• The Ethics of Conflict of Interest
• Using Apologies to Strengthen

The Ethics of Conflict of Interest
By Lauren M. Bloom, J.D., LL.M.

The past two years have been tough for the financial services industry. In hindsight, the crash of 2008 that triggered a deep recession was not only foreseeable, but probably inevitable. Too many people were looking for ways to beat the market, seeking out ever-more risky investments in the hope of generating ever-increasing returns. Investor expectations for growth became so unreasonable that they were bound to encourage fraud (think Bernie Madoff and his ilk) and the proliferation of chancy investments like subprime mortgages. It was only a matter of time before the whole precarious mess came crashing down.

At this point, investors both large and small are suffering from a profound lack of trust in their professional advisors. Those investors include pension plans, and they have a point. Far too many plan design and funding decisions were made based on unrealistic expectations and, in some cases, imprudently optimistic advice from pension professionals. Despite their expertise, too many pension advisors failed either to anticipate the coming crash or to help their clients avoid its consequences.

It also appears that some pension plans may have been the victims of intentional misconduct on the part of their advisors. Recent claims that public plans across the US have been targets of nationwide “pay-to-play” schemes have called the integrity of public plan advisors into question. If those allegations turn out to be true, the pension community’s reputation will be severely damaged and calls for increased regulatory oversight are sure to follow.

If pension professionals want to regain the trust of their clients and retain their independence, they will need to recommit to strong professional ethics. They will also need to be able to demonstrate that commitment to their clients and regulators. ASPPA members can do both by reacquainting themselves with ASPPA’s Code of Professional Conduct (and, for actuaries, the Code of Professional Conduct for Actuaries) as well as IRS Circular 230, and then taking steps to ensure that their professional practices fully comply.

ASPPA’s Code of Professional Conduct provides comprehensive guidance on ethics in professional pension practice, and all of its requirements are important. In the current climate, however, one ethical issue in particular stands out: conflicts of interest. It will be essential for pension professionals to deal appropriately with such conflicts if they are to maintain credibility and restore their clients’ trust.

Conflicts of interest can present a major problem for pension professionals, who often provide a range of services to various parties associated with particular plans. In an ideal world, the interests of the plan sponsor, administrators, fiduciaries, participants and practitioners would be the same; in practice, that is all too often untrue. In some situations it can be difficult for the pension professional even to identify his or her client. Is the client the sponsoring company’s management, its Board of Directors, the plan administrator, the participants or the pension professional’s firm? And whom has the professional been hired to serve? In many cases, one party—for example, a plan sponsor—may hire a pension professional to provide services that are intended to benefit someone else, such as the plan’s participants. Diverging goals, internal plan politics and conflicting requests for confidentiality from the many parties associated with a plan can put a pension professional in an ethically untenable position unless potential conflicts of interest are carefully considered and successfully resolved.

ASPPA’s Code addresses conflicts of interest and provides guidance on how to resolve them. First, an ASPPA member must recognize when an actual or potential conflict of interest exists, not only with respect to the member’s principal (i.e., the person or entity with authority to hire and fire the ASPPA member) but also other interested parties. That requires the ASPPA member to think carefully about the implications of an engagement not only for the principal requesting services, but for the member’s other clients, other parties with an interest in the plan, the ASPPA member’s firm and, in some situations, the federal government.

Section 10.29 of IRS Circular 230 offers clarifying guidance, stating that a conflict of interest exists if:

• The representation of one client will be directly adverse to another client; or
• There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s responsibilities to another client, a former client or third person, or by a personal interest of the practitioner.

Circular 230 permits the practitioner to make a professional judgment that a particular assignment will not be directly adverse to the interests of another client or create a significant risk of conflict. However, such judgments can carry real risk. Conflicts of interest often seem less serious at the beginning of an engagement than they do with the benefit of hindsight, and failure to properly identify and address a conflict can do real harm to a professional’s credibility. These days, an ASPPA member is prudent to take potential conflicts of interest very seriously, more so than he or she might have even a year or two ago.

Identifying real or potential conflicts of interest does not necessarily prevent the ASPPA member from accepting the assignment, but it does require him or her to determine whether he or she can act fairly or, in the words of Section 10.29 of IRS Circular 230, “be able to provide competent and diligent service to each affected client.” This obligation should not be taken lightly, and the determination should be made before the ASPPA member requests the affected principals’consent to having the member complete the engagement. The ASPPA member needs to think long and hard about whether he or she can be objective in serving his or her principal. Even if he or she is convinced that he or she can act fairly, the ASPPA member is wise to consider whether third parties would agree. An appearance of bias can seriously harm a professional’s credibility even if that professional is certain that his or her conduct is entirely appropriate.

The ASPPA member must also consider whether the law permits him or her to provide professional services in a situation where a real or potential conflict of interest exists. Section 10.29 specifically addresses this point, as does the requirement in ASPPA’s Code that members comply with applicable law. Some situations (for example, certain contingency fee arrangements) present so great a risk of conflict of interest that the law prohibits a pension professional from entering into them regardless of whether he or she can maintain objectivity or not. The ASPPA member should be sufficiently familiar with applicable law to comply with this requirement, obtaining legal advice as necessary.

If the ASPPA member concludes that he or she can act fairly and in compliance with law, he or she should disclose the conflict to all principals involved and obtain their consent to him or her performing the engagement. Section 10.29 requires practitioners to obtain clients’ confirmation of their consent in writing within 30 days, to keep the written confirmation for three years, and to provide the confirmations to the IRS upon request. (Nothing prevents ASPPA members from keeping such confirmations longer, consistent with their firms’ document retention policies.) If one or more of the affected principals refuses to consent, the ASPPA member should decline the engagement even if he or she believes that he or she could have provided unbiased advice.

Additionally, ASPPA’s Code requires members to disclose to their principals any significant conflict between their principals’ interests and those of a third party, and to make appropriate qualifications or disclosures in any related communications. Again, this requirement gives the member discretion to determine that a particular conflict of interest is insignificant enough that there is no need to disclose it, but such determinations require careful thought. In most cases, the member is probably wise to err on the side of caution, disclosing a seemingly minor conflict with a third party’s interest to the principal, rather than neglecting to do so only to discover later than the conflict was more significant than it first appeared.

ASPPA’s Code also requires members to keep appropriate control over their work product. Members should decline engagements if they have reason to believe that their work would be used to mislead or to violate or evade the law. They should also take appropriate steps to make sure that their work products are clear and presented fairly, with sources of the material clearly identified. These requirements complement the Code’s conflict of interest provisions by reducing the risk that the member’s work will harm the legitimate interests of third parties, and should be kept in mind as the member addresses conflicts of interest.

Conflicts of interest are not always apparent at the beginning of an engagement. If a conflict of interest emerges during the course of an ASPPA member’s work on a particular assignment, the ASPPA member should resolve the conflict consistent with the Code and Circular 230. This is true regardless of when the conflict becomes apparent.

If an ASPPA member is faced with a conflict of interest, he or she may wish to document the analysis he or she conducted to resolve it. Such documentation can be useful if questions arise later about the member’s compliance with the Code or Circular 230. Documentation concerning resolution of conflicts of interest should usually be created and maintained consistent with the document retention policy of the member’s firm and, if necessary, in consultation with an attorney.

Historically, many professional advisors have focused on disclosure as the key to addressing conflicts of interest, but disclosure alone is not enough. An ASPPA member is much more likely to be successful in dealing with conflicts of interest if he or she complies fully with all aspects of the Code. While rigorous compliance with the Code’s conflict of interest requirements may sometimes cause an ASPPA member to make painful decisions in the short-term, it will go a long way toward helping that member maintain professional credibility and strong relationships with clients and regulators.

Lauren Bloom

Using Apologies to Strengthen
Your Business Relationships

By Lauren M. Bloom, J.D., LL.M.

Nobel Prize-winning physicist Niels Bohr once quipped, “An expert is a person who has made all the mistakes that can be made in a very narrow field.”  Professionals like doctors, lawyers, clergy, architects, accountants and actuaries enjoy remarkable expertise in their respective fields.  No matter how capably they practice, though, professionals are only human and can, on occasion, make mistakes.  Here’s an example:
 
L&L Co. was a small, privately-owned company that produced high-end children’s toys.  Its signature product was “Little Lulu,” a dress-up doll with a realistic face and figure designed to discourage eating disorders in young girls by offering a fun, fashionable alternative to the anatomically impossible dolls produced by big toymakers.  L&L Co. remained a minor player in the toy industry until a famous Hollywood child star was hospitalized with anorexia.  The Little Lulu doll was prominently featured on several national TV talk shows, and sales skyrocketed.

Seeing the potential for profits, ToyCo, Inc., a huge national toy manufacturer, offered to buy out L&L Co.  Overwhelmed by the unanticipated demand for Little Lulu dolls, L&L Co.’s owners decided that selling out to a bigger company made good business sense.  The two companies approached an actuarial consultant named Matt L. Hasbrough and asked him to calculate the value of L& L Co.’s pension plan so the parties could agree on the price for the company.

L&L Co. gave Hasbrough little hard data to make his calculations.  The companies were eager to consummate the sale, though, and pressed Hasbrough to finish work as quickly as possible.  Working to a tight deadline with the flawed information that was available to him, Hasbrough estimated the cost of the plan’s obligations to participants at $1.5 million.

Using Hasbrough’s numbers, L&L Co. and ToyCo, Inc. representatives negotiated a $6 million sale price for L&L Co., and the transaction was consummated.  Hasbrough was delighted when ToyCo, Inc. thanked him for his speedy service and offered him a lucrative contract to serve as the actuary for its various pension plans.

About a year later, Hasbrough was cleaning out files when he came across a document from L&L Co.  Reading it, Hasbrough remembered that L&L Co. had a second group of employees who produced and marketed a line of children’s books and board games. Those employees were also participants in the L&L Co. defined benefit plan but Hasbrough worried that, in his hurry to finish work on schedule, he might have accidentally left them out of his analysis.  After doing a quick “back of the envelope” calculation, Hasbrough came to the distressing conclusion that he had underestimated the plan’s future obligations by approximately $1 million.

At this point, Hasbrough had several alternatives, none of them very attractive.  He could call his attorney and hunker down for a million dollar lawsuit.  He could resign from the ToyCo., Inc. account and hope that his successor never discovered the error.  He could say nothing, continue working on the ToyCo., Inc.’s pension plans and, over time, quietly modify his assumptions and methods so that ToyCo., Inc.’s management would never realize that they had taken on a much bigger pension expense than they thought when they bought L&L Co.  Or he could admit to his mistake to his client and apologize.

What should Hasbrough do?

In our ultra-litigious society, admitting to a million dollar mistake and apologizing for it might seem crazy.  But if Hasbrough wants to retain his professional integrity, he can’t just ignore the mistake and hope it will go away.  Trying to cover it up would be even worse.  And, if Hasbrough wants to stay on good terms with ToyCo, Inc., waiting to address the problem until someone else discovers it is not the way to go.

Delivering a timely, thoughtful and sincere apology may well be Hasbrough’s best strategy to manage his litigation risk and strengthen his relations with an important client.  By admitting to his mistake and apologizing for it, Hasbrough will demonstrate his honesty and professionalism, traits that are essential to maintaining client trust.  If he delivers his apology effectively, the chances are good that ToyCo, Inc.’s management will come away feeling even better about Hasbrough than they did before.  Still, it will be important for Hasbrough to carefully navigate this difficult situation to maximize his chances of success.  Here’s how:

Confirm and quantify.  As American folk hero Davy Crockett famously said, “Be sure you’re right, then go ahead.”  Before apologizing for his mistake, Hasbrough should check his figures and make sure that he really did make a mistake.  If his initial fears prove to be true, Hasbrough should do a more thorough calculation so he can provide a reliable estimate of what his error cost.  Apologizing for one mistake could demonstrate to his client that Hasbrough has the honesty and integrity to acknowledge his errors and make amends.  But if Hasbrough has to admit to yet another mistake in identifying or quantifying his original error, ToyCo, Inc.’s management may seriously question his competence.

Call for back-up.  Before apologizing to his client, Hasbrough would be smart to enlist a fellow actuary to help him think through the likely impact of his mistake and come up with viable solutions.  It’s not that Hasbrough isn’t bright or capable, just that a colleague might bring a fresh perspective to the problem, suggesting things Hasbrough hasn’t considered.  If Hasbrough has any concern that ToyCo, Inc.’s response to his apology will be to file suit, Hasbrough should call his lawyer, too. 

Hasbrough’s lawyer will probably tell him at first not to apologize, and with good reason.  Lawyers who have to defend their clients in malpractice suits are understandably reluctant to have their clients openly admit mistakes to potential plaintiffs.  However, recent studies have suggested that clients appreciate candor from their professional advisors and recognize that even the most hardworking and capable professionals make honest mistakes.  Indeed, studies of the medical profession suggest that an effective apology can significantly reduce a doctor’s risk of getting hit with a malpractice suit.  Making an apology could also help ToyCo, Inc.’s management take steps to minimize the damage caused by Hasbrough’s mistake, reducing or even eliminating his potential liability.  Once Hasbrough is sure that apologizing is his best strategy, Hasbrough’s attorney can help him word his apology in a way that puts his mistake in perspective and lessens his litigation risk.

Develop potential solutions.  Sometimes where a professional makes a mistake, one solution clearly stands out as the best possible way to make things right.  Much of the time, though, several workable alternative solutions exist.  Before approaching ToyCo, Inc.’s management, Hasbrough would be wise to develop at least a couple of ways to correct his error, then estimate what each of those alternatives is likely to cost ToyCo, Inc. in time, money and employee good will.  Hasbrough’s apology will be much more effective if he can present ToyCo, Inc.’s management with reasonable solutions and not just a million-dollar problem.

Hasbrough would also be smart to decide in advance what he’s willing to do to make things right.  Part of delivering an effective apology is making reasonable amends for his mistake.  For example, Hasbrough might offer to return his fee for the mistaken valuation, to provide actuarial services at a reduced fee or free of charge to implement the solution, or to meet with ToyCo, Inc.’s Board of Directors in person to apologize and explain what happened.

Don’t dawdle.  Hasbrough has some heavy spadework to do before he can deliver his apology; getting it done quickly and well needs to be a priority.  If Hasbrough delays unnecessarily before contacting his client, ToyCo, Inc.’s management may be inclined to question his integrity, his competence, or both.  As former Secretary of State Colin Powell once observed, “bad news isn’t wine.  It doesn’t improve with age.”  The sooner Hasbrough can finish his analysis and contact ToyCo, Inc., the more effective his apology will be.

Meet face to face.  Once Hasbrough has completed his analysis, it’s time for him to deliver his apology.  Hasbrough has the best chance of apologizing effectively if he travels to his client’s office at his own expense and meets in person with his designated contacts.  An apology delivered by telephone or mail (or, worst of all, e-mail) is much less likely to be effective, and charging ToyCo, Inc. for his time and travel to disclose a million dollar mistake could seriously damage Hasbrough’s future relations with the company.

During the meeting, Hasbrough should clearly and succinctly describe what happened and sincerely apologize.  If faced with tough questions, Hasbrough may have to resist the temptation to get defensive or point fingers at someone else.  Yes, L&L Co.’s data was faulty, but Hasbrough’s mistake was a product of his memory failure, not L&L Co.’s flawed data.  A straightforward explanation of what went wrong, accompanied by a sincere and direct “I’m sorry,” is most likely to meet with a good response.  ToyCo, Inc.’s executives may have a few tough things to say at first – if so, Hasbrough’s best strategy will be to listen quietly and avoid getting defensive.

Collaborate with the client.  Once Hasbrough has explained his error and apologized, it’s time for him to offer potential solutions.  If Hasbrough’s apology has been effective, ToyCo, Inc.’s executives may be happy to forgive the mistake and work with him to pick and implement an appropriate solution.  If their first choice is different from Hasbrough’s, so be it – it will usually be easier to get ToyCo, Inc.’s management to buy into the solution if they’ve taken a leading role in choosing it.  They may even suggest alternatives that didn’t occur to Hasbrough.  If Hasbrough and his client can collaborate in crafting a solution, forgiveness and a stronger relationship are more likely to be the result.

Follow through.  Once Hasbrough and ToyCo, Inc. have decided what to do, Hasbrough should quickly and thoroughly do his part to implement their preferred solution.  If Hasbrough gives great service now, it will enhance his client’s confidence in his professional abilities and trust in his integrity.  But if Hasbrough delays or produces slipshod work at this point, he can anticipate that ToyCo, Inc.’s management will not react well.  At best, he’ll probably lose a client; at worst, a lawsuit may ensue.

Clean house.  After resolving matters with ToyCo, Inc., Hasbrough should take a fresh look at his company’s internal procedures.  Implementing a peer review program, redesigning work flows, or even reorganizing his filing system might make it easier for Hasbrough to avoid similar mistakes in the future.  Reporting back to ToyCo, Inc. on the changes he makes may also help Hasbrough demonstrate that he is working hard to improve the quality of the professional services he provides.

Move on.  As Winston Churchill once said, “all men make mistakes, but only wise men learn from their mistakes.”  The same can be said of apologies.  An effective apology will not only strengthen Hasbrough’s relations with his client, it will give him the opportunity to learn better business practices.  Hasbrough may never be glad he made the mistake, but he’ll almost certainly be glad over time that he handled it well.

Lauren Bloom