Conflicts of interest

Richard Adams: I think a natural starting place for this debate is the Financial Services Authority's 'Dear CEO' letter to brokers in November. This highlighted what it regarded as a need for brokers to improve their efforts to manage conflicts of interest. In the research for this programme, brokers put forward questions such as can the panel define what constitutes a conflict of interest? And another question asked how do they arise and what are the most common misconceptions?

Steve White: Let's remember that as a broker you have a fundamental primary and fiduciary duty to your customer. The customer is king, remember. So, a conflict is anything that happens within the business process that conflicts with that obligation. Whether it be around remuneration, whether it be around other business considerations.

Graham Coates: The overriding principle from the FSA is that we should treat our customers fairly. So, potentially, a conflict of interest could be something that detracts from that and whereby you could be deemed to be treating customers unfairly. For example, if you have salesmen and you are paying them on a commission basis or a share of brokerage, how can you be sure that they are acting in the client's best interest rather than their own pocket?

Richard Adams: Brokers also asked how they can recognise potential conflicts in the first instance. Many wanted to know if there was a particular emphasis on remuneration?

Steve White: The 'Dear CEO' letter does highlight the fact that conflicts don't just exist around remuneration, they can exist around the way in which you interact with insurers in other areas. For example, soft loans, insurer provided training and other areas - could these affect whether your customers interests are at the top of the pile?

Stuart Reid: I think remuneration is raised quite a lot because it is key for those brokers - it is, after all, the life blood of any business. John Tiner said in a speech that the commission element is not something that they have the enthusiasm for getting involved in. It is for us as brokers to manage this conflict. Going beyond that, while that is important to brokers, it is the FSA's remit that we manage conflicts ourselves, however difficult. I very much welcome what John Tiner said - to rule thyself and not be ruled by others.

Steve White: I think it is important to remember that conflict of interest is not an issue that has suddenly materialised on 14 January 2005. Most intermediaries can probably take some comfort in the fact that they are almost certainly managing conflicts, probably without realising. In this new regulatory environment, however, if it is not written down it doesn't happen. So it is an evidential problem for a lot of people.

Stuart Reid: I agree. As far as we are concerned, FSA equals write it down. It is important to note that these conflicts are wide in their remit. It is important that this conflict of interest management does not just happen at the sharp end, at the sales end, and at the commission end, as people keep suggesting. It goes through the whole of the business. It is a standing board item agenda for us, as is treating customers fairly. It is top down, it is right throughout the company to ensure that the customer is not in any way put in a detrimental position.

Richard Adams: Is the lack of prescription from the FSA because the conflicts facing different firms are too varied for it to cater for? Or is it the lack of detail part of the principles-based light touch regulation or is it in fact because the FSA does not yet know what operational best practice looks like?

Steve White: It is a combination of the first two. The FSA is very keen to move away where they can from prescriptive rules into principles. For example, if the regulator says go from London to Birmingham, not everyone will go via Milton Keynes and Coventry. You have got the A40 or the M11 and across the A14 and up the M6. So as long as the objective is achieved the questions are all around choosing the route most suitable for your business.

Graham Coates: Another of the issues is that the conflicts themselves can be many and various as Steve suggested, the solutions to each of them may differ according to the way your business is shaped. So I would certainly agree with Steve that it is a mixture of the light touch but also giving the brokers scope and the ability to manage themselves in an adult manner.

Stuart Reid: One way of exampling this is again, in reference to John Tiner's speech. Talking about commission transparency, he said: "this would be a last resort and necessary only because the market and its clients had failed to sort out its own issues, which does not bode well for addressing some of the other challenges you face". It is for us to come up with solutions to the challenges necessarily that the FSA has brought us. As Steve quite rightly said, many are already making sure these conflicts are dealt with but may not even realise they are doing so now.

Richard Adams: I wanted to ask Stuart and Graham, by way of an example, if you could walk us through the considerations you had with a particular potential conflict, explaining how you managed it and documented it to illustrate some of the thought processes involved.

Stuart Reid: To name but one, the profit shares provided by insurers. I know this is a thorny issue sometimes for brokers and insurers alike. As far as we are concerned we have identified that the conflict exists and we manage it. The knowledge of the profit shares that we receive from insurers are not imparted to the sales or any customer facing staff, including the claims staff. No reward to staff is given for achieving profit share. That links in very much to the remuneration of sales staff as well. They simply don't know about it. They do get rewarded for putting business on but we hold back from them the element of profit shares, the commission levels that we run.

As another example we have changed delegated authorities in Stuart Alexander and that was also a thorny issue for us. It is very important at the size we are to maintain the claims delegated authority that sometimes we get from insurers, because we can provide the service that to be fair sometimes insurers cannot do direct. Therefore, we have identified there is a natural conflict there. We felt that the conflict in us settling claims on behalf of insurers was at least equal to the conflict that insurers may have in settling their own claims. We have identified that conflict, the management of the claims department is taken away from those that placed the insurance. The customer is told that we are handling claims on behalf of the insurers and the account handlers that we have at Stuart Alexander handle on behalf of the client. So, there is a complete Chinese wall between those two. The management of the claims department has been taken away from anybody who deals with the placement of business. We have identified where the problems are, we talk at all levels about how we are going to deal with those conflicts and we feel that we deal with and manage them efficiently.

Richard Adams: I imagine smaller brokers listening may well think well Stuart Alexander probably has the luxury of a compliance team to help identify and work out how to manage these problems. How much of this was down to the compliance team?

Graham Coates: Yes, we did have a compliance manager, and we are at a size where we can afford one, although he is definitely not a luxury. However, the compliance manager is really the facilitator. He is the one who looks at the FSA rules and guidelines to start with, gives us his interpretation of them. From that point, it is the responsibility, certainly of the whole board, to have input into issues of conflict of interest and then for the whole board to sit round as a group to debate these issues, decide upon those which are deemed to be conflicts and then demonstrate clearly and in writing how we propose to manage them. And it is not just a question of writing it down and filing it away, as Stuart said, this is a monthly standing item at the limited board. We also have the monthly compliance meeting which is Stuart and myself, our finance director and the compliance manager. So we take it very seriously at senior level.

Steve White: One question submitted talks about the right management culture and how can you demonstrate that. And, as Graham has summed up, the responsibility clearly sits with the management team, you can't delegate the responsibility out. So how do you demonstrate the right management culture? Put it on the board agenda, talk about it, set responsibilities, create ways of spotting where it is or isn't working. You can then demonstrate to the regulator that it is taken seriously at board level, which is what the FSA wants to see.

Stuart Reid: In identifying potential conflicts it wasn't just a question of top down, we asked our staff what do you see as a conflict? How do you see conflicts arise? Because those at the sharp end might see things that the management have not and that is a regular ongoing process.

Richard Adams: I now want to come on to the nitty gritty of what the FSA requires of brokers namely the conflict management policy. I know the British Insurers' Broking Association has produced two or three papers on this.

Steve White: Yes, our recently issued guidance paper talks firms through how they could construct a conflict management policy.

We say that it should contain at least the following elements: a statement of the firm's overall commitment to treating customers fairly in operating within the industry's codes of practice and regulatory principles; a statement of each business activity that could give rise to a potential conflict of interest; a statement of the systems and controls that management have in place to guard against actual conflicts arising and adversely affecting a customer of the firm.

As an example, potential areas of conflict include: profit share agreements; volume overriders; corporate hospitality and gifts; claims handling authorities; binding authorities; training and support; soft loans; commission disclosure; differential commission rates; inter group or associated company dealings; premium finance arrangements; individual personal links with insurers; insurer clubs; office sharing; staff remuneration; and bonus schemes. That is not an exclusive list but it may help the listeners get a flavour of where that might lead.

Other elements are: the statement as to how often the policy will be reviewed and by whom; the statement as to which members of the management team are accountable for conflict identification and management; the statement as to what training on conflict avoidance has been or will be provided to staff; the statement as to the procedures for the staff to report potential conflicts of interest to senior management; and, finally, the statement of the management information that will be collected and the key performance indicators that will be used within the business to monitor and appraise the control systems.

That is a pretty all embracing summary of what a policy might look like. Clearly, as Stuart has said the policy must reflect your own circumstances, rather than just copy and paste a generic document.

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THE PANEL

Richard Adams - Editor, Professional Broking magazine

Stuart Reid - Chief executive officer, Stuart Alexander

Graham Coates - group operations director Stuart Alexander

Steve White - Head of compliance and training, British Insurers' Broking Association.