Exercise Care in Conflicts

“Wait: Isn’t that a conflict of interest?!”

These words can strike fear into the heart of every board member—and especially on private company boards where they are likely to occur. But are conflicts of interest inherently “bad” or “wrong”? The answer is “no” as long as they are disclosed, managed, and do not afford a single board member an advantage not shared by the rest of the board. How does this work? How are conflicts of interest reported and, once recognized, how are they managed?

These questions are posed frequently in my work as a consultant with NACD’s Board Advisory Services practice. They are especially relevant when a board is composed of members who come from designated “buckets” or specific industry categories. No board is without these issues.

The negative connotation of “conflict of interest” stems from the early days of not-for-profit entities where board members were often sought primarily for their financial contribution. Often the quid pro quo of the contribution was an understanding that the board member’s company or firm would then be given preferential treatment in the choice of a partner going forward. In other words, if a prominent lawyer was solicited to join a board and this lawyer gave a sizable donation, it was “understood” that the entity’s legal work might gravitate to that firm. Even under non-profit regulations promulgated by the Internal Revenue Service, this apparent conflict would be acceptable if the firm charged its regular rates (or less than the regular rates) and no “excess benefit transaction” occurred.

In any context—whether a private, public, or non-profit entity and in a nonprofit context as well as the corporate context—great care should be taken in giving the appearance of impropriety.

For public companies, conflicts of interest are required to be reported in the company’s filings as a “related-party transaction.” The rules here are black and white, but here (as well as with private companies), “disclosure is the disinfectant that cures the wound.”

But how and when are conflicts of interest disclosed...and to whom?

The first step in managing conflicts of interest is to create a conflict of interest policy with an accompanying statement to be filled out annually (or when a new board member joins or when a conflict first occurs).

The Policy specifies what should be disclosed, when, and to whom. It often specifies what happens if a conflict is discovered but not reported by the person with whom the conflict exists. Conflicts are then accumulated by the recipient—usually the audit committee chair—and consolidated into an annual letter which is sent to the full board, outside independent auditors, and filed into the company records. 

Here’s an example of a disclosure that was reported in a recent conflict of interest statement and then included in the letter to the board and auditors:

“Regarding potential conflicts, I am a senior principal and partner at the Hapsburg Cos. Hapsburg provides services from time to time to the company. I receive no extra remuneration for such services and do not benefit personally from the relationship. I am not part of the decision-making process on either side of the transaction and have no influence as to whether or not Hapsburg is used for a given project.”

The protocol for excusing a board member with a potential or determined conflict during the vote on a matter is as follows: The board member should be invited to state his or her point of view if desired and relevant. Once this is done, the board member should recuse him or herself from the room, both for the discussion on the matter and the vote. When the vote is complete, the board member should be invited to return to the meeting.”

Conflicts of interest are not in and of themselves “bad.” They simply need to be handled correctly through the disclosures and protocols outlined above. Examples of conflict-of-interest policies and relevant provisions of governance guidelines relating to voting procedures may be found online in the NACD Resource Center.

D’Anne Hurd serves on and advises boards of public, private, and family-owned companies in a variety of industries. She also serves as an independent mutual fund trustee. Hurd is an audit committee financial expert and an authority on environmental, social, and governance issues and currently serves on the boards of Pax World Funds, EILEEN FISHER, Peckham Industries, Inc., and Martin Engineering, Inc. She is a member of NACD’s Board Advisory Services’ faculty and a frequent speaker at NACD events.