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Wednesday, February 12, 2014

What conflict of interest?
By Patricia Finlayson, ACIS, Chartered Secretaries New Zealand Inc

New Zealand, as a country, prides itself on the ease of establishing a business – what this often really means is the ease of formation of a company. A significant feature of that ease of formation is that the minimal requirements for appointment as a director are principally that the nominees should be at least 18 years old and not be an undischarged bankrupt or have been guilty of a number of crimes of dishonesty. It is interesting that individuals who may be in a position to put literally millions of dollars of other people’s money at risk are not required to have any formal qualifications, nor show, through a process of accreditation, that they have, through experience, gained the skills and judgement that one would generally expect of a person holding that sort of position.

It is interesting that we are required to demonstrate that we have the competence and skill to safely drive a car, fly an aeroplane, skipper a vessel of any size, practice in professions or trades, but there is no requirement for directors to demonstrate that they have the necessary knowledge and skills to carry out the duties expected of them.

It is probably fair to assume that most, if not all, directors understand the concept of limited liability – although, I suspect that many mistakenly believe that that applies as much to directors as it does to shareholders. However, it would appear unlikely that directors have taken as much care to understand their obligations as set out in the Companies Act 1993, and that professional advisers either do not spend much time ensuring that directors grasp the fundamentals of the duties they owe to their companies, or directors do not give significant weight to the advice given.

The concept of conflict of interest, and a director’s duty to avoid it, for instance, appears to completely evade many directors or they choose to ignore it. The problems with companies which failed in the stock market crash of 1987 and, more recently, in the spectacular failure of multiple finance companies in New Zealand, have often been characterised by high levels of conflicts of interest and close cousin, related-party transactions. Why is it that New Zealand directors appear to either find the concept of conflict of interest difficult to grasp or are wilfully blind to its occurrence when it would seem so glaringly obvious to an impartial observer?

Perhaps, in relation to larger companies, it is due to the fact that there is a relatively small pool of professional directors or professionals willing to act as directors, and that these directors often hold directorships of a number of companies. This may lead to their developing comfortable and cooperative relationships with their fellow directors which can be seen as a plus provided the boundaries are clear. Bruce Jesson, described in Wikipedia as a left-wing journalist, author, and political figure in New Zealand, published a book entitled Behind the mirror glass: The growth of wealth and power in New Zealand in the eighties (Penguin, 1987), in which he laid out the nature of interlocking directorships and the very cosy boardroom culture of New Zealand at the time. Some would say that not much has changed.

However, in recent years, there has been a determined effort by both National and Labour Governments to re-regulate to improve confidence in the financial markets, which has clearly been noted by directors to the point where concerns have been expressed that taking up an appointment as a director may expose that person to unreasonable liability and therefore is considered too risky for many. Nevertheless, there remains a public perception that directors with few or no qualifications or experience for the task and little or no ‘skin in the game’ are, or have been, dealing with investors’ money in a cavalier fashion often for their own, or their associates’, personal gain. The Registrar of Companies, the Financial Markets Authority, and the Serious Fraud Office are still clearing a backlog of cases involving the directors of these companies. The losses to investors have been in the billions of dollars.

So, if we accept that one of the most troublesome features of the company landscape is the level of incidence of conflicts of interest and related-party transactions, why is that so, what could be done about it, and how can a company secretary or administrator be influential in that process?

First, section 144 of the Companies Act allows a director who is interested in a transaction to attend any meeting at which the transaction is discussed, to vote on a matter relating to the transaction, and to sign a document relating to the transaction. This is a very liberal approach to dealing with conflicts of interest and it may be wise for a company to exclude a director with a conflict from participation in discussion or at least from voting on the matter. All companies should have a policy regarding the process for dealing with conflicts of interest which complies with the Companies Act. This is best included in the company constitution to give it weight and for reasons of transparency. Once conflicts of interest have been disclosed, it should then become a relatively straightforward matter to manage the conflict appropriately.

Second, it now seems to be a given that many directors are not adequately prepared for the role and do not have a good understanding of their duties as directors. They would almost certainly benefit from some form of compulsory induction or education if they cannot satisfy an appropriately qualified panel, set up for the purpose of reviewing potential directors credentials, that they have the necessary skills and experience to perform adequately in the role of director.

The question then is whether this process should apply to all companies? This may mean looking again at the question of whether the ‘one-size-fits all’ legislation is appropriate having regard to the potential losses to investors and creditors which may occur when a medium to large-sized company fails. Perhaps a higher level of competence and standard of practice should be expected of directors of companies where the level of risk to investors is particularly high due to the nature of the business.

None of this, of course, will make any difference in the cases where directors, who are well aware of their duty to avoid conflicts of interest, are either wilfully blind or completely unconcerned about meeting their obligation. However, it may ensure that generally well-intentioned directors are more aware of the possibility of conflicts of interest and turn their attention to identifying them more readily.

Third, where a company employs a company secretary or senior administrator assisting the board, that person should ensure that at all meetings the question “Are there any conflicts of interest that should be registered?” is put to the board members by the Chair, and that the interests register is well maintained. When the company secretary/manager of the secretariat becomes aware of a potential conflict of interest relating to a board member, this should be brought to the attention of the Chair. The company secretary should maintain a watching brief for conflicts of interest and ensure that they are managed in accord with the Companies Act and the constitution of the company.

These measures should go some way towards reducing the incidence of conflicts of interest and the problems caused by inadequate management of them.

The contributions from CSNZ members and guests are the opinions of the authors and content is not necessarily a statement of CSNZ policy.

NZLawyer \\ issue 202 \\ 8 March 2013


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