriate use of those tools in dealing with the more usual situations where conflicts of interest present themselves.
There are considerable risks to the credibility of the profession arising from conflicts of interest. In setting guidance, as well as considering the detailed advice the profession has received from its legal advisers in this area, we should examine best practice within other professions and draw lessons from their experiences, both positive and negative. Perhaps the approach of the legal profession with its considerable expertise in this field will be instructive in helping actuaries to adopt a suitably cautious approach to this topic in the future.
Ultimately, the success of the actuarial profession in dealing with conflicts of interest will be judged by the success of its individual members in dealing with these conflicts. With this in mind, I would strongly urge you to keep your knowledge on this subject up to date and to be ever-vigilant for work situations where your objectivity could be called into question.