What are conflicts of interest?

At their core, conflicts of interest are about integrity. ‘Conflict of interest‘ arise in situations where employees or third party legal entities such as vendors or business partners (including employees of those third parties) could be influenced, or where it could be perceived that they are influenced, by a ‘personal’ interest in carrying out their duty (Commonwealth Ombudsman 2017).

In this sense, ‘personal’ interest refers to perceived or actual benefits being derived, ranging from money to relationships or reputation. There are three forms of conflicts of interest (Commonwealth Ombudsman 2017):

• Actual conflict – where a direct conflict arises between an individual or entity’s personal interest and their fiduciary duties
• Perceived conflict – situations where others might perceive a conflict (even if an actual conflict does not exist)
• Potential conflict – situations which in the future could give rise to an actual or perceived conflict of interest but have not yet happened

Are conflicts of interest fraud?

Conflicts of interest are considered one of four ‘corruption schemes‘ by the Association of Certified Fraud Examiners (ACFE), the other three being bribery, illegal gratuities, and economic extortion. However, unlike some types of fraud, an actual conflict of interest only becomes fraudulent if it is not declared.

Declaring a conflict of interest (whether actual, perceived or potential) provides an opportunity for it to be managed, which could include the conflicted party recusing themselves from the conflicting situation or decision, or declaring this conflict to peers (such as where a board member is conflicted through multiple interests).

---

---

How do conflicts of interest arise?

Conflicts of interest arise can either intentionally or unintentionally (Commonwealth Ombudsman 2017) :

• Intentional conflicts occur where an individual or legal entity knowingly puts itself in a conflicting situation. This could arise where a potential conflict is entered into with the full knowledge of all affected parties (and appropriately managed), or where the party gaining a personal benefit attempts to conceal the conflict (fraud)
• Unintentional conflicts arise from poor management or awareness by affected parties, such as where employees do not recieve conflicts of interest awareness training, employers do not have conflicts of interest policies or require attestations.

Declarations – a key part of conflicts management

Conflicts of interest are all about transparency, or the lack thereof. Declarations are a key component of managing conflicts. Irrespective of whether an employee, contractor, supplier or potential business associate, businesses need to understand what (if any) potential conflicts they may have and work through a process to evaluate them.

Typically, the easiest way of managing conflicts of interest is avoiding them, but this is not always possible. Where a conflict does or may arise, it must be evaluated – sometimes this process can be quite onerous.

The U.S. National Academies of Sciences (NAS) notes that “conflicts are not binary (present or absent)”, and that they “can be more or less severe”. The NAS identifies two factors to assist decision makers when evaluating a conflict of interest declaration, being (a) the likelihood of undue influence by the secondary interest, and (b) the seriousness of the outcome. The NAS presents this useful rubric for assessing confict of interests:

Likelihood of undue interest	Severity of potential harm
What is the value of the secondary interest?	What is the value of the primary interest?
What is the scope of the relationship?	What is the scope of the consequences?
What is the extent of discretion?	What is the extent of accountability?

Depending on severity or perceived harm, treating a conflict of interest may require removing the conflicted individual / entity from the decision making process, or in other cases severing the business relationship entirely. Exactly how you need to manage a conflict depends on the situation (noting that in some cases there may be applicable legislation which will also govern this).

Good practice requires organisations to collect information on conflicted individuals or entities regularly – there is no set timeframe for this, but an annual declaration coupled with voluntary event-based disclosures by the affected party if they arise, makes sense for most organisations. Any more frequent and the program can be difficult to manage, whilst a longer gap between declarations can give employees the impression that conflicts aren’t important, as well as meaning the organisation is working on out of date information.

Once conflicts are identified and confirmed, managers of those employees or affected contracts (e.g. vendor managers) must be made aware of the conflict and charged with managing the risk in accordance with the organisation’s agreed treatment plan.

The challenge of detecting undeclared conflicts

Managing declared conflicts can be challenging enough for large organisations, however detecting them is something different altogether. Without a properly structured approach it is possible to spend a lot of time, effort and money without identifying anything conclusive.

In the absence of an allegation, such as a tip-off from a whistleblower or competing vendor, organisations seeking to be proactive in detecting potential undeclared conflicts should focus their resources on the business units, processes, people or vendors of highest risk. The ACFE identifies three main types of conflict of interest scheme (Wells, 2007):

• Purchasing Schemes – where a conflicted party manipulates the victim’s purchasing process to the benefit of the entity to which they are conflicted
• Sales Schemes – where the conflicted party negotiates discounts or processes write-offs to benefit the entity to which they are conflicted
• Other schemes – where the conflicted party diverts funds, clients / sales leads, and / or resources such as equipment from their employer to the entity to which they are conflicted for the conflicted entity’s benefit

Each of these categories of scheme is comprised of a number of typologies (perhaps best thought of as variations), some of which are more easily detected than others.

As you can see, conflicts of interest schemes can arise amongst employees in sourcing and procurement or sales and marketing roles; however, this is not exclusively the case. Conflicts of interest are generally quite complex to both detect and investigate. Typical methods of detecting conflicts include fraud data analytics (fraud detection) and investigative techniques including (Wells, 2007):

• Supplier vetting or due diligence (and comparison of ownership data with employee and contractor names and other indicators, such as phone numbers)
• Matching of supplier / vendor and employee identifiers (eg.g. Address, phone number data)
• Identification of employees who are take up employment with a vendor after termination
• Tipoffs and complaints, including from other disaffected vendors who are losing work as a result of the corruption scheme as well as employees who notice inconsistencies or favouritism

A well designed integrity program, inclusive of appropriate internal controls in key areas (such as purchasing), awareness programs and annual attestations can help mitigate the risk of these insider threats. Perhaps most importantly though, these same practices must extend to third parties, whether a vendor, business partner or other classification. A third party’s employees or contractors in positions which place the contracting entity at risk must be managed and monitored closely, sometimes with even more scrutiny than may be applied to the contracting entities staff – this decision is dependent on where the risk lies, and the inherent and residual rating of that risk.

Further reading

• ACFE (2022). ACFE Fraud Tree in Fraud 101: What is Fraud?, www.acfe.com
• Commonwealth Ombudsman (2017). Conflict of Interest Guidelines, September 2017, Australian Government.
• National Academies Press (2009). Chapter 2 Principles for Identifying and Assessing Conflicts of Interest in Conflicts of Interest in Medical Research, Education and Practice, Institute of Medicine (US) Committee on Conflict of Interest in Medical Research, Education and Practice, Washington D.C. https://www.ncbi.nlm.nih.gov/books/NBK22937/
• Wells, J. T. (2007). Corporate fraud handbook: Prevention and detection. Hoboken: John Wiley & Sons.
• Vona, L. (2017). Fraud data analytics methodology: The fraud scenario approach to uncovering fraud in core business systems, Hoboken, New Jersey : John Wiley & Sons, Inc

DISCLAIMER: All information presented on ForewarnedBlog is intended for general information purposes only. The content of ForewarnedBlog should not be considered legal or any other form of advice or opinion on any specific facts or circumstances. Readers should consult their own advisers experts or lawyers on any specific questions they may have. Any reliance placed upon ForewarnedBlog is strictly at the reader’s own risk. The views expressed by the authors are entirely their own and do not represent the views of, nor are they endorsed by, their respective employers. Refer here for full disclaimer.