Published 12th July 2023
In the realm of investment and fund management, the issue of conflict of interest looms large. It is a dynamic concern that underscores the intricate dynamics within corporate finance. Picture a complex web of relationships where personal interests intersect with the fiduciary duty owed to investors. This narrative resonates across boardrooms, where the pursuit of financial gain can unintentionally clash with the responsibility to act in the best interests of those who entrust their capital.
In Part I of our Legal and Compliance series, we will provide a general overview of conflict of interest issues which are commonly seen in investment management/ fund management firms, from a regulatory perspective. We believe this will provide useful insights into what regulators consider as best practices when managing conflict of interest issues.
1) What is a ‘conflict of interest’, from a Singapore fund management company’s perspective?
Singapore has robust and vibrant fund management framework which places substantial attention to transparency. In fact, the Guidelines on Licensing, Registration and Conduct of Business for Fund Management Companies (the “Guidelines”) has expressly required that a fund management company (“FMC”)¹ shall put in place mitigating measures to mitigate any conflict of interest and, where appropriate, disclose any conflict of interest to its customers.
The Guidelines outline that actual or potential conflicts of interest could include:
- the FMC procures the services of related corporations or other entities in which the CEO, directors or representatives of the FMC have controlling interests or substantial shareholdings;
- the FMC invests into the fund using its proprietary moneys or moneys belonging to its related entities or employees;
- the FMC invests customer moneys into the securities of the FMC’s related entity; and/or
- the CEO, director or representative of the FMC has interests which are distinct from his/her role as CEO, director or representative of the FMC, as the case may be, and which may be in conflict with the interests of the customers of the FMC.
By enforcing regulations and conducting oversight, the regulatory body helps maintain market integrity, protect investors and promote fair practices within the fund management industry. The regulatory body has the responsibility to safeguard public interests, given that the FMC handles funds from third parties. Consequently, the public places high expectations on the FMC, demanding that it fulfils a strict fiduciary duty to its clients and makes every reasonable effort to maintain the highest level of integrity. This is crucial for instilling confidence in investors.
In connection with the above, the FMC is then expected to have the ability to put in place proper policies or measures to ensure that the interest of the funds and their investors will be safeguarded in the process.
2) Why is it important for a fund management company to identify conflicts of interest?
Identification of conflict of interest is crucial as this helps an FMC to plan and put in place proper measures to address the same. Failure to manage and resolve conflicts of interest may lead to serious negative impacts which could result in financial harm to investors, reputational damage of the FMC, legal action against the FMC, or regulatory action against the FMC and its personnel.
Take a look at a recent case where U.S. Securities and Exchange Commission (“SEC”) charged Randy Robertson, a former BlackRock Advisors, LLC’s portfolio manager, for failing to disclose a conflict of interest arising from his relationship with a film distribution company (Aviron Group) in which the fund he managed for BlackRock invested millions of dollars.²
Robertson, a co-portfolio manager of BlackRock Multi-Sector Income Trust (“BIT”) had a significant role in recommending and overseeing BIT’s loans to the Aviron subsidiaries, amounting to approximately USD75 million. It was discovered by SEC that in 2018, Robertson asked Aviron to help advance his daughter’s acting career which resulted in his daughter obtaining a small role in a film produced – something which Robertson had failed to disclose to BIT’s board of trustees or BlackRock’s compliance and legal teams. It was reported that Robertson agreed to pay a USD250,000 penalty to settle the charges.
It was commented by Andrew Dean, Co-Chief of the SEC’s Enforcement Division’s Asset Management Unit that “Investment professionals must be forthcoming about any conflicts of interest they may have with the companies in which they invest client funds, including situations involving favours or assistance to family members”. Dean further commented that investors must be able to know that the advice they receive is free of undisclosed conflicts, regardless of whether the conflict is financial in nature.
3) What steps should an FMC take to manage conflict of interest risk?
In order to identify various types of conflicts of interest, it is crucial to take into account the scenarios in which the FMC, any of its employees or any person associated with it, or any delegated entity/ person, is involved or over which it has direct or indirect control.
An FMC should take all reasonable steps to identify any relationships in the course of managing the funds in which conflicts of interest are likely to happen, as below:
- the FMC, including its managers, employees or any person directly or indirectly linked to the FMC by control (related companies and/or affiliates), and a fund managed by the FMC (the “Fund”) or the investors in the Fund;
- the FMC invests client moneys into the securities of the FMC’s related entity or the funds managed by the FMC or its related corporations.
- the Fund or the investors in the Fund and another fund or the investors in that other fund;
- the Fund or the investors of the Fund and another client of the FMC;
- between two clients of the FMC.
It is important that FMC personnel are aware and alert of any potential relationship in which conflicts of interest are likely to happen, so that any potential incident could be brought to the attention of the FMC’s compliance department for consultation and mitigation action planning.
4) What are the situations/scenarios in which conflicts of interest could occur?
In fact, conflicts of interest exist in almost all sectors be it public or private. In the context of an FMC, the fact that an FMC is involved in the management and deployment of the clients’ funds in selected investments in the ordinary course of business, a conflict of interest may inevitably arise especially when it involves personal relationships.
Due to its factual nature, we have identified the following non-exhaustive list based on market practice which would usually constitute a conflict of interest:
- the possibility and likelihood of achieving a financial gain or avoiding a financial loss for the FMC (including its managers and/ or employees) at the expense of the Fund or the clients of the Fund;
- the FMC receives a benefit (tangible or intangible) with regard to portfolio collective management activities provided to the Fund;
- receipt of commissions or payment from the Fund’s underlying investments;
- the interests of the FMC (including its managers and employees) or of a delegated entity in providing a service to the Fund, not coinciding with the interests of the Fund or its investors;
- the possibility that the FMC (including its managers and employees) or a delegated entity would favour the interests of a Fund over another, for financial or other reasons, in its capacity in managing more than one Fund;
- the possibility that the FMC or a delegated entity would obtain a benefit from a third party in relation to the services provided, other than the commission or fees normally charged for this service;
- the introduction of shares of the Fund into other funds also managed by the FMC, the same shall apply when the management of the Fund portfolio is delegated to an investment manager;
- the nomination of directors, members of the management, or staff of the FMC as members of the board of directors of the Fund;
- co-management of a fund by more than one fund manager where the investment decisions will be made collectively by the co-managers which are subjecting to overlapping or conflicting mandates (either licensed or unlicensed)
5) What can a fund management company do to mitigate such conflict of interest?
No FMC can guarantee that a conflict of interest situation will never happen. Hence, when an FMC has identified conflicts, or potential conflicts, it shall be committed to ensure that these are effectively and fairly managed to prevent such conflict from attributing to a material risk of damage to the interests of the FMC’s clients.
The ordinary course of business of an FMC involves deal sourcing and evaluation of investment opportunities, investment decision making and deal allocation which may result in unfair deal execution or allocation of investment opportunities in favour of one or more clients at the expense of the other clients. In addition, undertaking business transactions for more than one client or fund and different fee structures may also potentially affect incentives for allocation.
To mitigate potential conflicts, where an FMC manages more than one fund with similar investment strategies and more than one fund participates in an investment, generally such investment should be allocated across the funds on a pro-rata basis, subject to variations considering differences in investment focus, investment horizon, return objective, and other considerations deemed relevant by the FMC in good faith.
Furthermore, an FMC shall establish an advisory committee for fund(s) under its management, which will typically comprise of major investors. Material conflicts of interests relating to the allocation of investments will be fully disclosed to the advisory committee and the advisory committee will propose recommendations to resolve these conflicts. In connection with this, an FMC shall also put in place and implement clear and fair allocation policies when dealing with investments for clients as a guidance for the FMC’s personnel.
In addition to the above, an FMC shall ensure that investors’ monies or assets will be properly handled by segregating the monies and assets in separate accounts opened under the name of the respective Fund to mitigate potential conflicts of interests.
In mitigating potential conflicts of interest, appropriate disclosure is a key. An FMC will need to disclose appropriately to its clients its proprietary investment, and fees and/or commission structures. Proprietary investment is where an FMC or certain shareholders and officers of the FMC may invest in funds or investments it is managing on behalf of clients. While this is encouraged by the clients as this illustrates “skin in the game”, such investment may potentially incentivise these funds to be managed to meet the personal objectives of the managers or the FMC rather than in the best interests of the other investors. It may also create the assumption that the manager of the FMC will favour the fund he/ she has invested over other fund he/she manages. As such, proper allocation procedures will play a role in ensuring such conflicts of interest will be mitigated.
Notwithstanding the above, we recommend that the compliance department of an FMC to maintain a register of conflicts detailing the nature of the conflict, the mitigating action taken, how this complies with the policy relating to the conflicts of interest, and assurance procedures undertaken to ensure effective implementation. This will serve as a future reference or guidance for the FMC’s managers and employees.
Stay tuned for Part II of this series, where we will share more on our strategy in managing conflicts of interest drawing from our experience being part of a larger corporation, with the objective of encouraging ideation and innovation in the industry.
¹The Guidelines refer Fund Management Companies as corporations with fund management as their principal business activity.
²SEC Charges Former BlackRock Portfolio Manager with Undisclosed Conflict of Interest. (2023, January 5). (link: https://www.sec.gov/news/press-release/2023-3)
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