Interest conflicts must be clearly identified and properly managed

BARON FURSTENBURG, head of pension reform strategy at LIBERTY LIFE, shows what’s to be done.

Many trustees might still be wondering why there is such a fuss about conflicts of interest. Those following the financial press and attending conferences, such as the Institute of Retirement Funds conference earlier this year, would have heard a lot of noise about the subject.

It seems natural to start with the fundamental question: What is a conflict of interest? It can be defined as “a situation in which a person has a private or personal interest sufficient to appear to influence the objective exercise of his or her official duties as, say, a public official, an employee, or a professional”.¹

Of course, there are many possible definitions. The key part of this definition is the word “objective”. It conveys the sense that people with ascribed duties, such as trustees, must be objective in the exercise of their powers and fulfillment of their obligations to their fund and members. They cannot be tainted in the execution of their duties by their own personal interests, or any other interests, outside of what is best for the fund and its members.

Interesting is another take on the issue from the medical field: “A person has a conflict of interest when the person is in a position of trust which requires her to exercise judgment on behalf of others . . . and also has interests or obligations of the sort that might interfere with the exercise of her judgment, and which the person is morally required to either avoid or openly acknowledge.”²

Conflicts of interests therefore have the potential to distort objective decision making. It means that you as trustee must be able to recognise when conflicts exist so that you can avoid them. Sometimes this might require harsh steps, such as withdrawing from a trustee meeting on a particular issue; at other times, you will have to manage the conflict as best as possible by disclosing it to the board and discussing with your colleagues the most prudent course of action.

Circular PF 130, issued by the Financial Services Board (FSB) in June last year, was one of the first steps by any regulator to broach the subject of conflicts of interest in the pensions arena. The circular was more about good governance of retirement funds in general. It provides an excellent high-level overview of the focus areas to which trustees should apply their minds.

Trustees should by this time already be conversant with the FSB’s views expressed in the circular on structural conflicts of interest, requirements for trustees to adhere to a documented code of conduct and for them to respect the confidentiality of the fund and its members.

What’s new in this space, if we look internationally, is the latest guidance released by the Pensions Regulator in the UK on conflicts of interest. In fact, our FSB’s circular PF130 planted the seed for the UK regulator to take a look at the issue in its own country context.³

Because of the parallels between the trustee-based pension systems of the UK and SA, a survey by PricewaterhouseCoopers has identified some interesting things SA trustees can think about in their own fund context.⁴ This is useful not only because it is pensions best practice but also because conflicts of interests will increasingly be addressed by SA policymakers and regulators as we go through the pension reform process.

When reading the guidance, however, two specific aspects about the UK pensions system should be borne in mind:

• There are over 100 000 schemes, so the pensions regulator pragmatically places a great deal of reliance on “self-regulation” with significant powers to intervene in the management of the fund and powers to impose stiff penalties;
• The UK scheme landscape still, in terms of membership numbers, has a majority of defined benefit (DB) schemes. This means that, although regulation takes into account both DB and defined-contribution (DC) dynamics, its focus is more on DB relationships since at present greater system risk lies there.

These issues aside, what does the UK guidance actually say? Well, there’s not much on blatant conflicts (“corruption” rather?) with regard to

trustees receiving kickbacks, retainers for asset-management business, tickets to major sports events and the like. Though we anecdotally hear such stories in the SA context from time to time, the UK focus on conflicts seems more civilised and restrained, much like high tea on the croquet front lawn.

The UK regulator, like the FSB, acknowledges that there is no-one-size-fits-all or fixed rules when it comes to managing conflicts of interest. Requirements to manage conflicts adequately will differ according to the size of the fund, whether it is self-administered or not, whether it is DB or DC, whether it uses the services of a “one-stop shop” etc.

The UK guidance nevertheless lays out five broad principles for sound conflict management:⁵

• Understand the importance of conflicts of interest: Trustees must have a clear understanding of the circumstances under which they may find themselves in a position of conflict of interest, and the ramifications this could have for decision making (and possible challenge to decisions). Trustees are expected to act impartially, fairly, and prudently. Ignoring conflicts of interests surely cannot be in the best interest of members.
• Identify potential and real conflicts: Both types of conflicts of interest should be identified and disclosed. This should go hand-in-hand with a register of trustees’ financial interests and their appointments to any other boards and committees.
• Evaluate, manage and avoid conflicts: Mere declaration of a conflict is not the same thing as managing it. At times, withdrawal or the appointment of an independent trustee may be preferable, but this cannot be a hard-and-fast rule. What is important is proper evaluation and management of these issues by the trustee board, indicating that it has properly applied its mind.
• Manage adviser conflicts: Advisers to a fund must be able to give independent advice. Any conflict on their part should be declared by them (and preferably not only after prompting by the trustee board). The trustees must then decide if any action in is warranted, or whether possibly another opinion on a specific matter should be canvassed; and lastly
• There should be periodic documenting and review of the conflict of interest policies and procedures. This would create a record of the discussions and decisions of the board with regard to possible conflicts and what was done to address them.

Only 15% of the SA funds in the PwC survey had a formal policy in place to identify conflicts of interest. As alarming, 75% of the funds with assets under R500m each had not considered a process for managing conflicts of interest.

Given the scandals emerging from time to time, most of which centre around governance, boards of trustees need not wait for the regulator to require such a policy of them.

Baron started his career in the pension fund consulting and investment banking industries measuring and monitoring market risk on the trading floor. He then joined National Treasury in 2003, where his role spanned policymaking on pensions reform, market conduct, long-term insurance and amendments to financial sector legislation in these specific areas. He has worked closely with the Financial Services Board for a number of years and been integrally involved in the pension reform process since the release of the first discussion document by Treasury in 2004. Baron recently joined Liberty Life as Head of Pension Reform Strategy. For 10 years, Baron has also lectured adult learners in mathematical economics, statistics and econometrics for a non-profit organisation that seeks to equip senior people in key positions through education and transformation. He holds a B.Com (Hons) and M.Com in economics from WITS University, and an MSc in finance from the University of London.