30 July 2021 Open with your browser  

How to prevent from mishandling of conflicts of interest

Written by: Mr. Stanley Cheng – Risk Consultant

Conflicts of interest are inevitable in the modern corporate landscape. How the management of the businesses manage the issues related to conflicts of interest will have a material impact on the credibility and longevity of the organization. An improper handling of connected transactions may lead to conflicts of interest and cause serious problems. Besides, the misconduct of the directors may result in breaches of the applicable anti-bribery and corruption laws. The penalties include fines, disgorgement of profits, and even imprisonment. Any actual or perceived violations of the regulatory regime may result in an irreversible reputational damage to the business.

The following is a case study concerning the mishandling of conflicts of interest. It is included in a statement of disciplinary action issued by The Stock Exchange of Hong Kong Limited (“HKEX”) on 30 March 2021.

Summary of facts
In 2018, China Yu Tian Holdings Limited (“Yu Tian”) and its subsidiary granted two loans (the “Loans”) up to US$3,000,000 and RMB7,500,000 respectively to parties connected to Ms. Wang Xue Mei and Mr. Wang Jin Dong, who were the two executive directors of the Company at the time. Despite their conflicts of interest, Ms. Wang and Mr. Wang took an active role in the proposal, approval, and execution of the Loans. The Loans constituted connected transactions, but Yu Tian failed to publish an announcement or seek approval from independent shareholders under the requirement of GEM Listing Rules.

Existing requirements under the GEM Listing Rule (“GLR”)
GLR 20.33 and 20.34 require the issuer respectively, to announce the connected transaction as soon as practicable after its terms have been agreed, and to obtain independent shareholders’ approval.

According to GLR 5.01, the board of directors is collectively responsible for the company’s management and operations. HKEX expects the directors, both collectively and individually, to fulfill fiduciary duties and duties of skill, care and diligence to a standard at least commensurate with the standard established by Hong Kong law. These duties include avoiding actual and potential conflicts of interest and duty (GLR 5.01(4)), disclosing fully and fairly their interests in contracts with the issuer (GLR 5.01(5)), and applying such degree of skill, care and diligence as may reasonably be expected of a person of his/her knowledge and experience and holding his/her office within the issuer (GLR 5.01(6)).

The GEM Listing Committee decided to censure Yu Tian, Mr. Wang, and Ms. Wang for their breaches of the GLR requirement.

Regulatory concern
HKEX provided that directors are accountable to the issuer and its shareholders for their conduct. They have an obligation, among others, to avoid any potential or actual conflicts of interest, and to procure the issuer’s compliance of the issuer with the GLR. In respect of connected transactions, this involves, in this case, procuring the Company to publish an announcement and to obtain independent shareholders’ approval.

Five practical measures for businesses to manage conflicts of interest
Base on the above case study, it is revealed that the management’s improper handling of conflicts of interest could bring serious consequences. The Hong Kong Institute of Chartered Secretaries (“HKICS”) issued an Ethics, Bribery, and Corruption Guidance Note in April 2021, which suggests the following five practical measures for organizations to manage conflicts of interest.

1. Ensure transparency
When it comes to conflicts of interest, transparency is fundamental. Individuals who are at risk of falling into a situation of conflict of interest, even if they consider that their impartiality will not be compromised, they should also disclose any possible conflicts of interest to prevent any possible doubts on their integrity when the conflict is exposed.

Taking a proactive approach in disclosing any possible conflicts of interest could help the organizations to prevent any unscrupulous staff taking advantage of the lack of information by the others for a corrupt purpose. In addition, it also helps organizations avoid unnecessary allegations due to lack of understanding.

2. Formulate a policy on conflicts of interest
Establishing a clear company policy on dealing with conflicts of interest is crucial for organizations. All staff members should identify and avoid any situations of conflicts of interest and declare all relevant interests which may conflict with their official duties, especially for company directors, who are required to declare the nature and extent of their interest to the board if they have a material interest directly or indirectly in a transaction, arrangement or contract or proposed transaction, arrangement or contract with the company which is of significance to the company’s business under Companies Ordinance. HKICS suggests that the policy should cover the following areas to mitigate the common risks of conflicts of interest:

? ethical values and beliefs of the organization
? policies on acceptance of advantages
? guidelines on the handling of conflicts of interest
? regulations on using proprietary information
? procedures for applying for outside employment
? policies on maintaining complete and accurate records and accounts
? rules on preventing the misuse of organization assets, and
? channels of complaint.

Besides, the management of the organizations should consider the actual situation of any potential conflicts of interest and possible public perceptions. The following appropriate measures should be considered to reduce risk exposure:

? restricting the relevant director/staff member’s involvement in the task;
? appointing an independent party to supervise the work; and
? redeploying another director/staff member to take up the task.

Any declared conflicts of interest and related decisions with justifications should also be properly recorded even if the risk is slight and no mitigating action is considered necessary.

3. Set up a system of internal controls
A well-designed internal control system can prevent and detect abuse, malpractices, corruption, and fraud in relation to conflicts of interest. Although there is no “one size fits all” approach, the following are key principles for establishing a sound internal control system:

? identify situations or scenarios where may be conflicts of interest or other risk areas (for example corruption or fraud) and implement controls to minimize the risks
? establish clear procedures and guidelines
? clarify duties and responsibilities for different levels of staff
? establish proper segregation of duties among staff
? incorporate checks and balances in record keeping
? detect warning signals of abuse, malpractices, and corruption
? protect sensitive information from leakage, and
? conduct regular reviews of systems and procedures.

4. Conduct ethics training
Organizations should provide regular training to staff at different levels to familiarize them with the requirement of an organization on managing conflicts of interest with different focuses. All levels of staff should focus on the legal requirements and the organization’s code of conduct; skills in handling conflicts of interest and ethical dilemmas. Senior staff and directors should focus on supervisory accountability, managing staff integrity and directors’ ethics.

5. Introduce a whistle-blowing mechanism
An effective whistle-blowing policy allows internal stakeholders (such as employees and directors) and external stakeholders (such as business counterparts and suppliers) to raise concerns in confidence. This will enable organizations to detect and remedy improper or misconduct behaviors early before causing serious damage. Effective whistle-blowing policies and procedures should cover:

? a corporate policy statement committing to high probity standards
? a pledge to handle the reports promptly, fairly and in strict confidence
? the scope of the concerns that require reporting
? a clear description of the responsibilities of relevant personnel
? the provision of reporting channels
? an assurance of protection to bonafide whistleblowers against retaliation, and
? effective communication and periodic review of the policies and procedures to ensure continuous effectiveness.

1. Exchange’s Disciplinary Action against China Yu Tian Holdings Limited (Delisted, Previous Stock Code: 8230) and seven directors (hkex.com.hk)

2. Statement of Disciplinary Action

3. HKICS Ethics, Bribery and Corruption Guidance Note (Seventh Issue) 

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