Conflict of Interest in Financial

Conflict of Interest in Financial Institutions

Conflicts of interest are of great concern in recent years and months, especially since the recent, highly-publicized buyouts involving Qantas and Alinta. In efforts to protect clients and mitigate risk in the financial sectors, conflicts in interest must be addressed suitably. These two buyouts have highlighted many of the worst issues pertaining to conflicts in interest in financial institutions. The result is that customer confidence has been shaken and general public concern for the trustworthiness of financial institutions and advisers has risen. This heightened awareness and wariness hurts the market by creating consumer concern where only a few financial players were acting questionably.

How questionable are the actions made by Qantas and Alinta management? What specific actions were taken (or not taken) in terms of conflict mitigation? What is the views of the Takeovers Panel in these matters? This paper seeks to review the existing literature concerning conflicts of interest, outlining the key terms and issues involved. It will additionally cover the recent transactions and conflict of interest issues related to the Alinta MBO and Qantas Private Equity Deal. Finally, it will turn to the views of the Takeover Panel, highlighting their views on conflicts of interest and, more specifically, their views on the Alinta MBO and Qantas Private Equity Deal transactions.

Section II will focus on the analysis, including background, definitions, evaluation and examples. Section III. Will discuss and analyze the Alinta MBO and Qantas Private Equity Deal transactions, including assessed / possible conflicts, background and discussion. Section IV will discuss the Takeover Panel's views. The sum of these issues will be dealt with in Section V.

II. Analysis

II.1 Background & Definitions

When using terms like "conflicts in interest" it is crucial to clarify the meanings of key terms since the language alone can be misleading. In their evaluation of Conflict of Interest, Mehran and Stulz identify conflict of interest as one party of a transaction having an incentive to take actions that would be detrimental to the counterparty of the agreement. Finding other definitions of conflicts of interest too narrow, this will suffice at the accepted definition in this paper.

Parties in a transaction may be individual investors, companies, consultants or financial institutions. In terms of conflicts of interest, these parties are at risk where they are considered "participating insiders." When participating insiders take advantage of the information specific to their position for their own direct or indirect gain, they are likely abusing their position and are in a position of conflicted interests.

Conflicts of interest often shock shareholders and the general public since they often blatantly ignore the basic requirements and duty expectations of those involved. For example, a bank that abuses a conflict of interest by recommending services that they know are not the best for a customer comes under public scrutiny for abusing the basic trust assumed in a banking relationship. A bank may suggest such services because they receive a higher interest rate or because they do not offer competitive services. This takes advantage of the lack of knowledge of the consumer, who often looks to the bank as a trusted consultant. Individuals and investors have come to assume some trust in banking and finance relationships, and most would agree that this is not an unreasonable assumption.

As will be discussed further in Section III, Qantas and Alinta are under scrutiny because managers from each stand to substantially gain from the buyouts of these companies. Since there would be personal gain, questions arise as to whether these individuals have acted in their own interest or, as their duties require, in the interest of company stockholders.

II.2 Evaluation

Conflict in interest can obviously create negative outcomes for those involved. Despite the substantial public outcry, I agree with Mehran and Stulz that the market should be allowed to regulate itself to some extent. However, Mehran and Stulz do not effectively solve the problem by explaining that "rational" buyers will be willing to pay more and recognize the value for a greater product. While in an ideal market buyers are informed and know what risk is involved, the essential issues in conflict in interest discussion surround the fact that clients and investors are almost always less informed that consultants and financial institutions.

The drawback of "hands-off" market regulation is that some individuals will get caught in the middle of transactions that later turn out to be ill-advised or tainted by conflict of interest. For example, brokers who perpetually suggest buying stocks or funds that they themselves are selling will end up hurting their own reputation when a client finds out. Self-regulation leads to the broker gaining a reputation as untrustworthy and unlikely to do further business, thereby taking care of the problem.

For those who demand legal guidelines, the Takeover Panel has suggested actions that companies can take to mitigate conflict of interest risk, particularly in the case of buyouts. This will be discussed further in section IV.

III. The Alinta MBO and Qantas Private Equity Deal

III.1 Background & Discussion

Recent discussions of conflict of interest bring two situations to mind: the Alinta Buyout and the Qantas. Both cases include examples of individuals who are undeniably participating insiders who appear to be trying to take advantage of their knowledge and positions.

In the case of Alinta, two individuals in particular have been singled out as acting unethically and not fulfilling their professional duties. Former Alinta Chairman John Poynton and Alinta Chief Executive Bob Browning began discussion in late 2006 to be part of a company MBO. When their interest in the company changed from their individual job duties to those of possible owners they became caught in the crossfire of interests, a position from which a conscientious manager would normally resign his or her post. Neither man did resign and during late 2006 / early 2007 they also failed to inform shareholders at Alinta what their intentions were. Additionally, Poynton sought consultation from Macquaries Bank concerning the buyout -- and action specifically against the request of Alinta's Board. When the terms of the buyout came to light, Boynton and Browning seemed to expect to keep their positions in management despite the clear conflict in interest between their ownership and the interest of the shareholders. Public concern and pressure, as well as the unsanctioned actions of the two men, led to their dismissal in mid-January.

In a related conflict of interest issue, Macquaries Bank was found to be advising Browning and Poynton, advising Alinta, and bidding on the buyout as an investor. Not only did Macquaries have interest as a long-standing financial adviser to Alinta, but it attempted to advise Poynton and the other members of the MBO in a "friendly" capacity. To stretch its loyalties even thinner, Macquaries additionally tied its own shareholders' interest into the project by becoming a potential bidder on the buyout. Beyond receiving negative press, Macquaries is now under close scrutiny by the Australian Securities and Investment Commission (ASIC).

Qantas has also been moving through the buyout process, though the methods of manager Geoff Dixon and the Qantas board are marginally better than those of Alinta. In addition to his position at Qantas, Dixon is the Chief Executive of the Alleo Equity Partners Macquarie Bank Texas-Pacific Group that seeks to take over Qantas airlines. Dixon is maintaining his position at Qantas; however, he does not participate or attend board meetings discussing the buyout. Additionally, the Qantas board and management had nothing to do with the buyout proposal.

III.2. Possible Conflicts

The reaction of the ASIC, the public, and interested parties from Qantas, Alinta, and Macquaries Bank imply that there is something wrong with the actions of those parties. Yet, Browning and Poynton acted without expectation that they could not manage their positions alongside their new interests. Macquaries responded defensively to all allegations, denying any conflict or maintaining that conflict was manageable through informed consent or an understanding of consultation on a friendly basis. So, is there anything wrong with the actions of the involved parties?

According to the ASIC, there are possible conflicts and the participants had a responsibility to avoid -- not just manage -- said conflicts. Browning and Poynton fall under the definitions for participating insiders, as well as those with a conflict of interest. Further, their conflict of interest is not solely a conflict but a matter of both individuals acting on that conflict of interest in a way that is questionable. Alinta as a company does not appear to be in the wrong, and attempted to alleviate blame by dispensing of both individuals after finding that they were involved in dealings specifically advised against.

Macquaries Bank clearly abused its role as a participating insider, as it tried to profit off of the Alinta buyout in every way possible. It collected fees from Alinta and maintained a relationship as a long-standing financial adviser ot the company; it ignored its first role to become involved -- friendly or not -- with advising the MBO group; and it involved its own shareholders in a buyout that it was specifically involved in on both sides. There is no doubt that Macquaries used its knowledge of the internal workings of Alinta to make decisions about whether or not to involve its own finances.

Qantas and Geoff Dixon attempt to avoid Alinta's problems by keeping Dixon away from the actual buyout dealings. However, the sizeable payout and other financial perks given to Dixon, especially in light of the other corporate abuses going on, seems suspect at best. Overall, the Takeover Panel's suggestion that individuals who are involved in the buyout of their employing company should step down seems the most solid advice in avoiding conflict of interest.

IV. The Takeover Panel and Conflict of Interest

In their Guidance notes, the Takeovers Panel attempts to alleviate or prevent negative outcomes, citing that private equity bids and other buyouts can have major effects. Many of the items outlined by the Takeovers Panel have specific applications in the deals and issues related to Qantas, Alinta, and Macquaries bank.

The Panel cites that its major concerns are to ensure that buyout bids are considered in an unbiased manner, without the influence of participating insiders to move forward with one bid or another. The Panel also lists that companies should ensure that any disclosure of information to buyout bidders is appropriately controlled.