What You Should Know About Conflict of Interest by Mark R

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What You Should Know About Conflict of Interest By Mark R. Simmons, CIA CFE

Employees, in performing official duties, are expected to act on behalf of and in the best interests of the organization that employs them. A conflict of interest arises for an employee, officer or director of an organization when that person acts, or appears to act, on behalf of someone other than the organization; and has, or appears to have, a self interest of which the organization is unaware and that is actually or potentially adverse to its best interests. If a conflict of interest results in economic or financial loss to the organization through fraud, waste or abuse, then administrative, civil or criminal remedies may be pursued, as circumstances or policy dictate.

What is Conflict of Interest?

Conflict of interest is generally thought of as any situation involving hidden "self-dealing", "related-party transactions", "non-arms length relationships", or "serving two masters" that results in gain to one party at the expense of another. A structured definition of the concept of conflict of interest is:

l the convergence between an individual's private interests/obligations/relationships and his or her professional obligations to the organization

l such that an independent observer might reasonably question the motive, actions and outcomes regarding decisions made or actions taken by the individual, as a director, officer or employee, and

l the individual, the individual's immediate family; or a third party or organization in which the individual or the individual's immediate family has a business interest or association, receives any "thing of value" as a result of decisions made or actions taken by the individual as a director, officer or employee of the organization.

What Are "Things of Value"?

"Things of value" include, but are not limited to: salaries or direct file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 2 of 8

commissions;finder fees; raises, bonuses, or promotion (other than those received as anemployee of the organization); receipt of automobiles, boats, or any gifts other than those of nominal value; receipt of paid vacations and trips; payment of credit card bills or of any other personal expenses; receipt of stocks, bonds, annuities or other investments; insurance policies paid for by a third party; an offer or promise of employment; realization of business profits or increased business value;realization of an unfair competitive advantage; or any other means of compensation or reward other than those provided by the organization to its directors, officers and employees.

Consider the following actual situation. John Doe held a policy/decision making position as an official of a government organization, and was also an employee of a service company seeking business with the organization. The service company that employed John Doe had business dealings pending before the policy/decision making body on which Mr. Doe sat. Mr. Doe had cast a deciding vote that resulted in the selection of the service company to perform work for the organization.

Mr. Doe created, at the very least, the appearance of a conflict of interest by participating in a decision making process that awarded business to the service company. Why? Because it is possible that John Doe acted in the best interest of the service company, or in self-interest, rather than in the best interests of the awarding organization. The possibility exists that in exchange for the favorable vote, the service company could reward Mr. Doe through promotion; year-end bonus; pay raises; gifts; gratuities and special benefits; special vacations; and any number of other benefits and rewards that would be hidden from the awarding organization.

The above scenario could involve coercion as well. Unknown to the awarding organization, Mr. Doe could be threatened with termination if he does not cast a favorable vote. Conversely, by threatening to withhold a vote of approval, John Doe could coerce special benefits and rewards from the service company for himself or others. In addition, the possibility exists that because John Doe voted favorably, the awarding organization might be deprived of obtaining the best value for the money being spent, to the financial advantage of Mr. Doe and the service company.

Conflict of interest can also exist and result in fraud when an organization has a hidden interest in, or derives a hidden benefit from, the outcome of an event or transaction. This more subtle type of conflict of interest could occur if officials of the organization, either alone or in conspiracy with providers of services, obtain public funds and use those funds for other than intended program purposes. In this instance, the organization has a hidden self-interest that is actually or potentially adverse to the interests of the government and the citizenry.

The following story (also true) is an example. An official of an organization directed the owner of a company doing business under contract to provide computer equipment and contractor staff that would be used to perform non- contract related work. When seeking payment for the extra work, the file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 3 of 8

contractor billed the hours for non-contract work as having been expended on contract related activity. The billing occurred with the knowledge of the organization official, who instructed lower level staff to approve the bill for payment. Because the contract was part of a federal program, the organization's chief fiscal officer in turn filed a claim for reimbursement with the federal government, which the federal government, in good faith, paid. This type of fraud, perpetrated against the federal government over many years by making false statements and filing false claims, resulted in almost $30,000,000 in fines and settlements in lieu of criminal prosecution of several organization officials and employees.

Is Conflict of Interest a Crime?

In the U.S., conflict of interest usually is not itself a crime unless the individual with the conflict is a government employee, or acts in collusion with a government employee. However, the conflicting interests of a director, officer or employee may result in fiscal or economic loss or loss of competitive advantage to the organization. Should this happen as the result of an intentional act of fraud or abuse, those involved could be prosecuted civilly or criminally for receiving a bribe, receiving a reward for official misconduct, receiving unlawful gratuities, coercive use of official position, or official misconduct.

Under U.S. Federal laws and regulations, organizations doing business with the federal government or who act as custodians or conduits of federal funds have an obligation and responsibility to manage, reduce or eliminate actual and potential conflicts of interest. Under civil law, directors, officers and employees owe a duty and loyalty to the organization and are expected to act at all times in the organization's best interest. However, when conflicting interests arise, the potential arises for directors, officers or employees to breach the duty and loyalty they owe.

A convergence of interests at times may be favorable to the interests of the organization, as long as they are disclosed and understood in the organization's decision-making process. However, when dual loyalties or interests exist, the possibility always exists that in carrying out official duties, individuals may act not in the best interest of the organization, but rather in self-interest or in the interest of others. This inherent risk of conflicting interests can result in favoritism toward, or unfair competitive advantage gained by, companies providing goods and services; and/or theft of services, material or equipment; and/or private gain to directors, officers or employees. When such events occur to the fiscal, economic or competitive disadvantage of the organization, the shadow of bribery, kickbacks, fraud and corruption arises. IN the U.S. these are felony crimes prosecutable under state laws as well as under Federal law. Neither professed ignorance of the law, professed innocence, or professed lack of intent to violate the law, can preclude the possibility of civil or criminal arrest and prosecution.

To protect the credibility and reputation of the organization's directors, officers and employees, it is important to avoid situations that produce a file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 4 of 8

conflict, or even the appearance of a conflict, with official duties performed on behalf of the organization

What Are Some Common Examples of Conflict of Interest?

The following are some common examples of conflicting interests that should be voluntarily and fully disclosed to the appropriate organization officials. Remember that these are indicators of potential problems, not proof of improper acts.

Administrative Decisions/Funding:

l As an officer or director of an outside entity, an officer of the organization engages in a decision affecting revenues to the organization that employs him/her.

l An officer or employee takes administrative action within the organization which is beneficial to a business in which he/she has a financial interest.

Procurements:

l An officer or employee hires a consultant who is a relative without prior approval by the organization.

l An officer or employee sole sources a purchase to a company owned by his/her brother/sister, or to one in which he/she has a financial interest or policy determining position, without prior approval of the organization of he/she is an member.

l A director, officer or employee engages in a decision at the organization affecting a contract between the organization and a company for which the individual serves as an outside director.

Consulting/Business Interests:

l A director, officer or employee makes referrals to a business in which that individual, a member of his/her family or an associated entity has a financial interest.

l A director, officer or employee has a business relationship with companies that do business with the organization.

l An officer or employee holds a consulting position at a competing organization.

Use of Services, Materials and Equipment:

l An officer or employee uses organization facilities or resources in furthurance of private consulting or outside business activities. file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 5 of 8

l An employee engages in research testing involving an invention to which he/she shares intellectual rights, or in which the employee, or immediate family members, have a financial or business interest.

l An organization member conducts organization supervised research for an outside business in which he/she, a member of his/her family, or an associated entity holds a stock or similar ownership interest.

As discussed later in this article, several other examples are available at various Internet sites.

What Steps Can You Take to Reduce the Risks Associated with Conflict of Interest?

In 1991, The U.S. Congress, through the U.S. Sentencing Commission, issued policies that federal judges must follow in fining organizations convicted of federal offenses. These have been codified in Chapter Eight of the U.S Sentencing Commission Guidelines for the Sentencing of Organizations (Section 8Al .2/K), with the purpose of "providing just punishment, adequate deterrence, and incentives for organizations to maintain internal mechanisms for preventing, detecting and reporting criminal conduct." As summarized by the Association of Certified Fraud Examiners (The White Paper,Vol.11, No 2, March/April 1997, page 50), the Federal Sentencing Guidelines stipulates several compliance requirements of organizations. They serve as a general guide for proactive actions an organization can take, not only to minimize liability for the criminal acts of its directors, principals, officers and employees, but also to minimize the likelyhood of occurrance in the first place.

"1. The organization must have established compliance standards and procedures to be followed by its employees and other agents that are reasonably capable of reducing the prospect of criminal conduct."

"2. Specific individual(s) within high-level personnel of the organization must have been assigned overall responsibility to oversee compliance with such standards and procedures."

"3. The organization must have used due care not to delegate substantial discretionary authority to individuals whom the organization knew, or should have known through the exercise of due diligence, had a propensity to engage in illegal activities."

"4. The organization must have taken steps to communicate effectively its standards and procedures to all employees and other agents e.g. requiring participation in training programs or by disseminating publications that explain in a practical manner what is required."

"5. The organization must have taken reasonable steps to achieve file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 6 of 8

compliance with its standards. e.g., by utilizing monitoring and auditing systems reasonably designed to detect criminal conduct by its employees and other agents by having in place and publicizing a reporting system whereby employees and other agents could report criminal conduct by others within the organization without fear of retribution."

"6. The standards must have been consistently enforced through appropriate disciplinary mechanisms, including, as appropriate, discipline of individuals responsible for the failure to detect an offense. Adequate discipline of individuals responsible for an offense is a necessary component of enforcement; however, the form of discipline will be appropriate will be case specific."

"7. After an offense has been detected, the organization must have taken all reasonable steps to respond appropriately to the offense and to prevent further similar offenses - including any necessary modifications to its program to prevent and detect violations of law."

The key to managing conflict of interest problems includes five factors:

l Establish a clear "tone at the top" that conflicts of interest should be avoided if at all possible, and illegal acts will be dealt with to the fullest extent of the law.

l Identify those areas of the organization's operations that have a high exposure risk.

l Establish an organization-wide policy on how conflicts of interest should be identified and handled.

l Educate directors, officers and employees on the elements and dangers posed by conflicting interests.

l Perform periodic reviews to evaluate the adequacy and effectiveness of established practices.

While these steps will not necessarily eliminate all likelihood that untoward acts will occur, they can help provide reasonable assurance that the risk of such acts, intentional or otherwise, can be minimized.

How Can You Find Out More?

The following publications, available from the Federal Government, include information on conflicts of interest:

Office of the Inspector General Department of Defense The Pentagon file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 7 of 8

Washington, D.C. 20301-1900

IG, DOD 4075.1-H, "Indicators of Fraud in DoD Procurements" IG/APO 7600.1-H, "Handbook on Scenarios of Potential Defective Pricing Fraud" IGDPH 4200.50 CIPO, "Criminal Defective Pricing and the Truth in Negotiations Act "

Other publications:

"Handbook on Fraud Indicators - Materials" "Handbook on Labor Fraud Indicators"

You can also visit Federal Inspectors General IGNet

Several books have been written on the contracting process that discuss conflict of interest issues. Among the better ones are:

Contracting Municipal Services by John Marlin (John Wiley & Sons, 1984)

Purchase of Service Contracts by Kettner and Martin (Sage Publicacations, 1987)

Contracting Out in Government by John Rehfuss (Josey-Bass Publishers, 1989)

The Institute of Internal Auditors has several reference books available on the nature of fraud and fraud auditing.

Following are some sites on the Internet where you can find material on conflict of interest issues:

Rensselaer Polytechnic Institute

The Association of Certified Fraud Examiners

The Institute of Internal Auditors

Conclusion

Whenever allegations of conflicting interests arise, the person being accused never seems to have a problem justifying or rationalizing the activity that gave rise to the allegation. Many will act offended at having their integrity questioned. Those with experience in such matters know, however, that in those instances where fraud or abuse actually exist, this type of reaction is also a contrived and calculated response used by the perpetrator to avoid prosecution. In many cases, it works, and organization officials do not pursue the illegal or abusive acts of a "trusted employee who would never do such a thing". Conflicts of interest cannot and should not be treated cavalierly. The appearance of a conflict of interest is always a red flag of warning that official file://C:\WINDOWS\DESKTOP\Conflict%20of%20Interest%20Websites%20and%20Fil... 16/01/2004 Conflict of Interest - Mark R Simmons Page 8 of 8

acts may have occurred that are not in the best interests of the institution, and in fact may not be within the law. Organization officials have a fiduciary duty, and, where public funds are involved, a legal responsibility, to minimize the risks associated with conflicts of interest; and to fully resolve legitimate allegations of impropriety or illegal acts that are the result of conflicting interests.

This article represents informed opinion. It is not a substitute for professional legal advice. As always in matters of law, a qualified attorney should be sought out to identify and interpret any conflict of interest circumstances that involve a potential breech of civil or criminal laws. Comments, criticisms, and differing opinions are welcome in the spirit of furthering our knowledge and understanding.

Last update June 24, 2003 Homepage URL: http://www.mrsciacfe.cjb.net/ Web site designed and maintained by Computer Basics

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