Compared with other industries, the financial services industry inherently has an elevated risk of conflicts of interest. In particular, connected persons and close personal relationships can influence decisions that result in significant business and financial impact. After all, we’re all human and sometimes act based on emotion. Unfortunately, those human, emotional connections can sometimes lead to severe conflicts.
The consequences can be dire when a firm fails to identify and act on conflicts arising from personal relationships. Market abuse, insider trading, and unethical and illegal behaviour can grow when left unchecked. So robust compliance policies and a means to record, monitor, analyse, and manage potential conflicts are vital for every financial firm.
When acting in ways that conflict with the interests of a firm, its customers and the broader financial market, employees, executives, and directors can face job losses, severe financial penalties, and even imprisonment. The affected organisation can also incur reputational damage, financial penalties, and in extreme cases, face being delisted.
Compliance teams play a vital role in reducing the risk of connected persons and close personal relationships turning into more significant issues. This article explores the types of conflicts and considerations for your financial firm to understand and manage risk from connected persons and personal relationships more effectively.
What Defines Conflicts of Interest?
Conflicts of interest, where personal relationships are concerned, can arise from the sharing of sensitive information or material non-public information (MNPI) by employees, executives, and directors with anyone considered a close personal relationship. These types of information can include operational methods, marketing or development plans or strategies, business acquisition plans, joint venture proposals, data that may impact stock and securities outcomes, and other MNPI.
Conflicts can also result from GEH (gifts, entertainment, and hospitality) activity, from OBAs (outside business activities) where work is being undertaken for multiple employers simultaneously, and other areas where personal gains may be happening at the expense of an employee’s organisation, its customers, or the broader financial market.
Conflicts of interest can be observed in the following ways:
Actual conflicts of interest
Where there is an observable conflict between an employee’s responsibilities to their firm and their personal interests.
Potential conflicts of interest
Where an employee has private interests that may conflict with responsibilities to their firm at some point in the future.
Perceived conflicts of interest
Where third parties or members of the public think that an employee is being unduly influenced in their decisions and actions, either now or in the future.
In all instances (even though there may be no actual conflict happening), firms still need to actively reduce the risk - and the perception - of conflicts occurring.
What Are Connected Persons?
‘Connected Persons’ can apply to anyone considered to be connected with your firm or its directors - or with your firm’s persons discharging managerial responsibilities (PDMRs). The term is also highly dependent on context. For example, some legislations, such as the UK Companies Act 2006, may regard a company director’s family member as a connected person. The director would also be connected with the company where a 20% or more of the equity share capital of the company is in possession, or where the exercise of control with more than 20% of the voting power at a general meeting is in place (as further detailed here).
Your firm’s compliance policy may also define a connected person as any person or entity whose information is provided to the firm. For example, partners, trustees, agents, and other third parties with whom you have a relationship relevant to the firm may classify as connected persons.
Additionally, anyone who may, by way of their relationship, have access to material non-public information (MNPI) about the company (where they otherwise would not) may also be considered a connected person.
What Are Close Personal Relationships?
Close personal relationships refer to any regular and ongoing relationship that is romantic, familial, or financial in nature.
Many firms have a ‘Disclosure Policy’ that obliges those within romantic relationships to divulge that information if it could cause a conflict of interest for the firm. These may be inter-company relationships or connected persons.
A firm’s ‘Conflicts of Interest’ policy may also provide guidance for resolving potential conflicts. For example, suppose a manager and their subordinate are involved in romantic relationships; reassigning one of the employees to another area of the business may be an appropriate course of action.
Close personal relationships can sometimes influence (or be perceived to influence) the decisions of employees, executives, and directors. These relationships can also result in exposure to MNPI that may not otherwise have occurred. Therefore, disclosing these relationships is critical to helping compliance teams monitor and avoid conflicts of interest.
The Impact of Personal Relationships on Gifts, Entertainment, and Hospitality
Many industries have strict policies about the giving and receiving of gifts, entertainment, and hospitality (GEH). Especially where the gift or benefit is of more than nominal value, it can be perceived as a way for one party to influence another’s decisions - or even be viewed as bribery in some cases. Additionally, when personal relationships are involved in the transaction of gifts and benefits, these perceptions may become elevated.
Compliance teams need to have robust policies and procedures in place that identify and collate any gifts received or given by employees to clients or counterparties. In addition, the capability to relate this data to personal relationships information can more effectively identify conflicts.
Your GEH policies should provide clarity and direction on when employees can or cannot accept gifts and dollar values of what they can accept. It’s also essential to maintain a central register which makes it easy for employees to declare GEH items and for your compliance team to track activities.
Periodic reviews of GEH records can also help your firm detect any irregularities or policy breaches to uncover potential issues before they become more serious.
MCO’s Gifts, Entertainment and Hospitality (GEH) module offers a comprehensive way to monitor employee gifts, meals, entertainment, travel and hospitality activities, allowing firms to record and detect risks arising from gifts and entertainment. It will enable your firm’s policies to be embedded with a rules-based approach to identifying potential misconduct and bribery risk.
Download your Gifts, Entertainment, and Hospitality Compliance brochure for more information.
Personal Relationships Under the Moonlighting Microscope
Outside Business Activity (OBA) is where employees undertake work other than what they produce for their primary employer under contract, aka ‘moonlighting’ or a ‘side hustle’. Conflicts of interest can arise when employees fail to communicate their OBAs to employers - and in particular, when personal relationships are involved in those moonlighting activities.
While OBAs don’t always result in conflicts, an evaluation must be undertaken to determine if potential conflicts exist. For example, employees may help out in family businesses in their spare time. However, if an employee is moonlighting for your firm’s competitor, it could create a direct conflict of interest - through that moonlighting activity and their personal relationship.
Without visibility and tracking of OBA and personal relationship information, firms are severely limited in identifying conflicts and preventing them from becoming larger issues. However, firms can avoid these conflicts by having clear policies around disclosing and evaluating OBAs and relationships that may influence those activities, along with defined approval or denial processes.
Review your firm’s OBA policy and consider aspects such as:
- The terms under which OBAs are permitted, for example, with required assurances from the employee that OBAs will not affect their obligations under current employment contracts.
- Employees being restricted from participating where an actual or potential conflict might arise from their outside business activities or the business interests of the employee’s close personal relationships.
- Prior written approval from Management and/or Compliance Departments being required to engage in OBAs.
Disclosure of Personal Relationships
Even when personal relationships have not resulted in favouritism, unfair advantage, or financial gain, failures to disclose those relationships can create the perception that there may be something to hide.
To maintain the trust of all employees, clients, and stakeholders, your firm needs robust processes in place that ensure:
- Employees have clear and easily understood definitions of the types of personal relationships which need to be declared.
- Inclusions of personal relationship policies within attestations to document that employees acknowledge and understand their obligations.
- Effective communication of policies and procedures.
- Processes for declaring connected persons and relationships that are straightforward for employees to initiate.
- The ethical implications of leveraging personal relationships for personal or professional gains are understood by all employees.
Financial firms that effectively manage the disclosure of personal relationships can significantly reduce conflict of interest risk and maintain the trust and confidence of their clients and the public.
Record-keeping of all employees and personal relationship data can be challenging due to the sheer volume - particularly for large firms with thousands of employees. However, automated RegTech (regulatory technology) solutions are available to do the heavy lifting for compliance teams with automated tracking and flagging potential conflict risks.
How to Reduce Conflict of Interest Risk Due to Personal Relationships
Financial firms must mitigate the risk of sensitive information such as operational methods, marketing or development plans or strategies, business acquisition plans, joint venture proposals, and other material non-public information being shared by employees, executives, and directors with anyone considered a close personal relationship.
The first steps your compliance department should take to reduce conflict of interest risk include:
- Review current regulations and codes of conduct set out by your relevant financial regulatory bodies.
- If your firm has no existing Conflicts of Interest Policy that addresses connected persons, make it a priority to write a policy that supports current regulations.
- Add rules to your Conflicts of Interest Policy that clearly define acceptable and unacceptable behaviour in the use of an employee’s position in the firm to gain an advantage or influence decisions.
- Describe in your Conflicts of Interest Policy the boundaries and limitations to employees using their relationships with competitors or other connected parties to create direct or indirect profit - and whether they are permitted to own shares of particular companies’ securities.
- Provide definitions of what classifies as a gift, entertainment, or hospitality. For example, if an employee invites a client to an event, it’s considered entertainment, whereas an employee giving event tickets to a client is a gift.
- Place specific dollar amounts on GEH items that employees can accept - and conversely offer other parties.
- Train, educate, and instruct employees. Provide all employees with regular training on your Conflicts of Interest policy. Educate employees about the consequences of failing to comply with your firm’s policies. Instruct them on how to use your firm’s systems to log information, such as GEH items, and make conflict of interest declarations.
- Ensure your OBA policy defines employees’ approval or denial processes and requirements to disclose OBAs and personal relationships that may influence those activities.
- Have straightforward, defined processes for employees to declare connected persons and relationships.
- Review the technology being used to track and flag potential conflict risks, with consideration of automated solutions that can do the heavy lifting for compliance teams.
Leveraging RegTech to Manage Conflict Risk More Effectively
MyComplianceOffice (MCO) is an integrated RegTech solution that alerts compliance teams when a connected person is associated with other data entered across the MyComplianceOffice platform, for example, OBAs, GEH, employee trading activity, and much more.
MCO provides a consolidated platform for compliance teams to manage areas of potential conflict, including:
- Personal account dealing
- Trade surveillance.
- MNPI disclosure.
- Close personal relationships.
- Attestations, registrations and licences.
- Outside business activities.
- Gifts, entertainment, and hospitality.
Learn more about the Connected Persons & Relationships module of MCO, and the broader Know Your Employee (KYE) compliance suite, which helps compliance teams manage data collection and facilitates workflow, communications, alerts, approval, reporting and record-keeping for critical compliance tasks.
For more information about how MCO’s innovative compliance management platform can help your firm effectively manage conflicts of interest, schedule your no-obligation meeting with MCO APAC Director, Kelly-Ann McHugh, or request your demo now.
Uncover the strategies you need to reduce risk and strengthen your overall compliance management process. Download your complimentary eBook, The Ultimate Guide to Conflicts of Interest.