Conflicts of interest – policies and procedures
This is Part II of III of an article series on Identifying and Managing Conflicts of Interest in Regulated Entities.
Click here to read Part I on the significance of identifying and managing conflicts of interest in regulated entities.
1. The procedure for dealing with conflicts of interest
The Companies Act sets out the procedure for addressing transactional conflicts of interest. The Companies Act requires a director who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company to declare the nature of his interest to the other directors either at the meeting of the directors at which the question of entering into the contract is first taken into consideration, or, if the director was not at the date of that meeting interested in the contract or proposed contract, at the next meeting of the directors held after he became so interested. Any director who fails to disclose their interest is liable to a penalty.
Directors have a fundamental duty to disclose or declare their interest(s). However, can the company choose to enter into the transaction even though a director is conflicted? And can the director vote on the matter? While the answer to the former question is in the affirmative, the answer to the second question depends on the company’s articles of association.
The model articles contained in Part I of the First Schedule to the Companies Act state that a director “shall not vote at a meeting of the directors in respect of any contract or arrangement in which he is interested, and if he shall do so his vote shall not be counted, nor shall he be counted in the quorum present at the meeting”. Essentially, the model articles provide that while the interested director can be present at the meeting in relation to any contract or arrangement in which he is interested, the interested director is prohibited from voting on the matter. This prohibition is very often included in the articles of association. Subscribers to the memorandum and articles of association are, however, free to allow a director to vote on the proposed or existing transaction.
The freedom to allow voting is not absolute. Specific legislation applicable to regulated entities apart from requiring directors to declare interests to other directors, obliges directors to refrain from voting on matters which the director is directly or indirectly interested in. In addition, specific legislation (in contrast to the Companies Act) explicitly provides that conflicted directors should avoid entering into discussions in relation to any contract or arrangement in which the director is interested and that the interested director should withdraw from the meeting while the matter in which the director has an interest is being discussed. The prohibition on engaging in a discussion and on being present during board meetings in which a contract or arrangement in which the director is interested are subject to the provisions of the company’s memorandum and articles of association.
The Code complements and buttresses the provisions of the Companies Act as well as the provisions of specific legislation. Similar to the Companies Act and to specific legislation, the Code requires directors to disclose conflicts of interest to the Board. However, unlike the Companies Act, directors are bound to disclose all conflicts and not only transactional conflicts. Similar to the model articles contained in Part I of the First Schedule to the Companies Act and to specific legislation, the Code requires conflicted directors to refrain from voting on the matter in which they are conflicted. Though, unlike the Companies Act, the Code obliges conflicted directors to refrain from participating in the discussion in which they have an interest. It should be noted that the Code’s provisions on conflicts of interest are subject to the company’s memorandum and articles of association and that the Code does not replace other laws, rules and regulation applicable to regulated entities under its remit.
2. Conflicts of interest policy
Regulated entities are required to establish, implement and maintain effective and proportional organisational and administrative arrangements to prevent conflicts of interests from adversely affecting inter alia the company and its clients. One example of an organisational and administrative arrangement which regulated entities (whether in terms of specific legislation or the Code) are required to implement is a conflicts of interest policy. An effective conflicts of interest policy should be set out in writing and should include at least the following:
- the identification of, with reference to the specific services carried out by or on behalf of the regulated entity, the circumstances which constitute or may give rise to a conflict of interest entailing a risk of damage to the interests of one or more clients; and
- procedures to be followed and measures to be adopted in order to manage such conflicts and to prevent such conflicts from damaging the interests of clients.
The company should assess and at least annually review the conflicts of interest policy. The company should then take all necessary measures to address any deficiencies. In tandem with establishing a conflicts of interest policy, regulated entities should keep and update a conflicts of interest register. The register should include a record of the situations or services carried out by or on behalf of the regulated entity in which a conflict of interest entailing a risk of damage to the interests of one or more clients has arisen or, in the case of an ongoing service, may arise.
Directors of regulated entities should strive to adhere to the conflict of interest requirements not only because breaches erode the principles of good faith, honesty and integrity but also because if directors breach the conflict of interest duty they could be liable in damages or could face criminal or administrative proceedings resulting in the payment of fines or at worse, custodial sentences. Since the MFSA considers good corporate governance to be a supervisory priority for 2022, a priority which is further reinforced with the recent publication of the Code, regulated entities should follow suit and keep the theme of conflicts of interest at the forefront of all activities. Abiding by the duty to avoid and prevent conflicts of interest maintains and enhances corporate governance standards which in turn will help to engender mutual trust between different stakeholders, enhance stakeholder value, protect investors and bolster the integrity and reputation of Malta’s financial sector.
Part III from this series will be released in the coming weeks.