Codes of conduct: Actual, apparent and potential conflicts of interest

Preventing and mitigating conflicts of interest (COI) is a mainstay of many  corporate compliance and ethics (C&E) programs.  And because there is no all-embracing COI legal regime (the way there is for, e.g., antitrust), particular attention should be paid to drafting and enforcing  COI provisions of codes of conduct.

In a prior posting we explored standards of waiver  in codes for COIs . See  Standards for waivers of conflicts of interest – Compliance and Ethics: Ideas & Answers. In today’s posting we address apparent COIs.

An apparent COI is a set of circumstances that can  be reasonably believed to constitute  a conflict of interest  even if there is in fact no conflict .Codes generally – indeed, almost universally – prohibit apparent as well as actual COIs.

Apparent COIs are sometimes seen as less serious than  the harm from actual ones. In my view this is a mistake, because the harm from an apparent COI can be just as great as the harm from an actual one.

Moreover, actual COIs can – given their nature – be particularly difficult to prove.  That is because, more so than with some other types of wrongdoing, key acts or circumstances in COI cases are often known only to the wrongdoers, particularly matters going to wrongful intent.

A hypothetical case

X Company is considering using Y Company as a supplier because Y offers the best goods on the best terms. But Y is owned and operated by A, whose twin brother A Plus is a senior manager of X. A Plus has nothing directly or indirectly to do with purchasing anything for X, and rigorous controls are put in place at X to ensure that A Plus does not in any way help Y in its dealings with X. Does the fact that X has mitigated any actual conflict mean that it has done so with the apparent one?

The analysis in such situations turns in part on the question: Apparent to whom? For instance, is it well known among X employees and the company’s other suppliers that A and A Plus are brothers? If so, then the employees and other suppliers—two groups whose trust, as a general matter,   companies have strong reasons to maintain—would likely need to know the particulars of the mitigation measures to believe that there is no actual conflict. But for various understandable reasons, companies in this sort of situation are often reluctant to publicize their mitigation measures in any detail. And even if they did, there would be a good chance that the parties to whom conflict is apparent would be skeptical of the effort’s sincerity and efficacy.

Not all apparent conflicts raise significant challenges of this sort. However, some present even greater mitigation difficulties than our hypothetical, such as where the apparent COIs become known to shareholders, who are typically a more distant and dispersed group than are employees or suppliers and thus presumably harder to provide comfort to.

Potential conflicts

Finally, note that the concept of “potential COIs” is sometimes used interchangeably with apparent COIs. However, they are clearly distinct from each other.

Potential COIs are addressed to something in the future, e.g., in our case, when X began to consider giving business to Y, as opposed to actually contracting with Y.  While not that common, having  a code (or other pertinent C&E documents)  address potential COIs can help prevent problems before they start.