Management of conflicts of interest in the financial services industry

By Will Moncrieff.

Key Points:
Financial services licensees now have to address conflict of interest policies more systematically.

Section 912A(1)(aa) of the Corporations Act now requires financial services licensees to have arrangements for managing conflicts of interest.

This obligation is additional to the general duty to provide financial services efficiently, honestly and fairly.

More than just analysts' reports

On its face the new requirement is uncontroversial, but further debate may come when ASIC releases its policy on the new requirement, which is expected some time in the next few months. Specifically, licence holders must now have adequate arrangements for the management of conflicts of interest that may arise in relation to activities they undertake in the provision of financial services as part of their financial services business. Licensees must also cover conflicts in the activities of their representatives.

Thus the requirement goes beyond the original concern as to the independence of research analysts' reports.

The requirement is directed to two types of conflict:

1. conflicts within the financial services business (eg conflicts within one area of the financial services business, such as dealing on behalf of various clients, or across different areas of the business, such as between publishing research in a client newsletter and market making); and
2. conflicts between something within the financial services business and something outside the financial services business (eg a conflict of interest between the financial services licensee lending (as principal) to a particular enterprise and the financial services licensee underwriting a public offer for the same enterprise).

ASIC policy

The Corporations Act does not detail the specific manner in which licence holders must deal with conflicts. Instead the real implications for financial service licensees will be dealt with in the forthcoming ASIC policy.

Full details of ASIC’s proposed policy are not yet known, but it will at least be partly based on:

1. the findings of ASIC’s surveillance report on research analyst independence released on 22 August 2003; a key finding of that report was that Australia is unlikely to have experienced the same level of misconduct as in the US; and
2. ASIC's policy proposal "Licensing: Managing conflicts of interest" released in October 2003 and industry responses to that proposal.

ASIC has foreshadowed that its policy will:

• seek to apply "best practice";
• adopt an outcomes based approach, ie. one that enhances consumer confidence, fairness, honesty, integrity and market confidence; and
• require licensees to establish arrangements for controlling, disclosing and avoiding conflicts.

ASIC's policy proposal contains a number of specific recommendations for research report providers, which ASIC currently expects licensees to adopt.

Impact

The real impact of the new conflicts management requirement has yet to be felt.

However, even if they have behaved better than their US counterparts, Australian financial institutions are now required to adopt more systematic conflict management practices that avoid over-reliance on the integrity of individuals.

Pending the release of ASIC's conflicts policy, licensees should now be reviewing the adequacy of their existing conflicts management policies and have regard to ASIC's policy proposal document.

In particular, research report providers should now be reviewing their policies and practices as to how they are documented, implemented, maintained and enforced, and give close consideration to the other various expected steps referred to in Schedule 2 of ASIC's policy proposal.