ACCOUNTANCY CONFLICTS: A ‘MANAGED’ APPROACH

The vast range of professional services carried out by chartered accountants immediately raises the possibility of potential conflicts of interest. Take the following three set of circumstances:

⁵³ M Mullally, n 7 above.

⁵⁴ Firm 17.

⁵⁵ See, for example, Legal Week, 5 August 1999, p 1.

⁵⁶ Ibid.

1. If a firm of accountants is auditing a company, the duties they owe as audi­tors are to the shareholders of the company.^[223] In practice, however, auditors are appointed by and rely on the co-operation of the board of directors. Moreover, auditors are used by the board to give advice on company affairs. Thus they may end up auditing the results of their own advice, perhaps run­ning the risk of not being appointed to audit the company the following year.^[224]

2. Similar difficulties can arise in respect of take-overs. Some firms of accoun­tants have a very large client base which means that they are frequently acting for two separate companies whose interests conflict—for example, a bidder and a target.

3. Difficulties also occur where a firm is advising two competing companies on the same business proposition. For example, advice may be given to two companies on a tender which is based on each client’s ‘bottom line’, that is, the minimum sum the client would require in order to do the work. The firm has information from one client that must not be revealed to the other client.

Despite these obvious difficulties, and in stark contrast to the Law Society, the ICAEW allows its members to ‘manage’ conflicts of interest. The head of ethics and legal services for ICAEW told me:

The European accountancy bodies have a somewhat more ‘sophisticated’ approach to issues of independence and objectivity than their legal equivalents.

He explained the need for this as follows:

The relationship between an accountant and his/her client is likely to be continuing rather than assignment-based.

The current manifestation of this ‘sophistication’ is the ‘framework approach’ which is found in the Guide to Professional Ethics issued by the ICAEW. Conflicts of interest are covered in statement 1.204 of the ICAEW Guide. Two types of conflict are identified in the introductory note—conflicts which arise because the interests of the accountancy firm may conflict with those of its clients, and conflicts which arise because the interests of one or more clients con­flict with those of other clients.

The ICAEW addresses conflicts in a similar manner to that of the Law Society, namely from a relationship standpoint—considering first the accoun­tant’s personal relationship with clients, and secondly the clients’ relationships with one another.^[225] However, issues relating to the possession of confidential

The Modern Fiduciary: Conflicts in Other Professions 65 information are not viewed in terms of relationship. The head of ethics and legal services for ICAEW told me:

Situations frequently arise which are perceived by the clients to be a conflict of inter­est but which, in reality, are no more than concerns about confidentiality of informa­tion which is a separate issue.

In other words, what would be regarded by solicitors as a commercial conflict (knowledge received from one client which would be of interest to another client) is not considered to be a conflict of interest by the accountancy profes­sion.^[226]

On this view, although such information should not be disclosed except with consent, the mere possession of it by a firm does not preclude that firm from act­ing for another party to whom such knowledge may be relevant.^[227] This imme­diately distinguishes the accountancy profession’s way of handling conflicts from that of the Law Society.

Firms are instructed to set up procedures for the identification of potential conflicts so that precautionary measures may be taken:

Firms should have in place procedures to enable them to identify whether any conflicts exist and to take all reasonable steps to determine whether any conflicts are likely to arise in regard to new assignments and to existing clients. Firms should consider recording the safeguards adopted to address any conflicts which have been identified.

Section B of statement 1.204 addresses what should be done when conflicts of interest do arise:

1.0 A self-interest threat will arise or be seen to arise where the interests of two or more clients are in conflict.

1.1. There is, however, nothing improper in a firm having two clients whose interests are in conflict with each other.

1.2. In such a case the activities of the firm should be so managed as to avoid the work of the firm on behalf of one client adversely affecting that on behalf of the another.

1.3. Where a firm believes that the situation may be managed, sufficient disclosure (see paragraph 4.6 below) should be made to the clients or potential clients con­cerned, together with details of any proposed safeguards to preserve confiden­tiality and manage conflict.

Provided, therefore, that the firm believes that it can manage the conflict with­out detriment to either client, and provided safeguards are in place, it may con­tinue to act for both parties.

According to rule 4.4, such safeguards should include the following:

(a) the use of different partners and teams of staff for different engagements, each having separate internal reporting lines;

(b) standing instructions and all other steps necessary to prevent the transfer of confidential information between different teams and sections within the firm;

(c) regular review of the situation by a senior partner or compliance partner not personally involved with either client;

(d) advising all the relevant clients that, in the particular circumstances, they may wish to seek alternative independent advice; and

(e) obtaining informed consent to act from all the clients concerned.

These safeguards are similar to those identified by the House of Lords in Bolkiah v KPMG.^[228] They differ, however, in one important respect. There appears to be nothing to prevent a firm from creating a Chinese wall ad hoc. This is despite the fact that Lord Millett, at least by implication, suggested that accountants do not ordinarily create walls ad hoc:

It is one thing, for example, to separate the insolvency, audit, taxation and forensic departments from one another and erect Chinese Walls between them. Such depart­ments often work from different offices and there may be relatively little movement of personnel between them.^[229]

In addition, Lord Millett appeared to accept KPMG’s claim that the devices used were indeed secure:

K.P.M.G. insist that, like other large firms of accountants, they are accustomed to maintaining client confidentiality not just within the firm but also within a particular team. They stress that it is common for a large firm of accountants to provide a com­prehensive range of professional services including audit, corporate finance advice, corporate tax advice and management consultancy to clients with competing com­mercial interests. Such firms are very experienced in the erection and operation of information barriers to protect the confidential information of each client, and staff are constantly instructed in the importance of respecting client confidentiality. This is, K.P.M.G. assert, part of the professional culture in which staff work and becomes sec­ond nature to them.^[230]

So it would appear that, in general, Chinese walls erected by an accountancy firm will comply with the provisions set out by the House of Lords. In that case the facts of Bolkiah v KMPG were perhaps unusual as they related to a relatively new area of accountancy, namely forensic work. Such work is akin to the work undertaken by solicitors, and in respect of that kind of practice the Law Lords concluded that it was difficult to erect a secure wall within one department.^[231]

Several observations can be made in respect of accountants’ use of Chinese walls.

Any decision on the part of a sole practitioner should take account of the fact that the safeguards at (a) to (c) of paragraph 4.4 above will not be available to him or her. Similar considerations could apply to a small firm where the number of partners is insufficient to spread the work as indicated in 4.4 (a) and (b) above.

Secondly, no account appears to be taken of the argument advanced in respect of solicitors, namely that where there is a partnership, ‘partners are obliged to disclose any knowledge relevant to [a client’s] affairs that may be possessed by any of its partners or staff.’^[232] On the contrary, it would appear that accountancy firms (and the profession generally) take for granted the viability of Chinese walls.

Yet, how secure are such walls and would it ever be possible to allow law firms to operate such a system? This issue is topical given that accountants have made no secret of their desire to move into the legal market^[233] and to set up multi-disciplinary partnerships.^[234] What truth is there in the claim that ‘if an accountant or auditor were required to disengage whenever there was a theo­retical or perceived threat to objectivity, the client and/or its shareholders could be substantially disadvantaged’?^[235] Should this consideration override the risk that a client’s interest might be damaged through the passage of confidential information? If these arguments are accepted, does it mean that the Law Society should likewise devote its energies to managing (rather than prohibiting) con­flicts?

There is some ground for caution.

Lawyers have higher ethical standards... The two professions have different cul­tures—they are important and valuable and should not be merged.^[237]

Of particular interest were the concerns raised about an increased likelihood of conflicts of interest:

Accountants are already riddled with conflict of interest situations... Chinese walls don’t work. I wouldn’t want an accounting firm even to know we had instructed their legal practice. It creates nervousness on the other side if the same accountants do work for them... Already, finance/consultancy arms of the big accounting firms are shar­ing client confidential data among associated parts of the same firm without clients’ knowledge and consent. This is not acceptable.^[238]

Other clients seemed satisfied that accountants were able to ‘manage’ conflicts of interest by means of Chinese walls. One FTSE 100 client stated:

Our view on the conflict issue is perfectly illustrated by the fact that we were and still are clients of Dundas & Wilson. Their merger has not made the slightest difference. Some might see a conflict. But I would be perplexed at how they arrived at such a deci­sion. The quality of the service does not change. In fact, it gets better, because they have the whole of the Andersen database to tap into. Therefore, for the same fee, we get better value. Even if we were audited by Andersen, or bought some other service such as IT, tax or management consultancy, there would still be Chinese walls in place. The fact is the goalposts are constantly shifting on what constitutes a conflict as all these service firms—which means lawyers, accountants, consultants and so on— get more and more global... The world is getting smaller and we have to live with all the professional firms getting larger.^[239]

Another FTSE client has observed:

There are always upsides and downsides when you look at potential conflicts... But you have to weigh up whether there is more risk in instructing a new firm that does not know your business, or whether the conflict issues can be resolved by using Chinese walls. We would only sack the other firm if there was a true risk of share­holders losing out—and this would be rare.^[240]

The viability of a Chinese wall as a means of preventing the flow of information within a firm, be it within the accountancy or legal profession, is a matter which will be considered in greater depth below.^[241] For now, all that can be said is that the accountancy profession believes that there is nothing improper in ‘manag­ing’ conflicts. Whether solicitors should or could follow this approach is also considered below. First, it is important to establish whether it is in fact legally possible, through regulation, to amend the duties which a fiduciary owes to his client.

FIDUCIARY DUTIES AND REGULATORY RULES: THE LAW COMMISSION’S FINDINGS

In 1990 the Law Commission was charged with the following task:

Certain professional and business activities are subject to public law regulation by statutory and self-regulatory control. The Law Commission is to consider the effect of such controls on the fiduciary and analogous duties of those carrying on such activi­ties, and to make recommendations.^[242]

As mentioned above, the report focused on:^[243]

i) contractual techniques for avoiding potential breaches of duty;

ii) structural techniques for managing conflicts;

iii) the public law dimension, that is how far a regulatory system can be taken to have modified the common law and equitable duties owed by fiduciaries.

1. Contractual Techniques

The first question of interest to the Commission was whether fiduciaries could amend the duties owed to their clients under the general law by means of either express or implied contractual provisions. It undertook an extensive review of the cases of Kelly v Cooper^[244] and Clark Boyce v Mouat^[245] and concluded that both decisions had gone a long way to clarifying the law on this matter. The Commission found that fiduciary duties could be modified by the express or implied terms of a particular contract.^[246] In certain circumstances, where the contract was silent on the matter, terms could be implied into the agreement if trade custom could be regarded as reasonably modifying obligations and pro­viding adequate protection for the client’s interests.^[247] An express provision in the contract would cover circumstances where retainers stated that, although the firm was under a fiduciary duty to pass on all relevant information to a client, there might be circumstances in which confidential information would be held within the firm and not passed on to the client. Implied provisions, on the other hand, would cover professions (such as estate agents) where it is common trade practice to act for clients with conflicting interests in different transac­tions. For example, if the agent were to act for client A and client B in the sale of their similar properties on the same road, as is common, the agent would not be required specifically to state that this situation might arise when entering into the contract to sell the properties.

The Commission added, however, that there were limits to the circumstances in which the court would imply terms into the contract. The first was where the firm had acted for two customers in the same transaction (for example, being employed by a party to find a specific type of property and valuing that property without informing the seller of the other client’s interest). Secondly, where the conflict was between a firm’s own interest and its duty to a customer (for exam­ple, if the property being sold was adjoining a property owned by the estate agent). Thirdly, where there had been ‘iniquity’ or ‘malpractice’ (for example, if a financial adviser deliberately advised a customer to purchase stocks, despite having confidential information that the stock was going to fall in price). Beyond these situations, contractual provisions—express or implied—would depend on the court’s interpretation of the facts of the case.

2. Structural Techniques

The structural device considered by the Law Commission was that of the Chinese wall. Several doubts were raised about its efficacy.^[248] The Commission was of the view that unless appropriate provision was made in the contract between a firm and a client, a Chinese wall could not be relied on in all cases as a means of managing conflicts of interest. The Commission also expressed doubts about the effectiveness of Chinese walls as a means of managing con­flicts, but concluded that ‘they were essential if the [financial services] industry is to operate in its present form with multi-functional investment houses per­forming a wide range of services.’^[249] Therefore, it was felt necessary to

remove any doubts... about the legal efficacy of the practice of withholding informa­tion by means of a Chinese wall which complies with the regulatory requirements as a method of managing conflicts of interest and duty.^[250]

Legislation was recommended, the effect of which would be that if a firm oper­ated a Chinese wall which complied with relevant regulatory requirements, it would not be regarded as being in breach of duty in circumstances where:

i) it withholds information from a customer pursuant to the Chinese wall arrangement; or

ii) it places itself in a position where its own interest in one department con­flicts with a duty owed to a customer of a different department and as a result neither department is aware of the conflict; or

iii) it owes conflicting duties to the customers of different departments on either side of the wall, but as a result of the wall neither department is aware of the potential conflict.^[251]

A Chinese wall would comply with regulatory requirements provided:

—there was physical separation of the various departments in order to isolate them from each other, often extending to such matters of detail as dining arrangements;

—there were on-going educational programmes for staff;

—there were strict and carefully-defined procedures for crossing walls and the maintenance of proper records where this occurs;

—compliance officers monitored the effectiveness of the wall;

—disciplinary sanctions were available where there had been a breach of the wall.^[252]

The Commission emphasised that such walls would have to be established arrangements within firms rather than created ad hoc. It would seem this requirement, in particular, may inhibit law firms from ever successfully relying on such a device. The organisation and structure of solicitors’ practices are such that lawyers usually work in teams rather than in separate departments. In addi­tion, clients often require legal advice that crosses departmental boundaries. In a corporate transaction, for example where one company is buying another company, almost every department in the firm may be called upon to give advice.^[253] Perhaps, therefore, the only way in which law firms would be able to satisfy the need for established walls would be when they had separate regional offices which routinely acted independently of one another.

It is as well to bear in mind that although the Commission’s findings were said to apply to all publicly-regulated bodies, their focus was on the financial services industry. There has for some time been a widely-held perception that financial institutions must, as a matter of practical necessity, act in conflict situations. Professor Gower states:

Conflicts are, inevitably, endemic among those providing financial services and are aggravated by the increasing tendency for a wide range of such services to be provided by a single firm or group.^[254]

It may be argued that the same is true of solicitors’ firms, but as no empirical evi­dence existed as to the effect of conflicts on law firms, the Commission was unable to give equal consideration to the legal environment.

3. The Public Law Dimension

The Law Commission also considered whether there should be legislation to provide that the courts should take account of reasonable regulatory rules in ascertaining the precise content of the common law and equitable obligations. The Commission was of the opinion that courts should take account of the reg­ulatory regime. It indicated that the cases of Kelly and Clark Boyce went a long way towards avoiding problems which might arise through a mismatch between fiduciary duties and regulatory rules.^[255] This was because it appeared that con­tractual provisions could allow firms and clients to waive such rules. Although Kelly was not seen by the Commission as the complete answer to any mismatch between fiduciary duties and regulatory rules,^[256] it believed that a court, when faced with such a mismatch, would probably take account of the rules in deter­mining the content of the fiduciary duty.^[257] No legislation was recommended on this point.