Conflicts of Interest

Virtually all corporate codes of ethics address conflict of interest because it interferes with
the ability of employees to act in the best interests of a firm. Accepting gifts or lavish
entertainment from suppliers, for example, is generally prohibited or strictly limited for the
simple reason that the judgment of employees is apt to be compromised. Company codes
usually contain guidelines on investing in customers, suppliers, and competitors of an
employee’s firm for the same reason.
Prohibitions on conflict of interest cannot be so extensive, however, as to prevent
employees from pursuing unrelated business opportunities, taking part in community and
political affairs, and generally acting as they see fit in matters outside the scope of their
employment.
One problem with conflict of interest is in drawing a line between legitimate and
illegitimate activities of employees in the pursuit of their personal interests. A further
problem is the large gray area that surrounds conflict-of-interest situations. Perhaps no
other ethical concept in business is so elusive and subject to dispute. Many people charged
with conflict of interest see nothing wrong with their behavior. It is important, therefore, to
define the concept clearly and to understand the different kinds of conflicts of interest.
The conflict in a conflict of interest is not merely a conflict between conflicting interests,
although conflicting interests are involved. The conflict occurs when a personal interest
comes into conflict with an obligation to serve the interests of another. More precisely,
we can say that a conflict of interest is a conflict that occurs when a personal interest
interferes with a person’s acting so as to promote the interests of another when the
person has an obligation to act in that other person’s interest. This obligation is stronger
than the obligation merely to avoid harming a person and can arise only when the two
persons are in a special relationship, such as employer and employee.

Specifically, the kind of obligation described in this definition is that which characterizes
an agency relation in which one person (an agent) agrees to act on behalf of another (the
principal) and to be subject to that person’s control. This fact explains why conflict of
interest is most often encountered by professionals—lawyers, doctors, and accountants,
for example—and among fiduciaries, such as executors and trustees. Employees of
business firms are also in an agency relation in that they have a general obligation to
serve the interests of an employer.
To complete the definition of conflict of interest, some account should also be given of a
personal interest. Roughly, a person has an interest in something when the person stands
to gain a benefit or an advantage from that thing. “Having an interest” is not the same as
“taking an interest.” A person can take an interest in someone else’s interest, especially
when that person is a family member or a close associate. In that case, however, the
benefit or advantage accrues to someone else.

Furthermore, the benefit or advantage is usually restricted to a financial gain of

some kind. Merely satisfying a desire, for example, would not seem to be enough, for
otherwise a lawyer who secretly hopes that the client will be convicted would face a
conflict of interest, as would a lawyer who prefers to play golf instead of spending the
time adequately representing a client. The benefit or advantage would also have to be
substantial enough to interfere significantly with a person’s performance of an
obligation.
Nature of Conflict of Interest
 ACTUAL AND POTENTIAL CONFLICT OF INTEREST. There is a distinction
between actual and
potential conflicts of interest. A conflict is actual when a personal interest leads a person to act
against the interests of an employer or another person whose interests the person is obligated to
serve. A situation constitutes a potential conflict of interest when there is the possibility that a
person will fail to fulfill an obligation to act in the interests of another, even though the person
has not yet done so.

PERSONAL AND IMPERSONAL CONFLICT OF INTEREST. A second

distinction can be made
between personal and impersonal conflicts of interest. The definition developed in the preceding
section is phrased in terms of a personal interest that comes into conflict with the interests
of another. A conflict can also arise when a person is obligated to act in the interests of two
different persons or organizations whose interests conflict. Thus, a lawyer who represents two
clients with conflicting interests may not stand to gain personally from favoring one or the
other, and yet, according to Rule 1.7(a) of the American Bar Association’s Model Rules of
Professional Conduct, such an arrangement constitutes a conflict of interest. 21 A lawyer who has
a personal interest that conflicts with the interests of a client has a personal conflict of interest,
whereas a lawyer who represents two clients with conflicting interests faces an impersonal
conflict of interest.
INDIVIDUAL AND ORGANIZATIONAL CONFLICT OF INTEREST.
Third, conflicts of interest can be either individual or organizational. In the agency relation, the agent is
typically a person acting in the interests of a principal, which may be another person or an organization.
However, organizations can be agents as well and hence parties to conflicts of interest.

For example, many large accounting firms, like Arthur Andersen, provide management services to
companies they also audit, and there is great concern in the profession that this dual function endangers
the independence and objectivity of accountants. For an accountant to provide management services to a
company that he or she also audits—or for an individual ad person, banker, or lawyer to accept clients with conflicting
interests—is a clear conflict of interest. But why should it be a conflict when these functions are performed by different
persons in different departments of a firm? The answer is that an accounting firm, for example, also has an interest that
is shared by every member of the organization, and the interests of the firm can affect decisions about individual
clients. Thus, when management services are more lucrative than auditing, firms may have an incentive to
concentrate on them to the detriment of other functions. They may also be tempted to conduct audits in ways that
favor the clients to whom they provide management services. Further, large law firms face the possibility of
conflict of interest when they have clients with competing interests—even when the work is done by
different lawyers in the firm.
The Kinds of Conflicts of Interest

• The concept of conflict of interest is complex in that it covers several

distinct moral failings that often run together. It is important to
separate them, though, in order to have a full understanding both of
the definition of conflict of interest and of the reasons that it is morally
wrong for a person to be in a conflict-of-interest situation. Briefly, there
are four kinds of conflicts of interest:
• (1) exercising biased judgment,
• (2) engaging in direct competition,
• (3) misusing a position, and
• (4) violating confidentiality.
 Biased Judgement
Whether it is a potential conflict of interest for a purchasing agent to accept a gift
from a supplier who expects favorable treatment in the future is less clear. An
answer to this question depends largely on the value of the gift, the
circumstances under which it is offered, the practice within the industry, and
whether the gift violates any law.

The code of ethics of a large bank, for example, states that employees should not
accept gifts where the purpose is “to exert influence in connection with a
transaction either before or after that transaction is discussed or consummated.

Gifts, for any other purpose, should be limited to those of nominal value.” “Gifts
of nominal value,” the code continues, “generally should be limited to standard
advertising items displaying a supplier’s logo.” A maximum value of $25 is
suggested as a guideline
DIRECT COMPETITION.

For an employee to engage in direct competition with his or her

employer is a conflict of interest. One reason, of course, is that an
employee’s judgment is apt to
be impaired by having another interest. In addition, the quality of the
employee’s work might be
reduced by the time and effort devoted to other activities. Unlike other
kinds of outside business
interests, however, direct competition is generally prohibited by companies
even when it is disclosed
and there is no danger of impaired judgment or diminished work
performance.
 Misuse of Position
Misuse of position constitutes a third kind of conflict of interest. Consider the hypothetical case of a bank
manager who, in the course of arranging home improvement loans, makes it a point to ask customers whether
they have lined up a contractor. She casually drops the name of her brother who operates a general contracting
business and mentions that a number of bank customers have been very satisfied with the work of his
company.
The bank manager’s mention of her brother is clearly improper if she misuses her
power to grant or deny a loan to induce customers to use him as a contractor. A conflict of
interest is still present, though, even if she does not allow her personal interest to have any effect
on the decisions she makes on behalf of her employer. There is no conflict between the interests
of the manager and those of the bank, and the bank is not harmed in any significant way. Still, the
manager has taken the opportunity to advance her personal interests while acting in her capacity
as an official of the bank. Holding a position with a company or other organization gives a person
powers and opportunities that would not be available otherwise, and an employee has an
obligation not to use these powers and opportunities for personal gain.

Extortion also constitutes a misuse of position. Unlike bribery, with which it is often confused,
extortion does not involve the use of a payment of some kind to influence the judgment of
an employee. Rather, extortion in a business setting occurs when a person with decision-making
power for a company demands a payment from another party as a condition for making a
decision favorable to that party
VIOLATION OF CONFIDENTIALITY.

Finally, violating confidentiality constitutes, under certain

circumstances, a conflict of interest. The duty of lawyers, accountants, and other
professionals,
for example, precludes the use of information acquired in confidence from a client to
advance
personal interests—even if the interests of the client are unaffected. Similarly, because a
director
of a company is privy to much information, it would be wrong to use it for personal gain or
other
business interests.
Trade Secrets
Managing Conflict of Interest
Conflict of interest is not merely a matter of personal ethics. A person in a conflict of
interest, either potential or actual, may be in the wrong, but conflicts usually occur in the
course of being a professional or a member of an organization. Often, these conflicts
result from structural features of a profession or an organization and must be managed
through carefully designed systems.

Objectivity: A commitment to be objective serves to avoid being biased by an interest that might interfere with a
person’s ability to serve another.

Avoidance: The most direct means of managing conflicts of interest is to avoid acquiring any interests that would
bias one’s judgment or otherwise interfere with serving others. Avoidance is easier said than done, however. First, it
may be difficult to anticipate or identify a conflicting interest. Second, acquiring conflicting interests may be
unavoidable due to the nature of the business. This is especially true of investment banking, where conflicts of interest
are built into their structure. For example, a large investment bank routinely advises clients on deals that affect
other companies which the bank also advises or whose securities the bank holds.
Disclosure: Disclosure serves to manage conflict of interest primarily because whoever is potentially harmed by the
conflict has the opportunity to disengage or at least to be on guard.

In legal ethics, a conflict of interest is permissible if three conditions are satisfied:

(1) the lawyer discloses the conflict to the client,
(2) the lawyer is confident that he or she can provide wholly adequate representation so that the client will be unaffected
by the conflict, and
(3) the client accepts the lawyer’s service under those conditions.

Competition: Strong competition provides a powerful incentive to avoid conflicts of interest, both actual and potential.

Rules and Policies: As already noted, most companies have policies concerning conflicts of interest. These typically require
employees to avoid acquiring adverse interests by not accepting gifts or investing in potential suppliers.

Independent Judgement: Insofar as a conflict of interest results in biased judgment, the problem can be corrected by
utilizing a third party who is more independent. In courts of law, a judge who, say, owns stock in a company affected by a
case is generally obligated to recuse himself or herself and allow the decision to be rendered by other judges.

Structural Changes: Because conflicts of interest result from providing many different services to different customers or
clients, they can be reduced by compartmentalizing these services. Within multifunction institutions, conflicts can
be reduced by strengthening the independence and integrity of each unit.