Conflict of interest

Gateway to Corruption


By Paul Catchick, CFE
JanFeb-gateway-corruption    
 © DARIO LO PRESTI AND ANAR MAMMADOV/ISTOCK/WAVEBREAK MEDIA/THINKSTOCK 
Corruption can take many forms, but its genesis often starts with the same issue: a conflict of interest, whether it’s an employee’s relative with whom a company does business or a manager choosing to hire a friend’s unqualified son. The author outlines why conflict of interest can lead to corruption and how this information can help CFEs detect and prevent this type of fraud for their clients or organizations.

Cynthia began working for a regional office of a multinational corporation, XYZ Inc. Her brother, Clyde, happened to own a company selling office supplies to XYZ. Although Cynthia was fully aware that Clyde’s company conducted business with her employer, she never mentioned this to her colleagues. Cynthia had a conflict of interest, but because she wasn’t abusing her position for her own benefit, she thought the situation was benign. 

Subsequently, however, Cynthia became an assistant in XYZ’s procurement department, but she still failed to declare her conflict of interest. Occasionally, she processed purchases from Clyde’s company at the request of her supervisor, but at this initial stage, Cynthia wasn’t involved in awarding business to her brother’s company. 

After she processed orders for Clyde’s company for some time, Cynthia realized that she was able to influence the awarding of business to her brother; she even became a director of his company. She then took advantage of her incoming supervisor’s inexperience to begin allocating business to Clyde’s company more frequently. Furthermore, she would also intercept purchase requisitions meant for more junior procurement colleagues and tell them to make the purchase from her brother’s company. 

The new supervisor was happy to let Cynthia run things because it reduced his workload. However, he failed to realize that his inaction allowed Cynthia to direct business toward her brother’s company, even though it was more expensive than competitors. XYZ was now spending six-figure sums annually in multiple small- to medium-sized transactions (and was entering transactions just below the threshold that would have required competitive tendering). 

My investigation concluded that Cynthia had engaged in corrupt activity. Her company fired her and dropped Clyde’s company as a supplier.

(I’ve changed the names and details of this and subsequent real cases to avoid identifying individuals.) 

This case illustrates how an apparently benign conflict of interest was the first step on the route to outright corruption. Indeed, in the broadest sense every act of corruption must first involve some kind of conflict of interest. The intention of this article is to demonstrate why this is so and to suggest ways of targeting corruption through identifying conflicts of interest. If an organization is able to manage and control conflicts of interest, it can better manage corruption.

DEFINING THE LINK TO CORRUPTION

To understand why corruption must always involves a conflict of interest, let’s look at the definitions of the respective terms. The Organisation for Economic Co-operation and Development states: “Conflict of interest occurs when an individual or a corporation (either private or governmental) is in a position to exploit his or their own professional or official capacity in some way for personal or corporate benefit.” 

In other words, a conflict of interest exists when someone could abuse his or her official position for private gain.

The World Bank has provided a very succinct definition of corruption: “the abuse of public office for private gain.” While the World Bank definition focuses on public-sector corruption, the definition is largely interchangeable with private sector corruption since the term “public office” can equally apply to any official or any office — whether public or commercial — held by an employee.

A comparison of these definitions shows why the two concepts are so closely intertwined. A conflict of interest exists where an official could abuse his or her position for private gain, whereas corruption exists where an official does abuse his or her position for private gain.

Thus while a conflict of interest doesn’t always lead to corruption, corruption always requires a conflict of interest.

For example, accepting bribes is an example of corruption. The bribe taker has put his or her private gain — the receipt of the bribe — above the need to act in the best interests of his or her employer. Thus, there’s both a conflict of interest and resulting corruption.

Employees also can find themselves in initially benign conflict of interest situations as Cynthia was before she took the further step of taking advantage of it. 

Indeed, the mere act of having a conflict of interest isn’t necessarily, in itself, inappropriate or even avoidable. After all, employees can’t be faulted simply for having financial or family connections to businesses that their employers subsequently decide to trade with. What’s important is how the employees and their employers respond to the conflicts of interest. It’s the response — rather than the conflict itself — that determines whether the employee has acted with integrity.

AWARENESS AND RESPONSE

Employees’ and management’s correct responses to conflict of interest situations, in turn, rely on an awareness of what it means and the potential implications. This isn’t always as straightforward as it sounds. Conflicts of interest and corruption may be subject to differing interpretations. 

Criminal codes relating to conflict of interest vary widely depending on the jurisdiction, so it’s hardly surprising that some employees may misunderstand the concept. This can particularly affect larger multinational organizations that work across different geographic, ethnic and cultural borders, but the effects of globalization can even mean that smaller local enterprises may be composed of employees with differing value systems. Therefore, any organization that wishes to enforce a strong conflict of interest policy must ensure that staff understand it and are aware of the ramifications and how they should respond. After all, an employee who doesn’t fully understand the concept can’t necessarily be expected to react appropriately when faced with such a situation. 

It helps to distribute codes of conduct to all new employees, but this in itself may be insufficient. After all, even Enron had a 64-page code of ethics. Conversely, if we can prove that an employee knew the rules, it will be easier to build strong evidence in a subsequent investigation. In one investigation, I was able to rebut an employee’s claims that he knew nothing about conflict of interest after I pointed out that he had signed an attendance register for a conflict-of-interest awareness session.

Although there are various strategies for responding to and managing a conflict of interest, invariably the most straightforward course of action for any employee is simply to declare the conflict to their managers, who can then decide how to manage the situation. This simple system will work only if management is supportive and sets a good tone at the top in which the employee knows he or she won’t be vilified for the mere act of having a conflict of interest.

In some professions, such as audit, it’s actually a professional requirement that staff declare any conflicts of interest — either periodically or before commencing an audit assignment. However, even without a professional requirement, it’s always desirable for any employee to declare a conflict of interest, particularly for those staff engaging with external parties, such as procurement, project management, finance and even warehousing.

Suppose Deborah works in a company’s administration department, and the company moves its headquarters. The managing director has seen a new office and asks Deborah to negotiate a contract. Deborah, who up until this point knew nothing of her boss’ plans, realizes that her husband’s firm owns the new building. Thus, through no fault of her own, Deborah is in a position in which she has a conflict of interest. What matters now is her response. There are a number of possibilities:
  1. If she says nothing and proceeds to negotiate the lease contract with a view to giving her husband the best possible price at her own company’s expense, this would be a case of corruption. Again, we can see that the corrupt activity can only exist with the pre-existing conflict of interest.
  2. Even if Deborah had negotiated the lease contract with the genuine interests of her company in mind and without any thought to personal profit, a failure to declare her conflict might still reflect badly on both her and her company to anybody else who became aware of her connection. (This would be a “perceived conflict of interest.”)
  3. If, on the other hand, Deborah promptly declared the conflict of interest to her boss, then her boss would have to mitigate her involvement and manage any perceived conflict of interest — perhaps by asking somebody else in the department to negotiate the contract. Deborah has avoided accusations of impropriety, and her boss has dealt with the matter fairly and knows that the lease negotiations will be conducted objectively.
It’s best to declare a conflict of interest in writing because it will enable the employee to show any auditors or investigators later that he or she responded properly. And if management subsequently fails to deal with the matter appropriately, it will face difficult investigation questions rather than the employee who held — but correctly declared — the conflict.

 


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